This year began with the largest percentage point losses on North American markets in history. The volatility has investors running scared, but we see opportunity. For the first time in several years, value is beginning to creep back into our research. The trouble is that investors treat stocks differently than almost any other purchases they make.
Think about it. When a desired TV, boat, or pair of shoes goes on sale, most people get that happy feeling and scramble to make the purchase, congratulating themselves for getting 20% off. When stocks take a 20% haircut, many investors panic and sell or become fearful to buy anything at all. When you own good stocks, this strategy is dead wrong. Remember, savvy investors become greedy when others are fearful.
In KeyStone’s Fall 2015 quarterly update and as the markets corrected, we reiterated a stance we have taken for well over a year now: there was no hurry to jump into the market. Broader valuations have been high and due for a correction. At the time, KeyStone’s Small-Cap Growth Stock Portfolio was holding an approximate 40% cash position, a level we maintained for much of 2015 and remain at today. In fact, we continue to advocate only select buying given the volatility.
If you are looking to take advantage of the downtrend that started 2016, begin with “half positions” in good companies and keep a higher level of cash on the sidelines than we typically advocate. This has and will continue to set us up very well for some long-term buying opportunities that will inevitably develop. We remain patient in that regard as almost always the market overshoots underlying fundamentals to the up and downside.
Corrections like we are currently witnessing are precisely why we recommend investors build their 10-12 stock small-cap growth and income portfolios slowly over a 12- to 18-month period. This disciplined approach will help prevent you from buying all your key assets at what might be the top in a given year or market cycle. Perhaps most importantly, it will leave you with capital on the sidelines that can be used to buy quality stocks when they inevitably come on sale during a 12-18 month period. This is likely what we are witnessing now.
Mistakes are made when investors feel the absolute need to jump in (almost like they are “missing out”) and buy 10-12 stocks in a month’s time. Sure, it would be great if you hit a one- or two-year market low but the likelihood of that occurring is remote. While today’s correction appears like an opportunity, “the bottom” may or may not have been reached.
Corrections or bear markets do not last forever. In fact, the pain can be violent and swift, quickly cutting the fat off the market and leaving in its wake a period of consolidation. That’s when most investors are fearful but great investors should become greedy. However, greed does not mean you should buy indiscriminately. Here are a couple of strategies to employ when buying in down markets.
Layer into positions.
When deciding to buy a stock, particularly one you are purchasing for its solid long-term fundamentals, you do not have to fill your full position in a single trade. You have the option of breaking up the trade into two or more pieces. Picking a bottom is often a fool’s game. If you are comfortable with the long-term outlook and the stock is trading at reasonable to cheap valuations, beginning with a partial position in a volatile market can be prudent. For example, say you want to buy $10,000 worth of XYZ company. Start with a $5,000 position and add to it in a month or so. You may be paying more or less, but you have may have allowed the volatility to settle and stability to return.
Create a watch list.
KeyStone has a list of great companies, with solid growth and strong balance sheets that we constantly monitor for attractive entry points. I suggest any good investor should do the same. For the better part of 2015, most companies on our monitor list appeared expensive, but with the market correcting we are starting to see value. Some of these stocks we will buy today, some in the future, and some will never hit an appropriate entry point. We are disciplined and patient with these stocks and choose to buy quality at reasonable to great prices, rather than quantity.