After more than a year of steady gains, stock markets became suddenly volatile and tumbled sharply (relative to market action over the past year, not the panic in late 2008 and early 2009) today. It is foolhardy to assert that this is the start of the new bear market that so many seem to be expecting or that stocks will continue to trend higher. Since there will be no shortage of pundits confidently stating one case or the opposite, investors might wonder what exactly they are supposed to do. Here are some suggestions:

Remember risk: While stocks can go up like a rocket, they can just as easily head in the other direction. If they do, do you have the resources to ride out a decline? If not, you may have too much allocated to stocks. Even if you have the ability to bear risk, do you have the stomach? If you experienced sleepless nights and temptation to abandon stocks altogether in the bear market of 2008-09, you may again have too much exposure to stocks.

Raise some cash: In the latest Berkshire Hathaway annual report, Warren Buffett encouraged investors to reach for a bucket instead of a thimble when it is raining gold. While I found myself investing regularly at the early stages of the 2008-09 bear market, I ran out of buckets when it really started to rain gold. So, one of my lessons from the Great Crash was to keep plenty of cash around to take full advantage of rare market opportunities.

Rebalance, if necessary: While Canadian stocks have rallied strongly over the past year, other asset classes may not have kept pace. Gains in US stocks were negated by the rise in the dollar and European stocks suffered a double whammy of Canadian dollar appreciation and a falling Euro. Increasing bond yields meant bond prices have moved in the other direction. Given all this, your portfolio allocations might have deviated from your targets and it may be time to rebalance.

Stay the course: Assuming you have assembled a portfolio that is appropriate for your circumstances and temperament, the best course of action might be to do nothing. It is tempting to constantly tweak the portfolio in the face of every little move in the markets but that is likely to be counterproductive for retail investors.

Of course, all this is easier said than done and none of this is really new but nevertheless, there is some value in reiterating the basics every now and then.

This article has 25 comments

  1. My RRSP is over 10% cash – not because of some strategic plan but because I have been completely ignoring it. 🙂

    If the market falls far enough then I will be motivated to go in and buy something.

    I suspect the Greek drop is temporary however.

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  3. I think we should all support the Greeks too. If you like to travel, go to Greece. If not, at least help them (in principle) by buying a Greek pizza. Delicious: feta cheese, onions, olives, etc. I recall someone suggesting that Germans should visit Greece to help support them, since Germany is a very strong exporter, and they should help out by importing from Greece. One way to import is to travel there and spend money.

    Your “stay the course” point is very important. My father-in-law is retired upper management, and he always stressed that doing nothing was an option. Sometimes it’s a good option, and sometimes it’s a terrible option that stresses the fact that something must be done. Generally, in my experience, doing nothing, or acting slowly is a decent option when investing. Transaction costs and capital gains taxes diminish returns, sometimes substantially.

  4. You state:

    “Since there will be no shortage of pundits confidently stating one case or the opposite, investors might wonder what exactly they are supposed to do.”

    And then you tell them what to do.

    What makes you any more qualified than the pundits you refer to?

  5. Remember also to lock profits when uncertainty appears, especially if you are holding equities on margin. If a correction does hit, it’s better not to worry about owing money, on the contrary at least you can have the opportunity to buy in if you spot a deal.

  6. @ Jim- What was said was “here are some suggestions”. The suggestions are simply “reiterating the basics” which are the essence of this blog. What the Canadian Capitalist has taught me is the “real life” methods of deploying common sense investing strategies I have read in many investing books but needed a little hand holding when it came time to execute. The suggestions are sound and welcome to any that wish to adhere to them, you are welcome to take them or leave them.

  7. Canadian Capitalist

    @Jim: I have no opinion on whether we are looking at the start of a bear market or the bull market continuing. And I’m definitely not saying that investors should sell (bear market) or buy the dip (bull market). The points in this post are something that bull or bear investors should be doing anyway.

  8. It is at times like these that one might ask what is the difference between Iceland’s experience and what we’re now likely about to see with Greece? Why would we expect any difference in market reactions? Iceland’s economic collapse, recognizing that it was inside the confines of a greater worldwide malaise, appears to be more of a statistical anomaly than being the catalyst for triggering a massive selloff.

    I am pessimistic about Greece’s chances of pulling out of their economic tailspin as they seem to have a long history of a massive bloated civil service and structural deficits. I fully expect that they will eventually get kicked out of the EU monetary union and they will have to bring back the drachma and inflate their way out of their predicament.

    In the vein, we’ve seen collapses in much larger economies of countries like Argentina and Brazil and the Asian Tigers without causing much long term damage to the global economies.

    I am sure Economists and MBA schools everywhere are watching events unfold as intently as I have been as they would be wonderful case studies for future generations to learn how NOT to manage their economy.

  9. Canadian Capitalist

    @Mike: My guess is that this bull has legs but it’s just that — a guess. Personally, I’m going for a balance. I’m investing regularly but also building up a cash cushion at the same time.

    @Gene: Staying the course is incredibly hard to do. My guess is investors are still gun shy of stocks having just experienced a punishing bear market. Many opted not to stay the course but to adopt a wait-and-watch approach and missed out on a big honking rally (at least so far).

    @Mitch: Book some profits is another way of saying rebalance. Personally, I’m rebalancing with new money but those with larger portfolios might have to sell stocks to buy bonds. Of course, they could reinvest their dividends / interest in the asset class that is falling short.

    @John: Thanks for your supportive comments. Sometimes I write a post thinking out aloud for myself more than anything. This is one of those posts.

    @Phil: I guess one reason for caution (the bear argument) is that the Greek contagion could spread to other countries such as Portugal, Spain, Italy and Ireland. And Germans could tire of bailing out spendthrift Greeks, Portuguese and Spaniards resulting in further instability.

    I find it ironic that the choice refuge of panicked investors in the US dollar and US treasuries, the same instruments that investors like to say “is going down” at all other times.

  10. I appreciate a reminder about common sense, thanks for re-iterating the obvous; it’s easy to get distracted by the news….

  11. Hi CC.

    The thing that I see about the bearish sentiment towards the USA, as one of the talking heads on BNN likes to say – you can never count out the Americans. No matter how bad things get, they always seem to find a way to recover. The argument goes where it derives from the fact that they DON’T have a lavish state sponsored safety net that makes Americans so hard working and driven to fix their own problems.

    Personally, I agree with that assessment purely from anecdotal evidence. It was early in my career when I was living in Rochester, New York when the city’s biggest employer, Eastman Kodak, laid off 80,000 employees worldwide, I think about half was in the Rochester area alone. The local economy did take a short term hit, no doubt about it, but many new companies and small businesses almost immediately started sprouting up throughout the city and the local economy diversified. For someone like me, that was absolutely amazing to see – in my personal experience, Canadians as a whole are not nearly as enterprising as Americans on the whole. It was then that I learned never to count out Americans! You can easily find yourself on the wrong side of that trade.

  12. Phil S,

    Your anecdote and analysis are enlightening. Thanks for sharing them. It does seem there is something almost magical about the US culture and economy that fosters Americans attitude and business acumen. I suppose part of it is also the fair legal system and strong property rights. Low taxation is probably also part of it. Very interesting indeed.

  13. Let’s remember that Greece only makes up 2% of the EU’s economic picture… California is more of a concern. Emotion is driving this reaction!

  14. CC – Big fan of the site so don’t take this comment like Jim’s lashing…. but you espouse passive investing and indexing… yet when you say

    “So, one of my lessons from the Great Crash was to keep plenty of cash around to take full advantage of rare market opportunities.”

    I find that contridictory as this statement is pure active management – the stuff that is not supposed to work, and correctly reflects all information in the market. Your pre-set fixed rebalancing with new money would take advantage of this automatically.

    So, other than your fixed rebalancing, can you comment on this and whether it contradicts your philosophy?

  15. Something has changed at CC….it just seems as some sort of sell out is going on…hay you got to eat,but i’m not so sure it’s for the best in the long run.

  16. Canadian Capitalist

    @Phil: Jon Chevreau pointed out to an interesting talk by Odlum Brown’s Murray Leith. In it Mr. Leith points out an interesting fact: a company like TD Bank gets more revenues from the US market than does a company like Coke. So many American companies are global companies that derive a lot, if not most, of their sales from overseas markets.

    Achieving Peace of Mind in an Uncertain World

    @Rob: First, I should clarify what I meant by “raising cash”. I definitely don’t mean selling stocks and going to cash in anticipation of a market downturn.

    When the 2008-09 bear market began, I kept investing new money, reinvesting dividends and rebalanced once by selling bonds and buying stocks. However, in early 2009, cash simply dried up but with a shaky economy came threats of layoffs. So, new savings that would otherwise be invested (recall that earnings yield was better than 10% on the S&P and TSX in Feb and March) went to build a bigger savings cushion resulting in a missed opportunity. I figure I’d like to have the opposite problem. Cash is king when things are bad and cash is trash when things are good, so a balance should be maintained here. I found that when things were bad I felt I had too little cash and other investors might face the same problem.

    I have in the past kept new money that should go into an asset class in cash because the valuations did not make much sense (REITs and emerging markets in 2007 come to mind). Is this timing? Perhaps it is but sometimes, valuations make no sense. REITs trading at historically low spreads over 10-year bonds did not make much sense to me. That’s not the case now because I think stock earning yields are at a premium to bond yields and stocks are not obviously overvalued.

    I’ve written about this in the past:

    FWIW, I don’t think stocks are obviously overvalued now (earnings yield better than 6% compared to 4% for bonds).

    @dj: I don’t know why you’d feel that some sort of sell out is going on. Is it the comment about “raising cash”?

    • Canadian Capitalist

      One other point I wanted to make was that I was tempted to lower the bond allocation because stocks started were obviously cheap. I did not actually do it (regretfully) but even though in hindsight it would have been the right move, the reasons would be wrong. For all you know, stocks could have gotten even cheaper from their March 2009 levels. I even wrote about it here:

  17. CC – thanks for clarifying – not sure I have changed my mind about my comment, but I’ll ponder that, Appreciate the comments. There are a tonne of blogs, but not many blogs of this high quality.

    FWIW – I am going to bet that dj either backs off his ‘sell out’ comment if he answers your question about what he means… or he simply and cowardly leaves his comment unsubstantiated.

    One of the reasons I am such a fan of the site is that I think CC’s ethics are very high, and he simply would not sacrifice his ethics and reputation for a few extra bucks. DJ’s ‘sell out’ comment is pure garbage, as I don’t think CC could act more above board.

    DJ – maybe you can’t operate ethicly when money is involved (maybe you can – I don’t know you). But some people have the ability to earn money and maintain their ethics. CC is one of those rare individuals in this industry.

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  19. You either believe, as Buffett does, to stay the course (believe in capitalism). Which can be hard considering the U.S. National Debt is approaching 13 trillion; is sure to be 20 or 30 trillion in my life time. Then you have to consider the oil depletion issues we face (which effects everything from tires, plastics, to fertilizer, etc.)

    That’s why part of my deep value / growth strategy (something like Lynch) includes my fingers being crossed and a lucky rabbits foot.

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  22. Title deceived me. I thought it would be an opinion piece on Greece. Anyway, you don’t need to worry about Greece. They’re getting their $145billion bailout as expected. All failing countries/states will be bailed out and the US will be the last to fall. The Euro currencies have recently been on the decline and so have their stock markets… possible sign of things to come. Even Buffett is bearish on currencies holding value.

    Even if you’re a total couch potato investor, I’d advise investing at least a portion into whatever you think will benefit from all currencies devaluing.

  23. Gee Rob,no need for the name calling, CC ,i’m just finding i need to read between lines a bit more, would like to here what you have to say about Long,Mid,and Short term Bonds . Keep up the good work you do!

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