This article was first published in the National Post on March 13, 2021. It is being republished with permission.
by Tom Bradley
The stock market is getting wilder by the day. This week it was flipping back and forth between the “opening up” and “lockdown” stocks. Technology was getting crushed one minute and soaring the next. Meanwhile, boring stuff like revenues, profits and balance sheets was getting lost amongst the stories and trends.
I find this kind of action frustrating (and have been known to scream at the screen occasionally), but I’m not ready to throw in the towel. Quite the opposite. As active managers, volatility and inefficient markets are our lifeblood. We spend our whole lives looking for mispriced securities.
In that vein, I asked my partner, Salman Ahmed, how we can take advantage of the mayhem. He offered me three words — ‘patience’, ‘preparation’ and ‘plan’. His cryptic answer means certain things to me. I’ll translate what it means to you.
What have you done for me lately?
There’s no doubt, investors are less patient today. I hear people complaining because a stock hasn’t done anything in two months. It’s “dead money” if it’s not up 30%.
The problem with making decisions based on short-term moves is that they don’t work. No one knows what a stock is going to do in the next week or month. What investors fancy now may be passé next month. Conversely, something that’s not working for you may, out of nowhere, go mainstream.
But the bigger question is, do you care? If you own companies that are growing their earnings and dividends year after year, and are trading at valuations that make sense, why does it matter if they’re in vogue or not. When the stock of a good company is flat or down for an extended period, it’s like a spring that’s being gradually compressed. It will eventually pop. In the meantime, you get a chance to buy it fully loaded.
Doing the work
Preparation refers to something we keep hearing from investment managers. They tell us that the structure of the market has changed due to algorithmic trading, increased use of leverage, and more capital in the hands of hair trigger traders. Price changes are swift, violent and can reverse in a heartbeat. As a result, opportunities are fleeting and can easily be missed.
The antidote for speed is preparation. Two good things happen when you do the work ahead of time. First, you can act quickly when opportunities arise. And second, you won’t get spooked when a stock is down 10% because it doesn’t fit with the theme of the day, or earnings were a penny or two below expectations. Having a good sense of what a stock is worth enables you to snap it up when it goes on sale, however briefly.
If you hold individual securities, preparation means having a wish list with three columns: stocks you want to own; existing holdings you want to add to; and those you’ll sell on market “melt ups.”
Tilray or bust
If you want to trade Tilray, dabble in SPACs, buy Nasdaq options, or open a Bitcoin account, you don’t have to abandon your investment plan. You can, and should, do it in the context of the plan.
What matters is that you categorize the investment, so you know where it fits into your portfolio. If you’re buying a stock because you think it is going to double by summer, know that it could halve in a fraction of the time. Put your cannabis and option trades in a bucket labeled “high risk,” money you can afford to lose without spoiling your retirement.
If you’re not sure how to classify something, use my simple rule: if it promises an equity-like return, it has equity-like risk.
You also need to size your purchases appropriately. Your SPAC and Nasdaq bets shouldn’t be so big that they overwhelm everything else you’re doing. Remember, diversification is the only free lunch in investing. Owning a variety of companies in different industries, geographies and currencies reduces volatility and eliminates the risk of permanent capital loss. You never want to compromise on diversification, regardless of how convinced you are that Bitcoin is going to the moon.
As you navigate these turbulent markets, keep Salman’s words in mind. Give your strategy time to play out, do the work ahead of time and don’t bet the farm.
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