Stock Market Down: What To Do Next?

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.

My Suggestion

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.

Comments

  1. Evan says:

    I think it comes down to understanding your personal risk tolerance. Maybe it is 10% cash that makes you sleep at night? Maybe you can sleep with 1% cash?

    The problem usually arises when the investor doesn’t know themselves enough to know what keeps them off the ledge

    • Investor Junkie says:

      This is more about having cash reserves to take action in market opportunities then being able to sleep at night. IMHO bonds should be a good mix of your portfolio.

      The problem you describe is seen often. Too many people state they say want 80% in stocks only to realize when the shit does hit the fan, they were too much into stocks.

  2. 101 Centavos says:

    I’m probably more into cash ( money market funds) than the standard investor. 25% or so in my brokered 401K, 50% in my standard 401K, and 40% in my aftertax broker account.

  3. Van Beek - Trend Investing says:

    Your advice to be prepared before the dramatic events occur and to make your investments more logical and less emotional are spot on. I share also your confidence in good asset allocation.

    As an enthusiastic long-term trend investor, I was only wondering why you do not believe in market timing but recognize that some times are better than others to add money to the stock market. Why do you see a disconnect between the two?

    From the article I understand that you think that stocks are still a little expensive. Does that mean that you think that currently it is not such a good time to add money in the stock market? If that is the case, why not sell and step in again when you think the time is better?

    • Investor Junkie says:

      I believe on strategic asset allocation. I don’t believe in timing the market exactly. No one can predict the short term tends. For now it’s possible stocks will get cheaper, but they may not. It depends upon the mood of Mr. Market. We have seen years when the market has been over or under valued but the market trended in the other direction.

      I believe there are times when the market as the whole or specific stocks are cheap. While determining when something is cheap has some subjectiveness to it there are some good metrics to determine is.

      I as far as selling I believe only selling of index funds are outside of my band or with an individual stock a fundamental change in the company.

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