That large downward corrections (in excess of 50%) in the prices of certain financial assets* will take place in due course is in no doubt. Much has already been written on this subject so I don’t want to waste time on the why or how. Let’s just accept it; it’s most surely going to happen.
[*Most, but by no means all, valuation extremes I’m referring to are concentrated in the U.S. As far as most China stocks, ex the ‘new economy’ cabal, are concerned I have no concerns about a major reckoning. It’d be naive to assume though, in the event of some specific reckonings, there wouldn’t be a period when bathwater and babies, globally, were treated alike.]
For those about to receive the lesson I’ve received five times already in my career I’d only elaborate by saying yes, we don’t know the story-line this time; because, yes indeed it’s different. As it is every time.
However, we may not know the precise narrative at this stage, but we know, with complete and utter certainty, how the chapter ends
Besides, timing is not the point of this note. I’m not trying to be the hero who calls a top. After the adjustments many will be vying for that prize and, if it has a value to them, they’re welcome to it.
Instead, I want to concentrate on how we should be setting up in anticipation of events we know, with 100% certainty, will occur and how we should behave as and when they’re finally upon us?
Let’s begin with preparation. There are four things we can and should be doing today:
- Preparing our defenses. This will be different for each depending on circumstances. For me this involves checking robustness of assumptions on current holdings. Making sure I don’t own anything that doesn’t have real and significant asset backing and, from a personal point of view, making sure there’s a little bit of rainy-day cash handy in the event one or two dividends don’t show up as planned. Above all, making sure I’m happy to own assets that are soon to get a solid punch in the face, and continue to own those assets for a long time after.
- Preparing to be shocked. This is tricky. A ‘shock’ by its very nature is an event that induces panic because its something beyond our ken. These types of events became known after the GFC as ‘Black Swans’; but a black swan isn’t terrifying so it’s a sloppy metaphor. What I’m talking about is, perhaps, the simultaneous assassination of three major world leaders, the collapse of the U.S. dollar or an exchange of nuclear missiles between Pakistan and India. In short am I, today, prepared for absolutely anything?
- Preparing to lose money. A house may be on a solid foundation but if a storm is severe it’ll lose a window, or two. Consider, now, that a position whose valuation goes down will have neither ‘cost’ you money nor will the value of that asset necessarily have been affected. Losing money and suffering the mental anguish of lower valuations are NOT the same thing! [An aside. A mistake at these times is to set stop-losses. These tend to force-liquidate quality assets at depressed prices and rock nerves badly. Buying back is subsequently difficult, and then, you really have lost money. For that reason I’d urge avoidance of the strategy.]
- Preparing for three lean years. Here are S+P returns for 2000, 2001 and 2002, -9%, -12% and -22%. There are three sub-points here: a) don’t jump in to old favorites on the first 10%, 20% or even 30% decline, b) what gets bad can get worse and, in cases where the underlying valuation is suspect, go to zero, c) a stock doesn’t care that you own it. Tremendous businesses and sound assets can stay depressed for very long periods. Mark targets early but nibbling over months will probably be the best strategy for post-fall acquisitions.
And what to do at the time? This is both easier and harder to consider:
Easier because? All one will have to do then is not panic, ignore shouty-talking-heads and, whomsoever God it pleases you to, let them take the wheel.
Harder because? We know how difficult it’ll be to do all that in the event. The prospect of the dentist’s chair a week on Thursday is unlike the appointment when the drilling starts!
The point I want to return to before signing off is the inevitability of what is about to happen. Volcanoes erupt, forest fires break out and overvalued financial assets always face reckonings.
One doesn’t have to like these processes but to go on about one’s business as if what has happened with certain regularity in the past isn’t about to happen again would be just plain foolish.
Nial Gooding
Thursday, February 11th, 2021