A note from Sterneck Capital Management’s Investment Committee:
First, we feel it is important to frame the recent pullback by placing it in the context of the total market move during this current six-year bull run. From the 2009 low to recent highs, the broad market has moved up 217%. The recent pullback was 15%.
Under the surface, a large number of stocks have been in steep declines for the last few months. The indexes have been held up by a small number of large cap stocks that have a disproportionate impact on the indexes’ price. With these large cap names now ceding ground, it is placing further pressure on the broad sector of already weak names, it is in these stocks where the potential opportunity lies. These are names that are now down 30/40/or 50% or more from their 52 week highs. However, there is no reason to be a hero in these stocks and catch every last penny of an up move. This is a message we have been communicating in recent presentations: knife catching is for circus performers, not investors. Even at current prices, few stocks are extremely cheap. Despite the pull-back, most are up considerably over a 3 and 5yr period. However, if and when markets stabilize and earnings visibility or sentiment improve, then we can initiate and accumulate new positions. We are less concerned about missing the first 5 or 10% of an individual stock move, if it is set to appreciate 30 or 40%. Conversely, we care deeply about avoiding 20 or 30% draw-downs, since we know that it takes a 40% upside return to make up for a 30% downside move.
The current price action in oil is an excellent example of why one should not simply buy something because it is down a perceived large percentage from its highs. In July of last year oil was at $107. Should it have been bought when it fell 20% to $80, particularly since it is known the demand for oil is high, and resources finite? A 20% drop must be a buying opportunity, yes? Or perhaps one should have bought it at $50, down over 50% –what an opportunity! Well, the good news is if we didn’t buy it at either of those spots, we can buy it today for $38 p/barrel, down 66% from its highs! Even the lucky few who bought their oil on the March low of $42 (who were likely bragging about their 50% returns when oil was at $60 in July) are now underwater!
Using a previous price as a reference point for where to buy something is a perfect example of the common psychological fault of “anchoring” that we often discuss.
So what is the message? The message is patience. Returns are not made in a day; but significant losses can impact portfolios for a long period of time. Oil would have to double from here to get investors back to even on the oil they bought down 25% from its high. The old adage of “be very aware of the downside, and the upside will take care of itself” is very relevant in the current environment. This said, the wider market move has potentially set up some excellent opportunities, but we prefer to be patient stalkers of those opportunities rather than foolhardy knife catchers.