FOMO rears its head
We’ve just had a couple of years of investors and speculators becoming increasingly fearful of missing out on late cycle stock market gains.
But that third or rampant speculation phase of the market cycle has now passed.
Prudent investors prepared for the crash by reducing their market exposure.
But some are now facing a different dilemma, involving the fear of missing out on the arising opportunities.
Firstly, breathe…take a chill pill, and relax.
We aren’t yet half a dozen weeks into this downturn, and we haven’t even had the first unemployment rate reports, let alone the cascade of floundering company earnings releases.
Let’s just recap on a few slides before moving on to the key point of this post.
Firstly, the recent extreme level of daily volatility is not the sign of a healthy market.
In fact, it’s an indicator of precisely the opposite.
The best and worst days in markets tend to cluster into those periods wherein investors experience large drawdowns.
Secondly, we only tend to see these repeated daily moves of more than 5% (in either direction) during times of great market distress or turmoil.
This isn’t a great signal either.
Thirdly, remember that drops are almost invariably followed by pops, even through the worst stock market downturns in living memory.
Intermittent rallies are part and parcel of market crunches.
And fourthly, note that the trend may continue to be your friend, since even the most brutal bear markets will always intermittently feature rallies.
It’s just the nature of the grizzly beast.
Realistically the pain of this recession is only just beginning for many listed companies, and we’re nowhere near the end of the opportunities for prudent investors with cash available to deploy.
The Kelly Criterion
Now, on to the key point.
Let’s tie this back to our overall investment philosophy, particularly with reference to the Kelly Criterion.
One of the reasons the Kelly optimisation model holds that we should never be 100% invested in stocks is simply because there will always be great opportunities to buy low in the future.
The goal of the value investor is to buy a dollar of value for 50 cents (or ‘step over one foot hurdles’ depending upon your preferred analogy).
To protect your capital you must always buy low and sell high, to survive and be around for the all those wonderful opportunities in the future.
We might be able to better understand the fear of missing out if there was only one stock market or basket of securities to choose from in the world.
But today this is not nearly the case.
It’s a big world out there, and by irrationally focusing only on one market (the home bias) then so many wonderful opportunities may pass investors by.
So far, some sectors (e.g. energy) and some commodities (e.g. copper) are beginning to look interesting, but US stocks are still too expensive given the dire outlook, and there will be no shortage of ETFs on sale over the coming year or two.
You can think of your investing as a series of repeated similar bets, patiently picking off the great buying opportunities as they arise.
The simple knowledge that there are many stock markets and sectors around the world, and that they each have their own market cycles, can be your informational edge.
One thing that we do know is that a global recession will throw up countless opportunities to scoop up bargains in a low risk fashion.
The great benefit of the Kelly Criterion is to maximise your long-term wealth and geometric returns, buying more units when stocks are on sale and earnings yields are attractive.
By being patient you get to buy more units, at a better price, with higher yields.
You won’t achieve this by continually reacting to daily market moves and snatching at every 5% dip.
Of course, if global markets panic and fall to extremely low valuations, then it makes sense to ramp up your exposure to equities capitalise on the opportunities, in accordance with Fortune’s Formula.
But at this stage there’s no logical need to rush or fear missing out.