The stock market blew up today big time. The Dow Jones was down today 634.76 points. It was the sixth biggest loss ever. Last Thursday we had another epic 500+ point loss. In stock market losses like today, I’m always reminded of the useless government propaganda films during the cold war. Specifically the “Duck and Cover” film comes to mind. As a child of the 1970′s we had to do these inane fire drills every few months. Somehow covering your head and ass under a desk would protect yourself from nuclear annihilation. At least with Indiana Jones he stood a better chance in a refrigerator. The stock market losing streak of the past few months is no different, and you need protection.
Just like “Duck and Cover”, there is really no where to hide when the stock market takes a plunge. Unless, of course, you have cash, cash like investments, and defensive investments like gold. The time to prepare for any emergency is BEFORE it occurs, not after. So if you are looking at your accounts today and saying “oh shit”, it’s just a little too late. Hopefully you’ll learn something from today and gain an education in the process.
In looking at my personal retirement accounts today, I was thinking are there any investments we could sell off? Like everyone else, the problem is with most retirement accounts it is mutual fund based which means at least one trading day before the order can be completed. So like today where you execute a sell, you are already down 5.6%. The axiom you make money in stocks is when you buy it, not when you sell them, rings true. So unless you are expecting the market to go lower (who knows what will happen), you might miss out on the next upswing in the process. Though it could be said, owning ETFs instead of mutual funds can be to your advantage should you need to get out quickly.
I’m a big believer of proper asset allocation. This makes investing much less emotional and much more logical. This doesn’t mean, though, you must stick completely ridged to your asset allocation plan. A few months ago I increased our cash position to 12% from our previous 3% allocation. I felt based upon the PE10 metric the stock market was getting just a little too forthy. This doesn’t mean the stock market could have gone higher. It did and lost some gains in the process. What it meant to me was I happy with the gains I got and took some of the profit off the table. I did just exactly that.
I don’t believe in timing the market, but I DO believe there are better times to add money to the stock market. The 10-year price earnings (otherwise known as PE10) recently was as high as 25. By the historical standards of 16 the market was not cheap and was overvalued by approximately 30%.
Keep in mind this isn’t necessarily a direct predictor of the future returns, but in general PE returns to historical averages. Why is this? Markets cannot keep increasing forever. Markets must return to the average. Economies can only grow so fast, and productivity can only increase so much. Just like the law of gravity, this also applies to company growth. So ignore this law at your own peril.
Is the market cheap now? NO, but it is cheaper than before. As of today the PE 10 is at 19.32. This doesn’t mean the stock market MUST go lower. Stocks are also compared to other investments. Are bonds a better deal than stocks? Is gold a better investment than stocks? An investment is always compared to other possible investments.
The stock market could go lower, but it could also go up from here. Right now, with his lame speech today, it’s possible stocks may go down until President Obama is out of office.
The market could also go lower than the historical average. Over its history, the stock market has a few times. It did this during the Great Depression and also when the “Death Of Equities” magazine article was published.
What any value investor should be looking for in stocks, (or an individual stock) is how are they priced. Are they on sale, or are they priced fairly? At the moment stocks are still somewhat expensive.
I’m not suggesting be a market timer and do complex put and call options with your investments. That’s for the advanced trader, and for most people it does not end well. What I am suggesting is you always have a certain amount of cash on hand. Think of it as emergency savings for your investments. You never know when you need it, and you should be ready to pounce at a moment’s notice.
What is the right amount of cash? That depends upon a lot of factors. I will leave that decision to the reader. What I will say is you should always have a decent amount of cash available, at least 3-5% of your total asset allocation.
If you don’t have a decent discount stock broker, now might be time to get one.
Recently, I’ve updated of the stock broker promotions going on. Specifically two of the brokers:
If you don’t have cash on hand with a discount stock broker, I suggest learning from this experience and having one ready for future opportunities. TradeKing appears to be the best of the bunch. They are offering a $100 signup bonus until the end of August.