Fear has taken over the market. Why you should be optimistic.

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*The following information was taken out of the Iron Gate Global client newsletter. Portions have been removed where specific investments were addressed. For more information please contact Brett Pattison, brett@igga.dev

What a fantastic time to be an investor!

The S&P 500 is down over 6.15% in the last year. The global markets are and down 15+% over the past 8 months. The average S&P 500 stock is down -20% from their highs taking many of our favorite investments with it . . . you might think that being optimistic sounds crazy!

Let us tell you why it’s not.

First off you must realize that being optimistic with the market pulling back is hard! Your brain is designed with a survival instinct. You will do whatever you can in the short term to survive. Hunger, thirst, fatigue, cold, hot . . . whatever the situation your brain and your body will fight for life. While this is fantastic for your physical life, it’s horrible for financial survival.

Below is cycle of investor behavior that includes the feelings that investors go through in the short term. From feeling like a genius one minute to thinking the market is not for you, this cycle can wreak havoc for those with the wrong mindset . . . the physical survival mindset.

cycle

(To watch a video explaining this cycle, click here)

Understanding this cycle is important as it can serve as a tool for self-evaluation. You should often ask yourself, “how am I feeling?” or “how are most market participants feeling?” Acting on those feelings can be detrimental and can destroy your wealth. (Investors should do the opposite of  how they feel!)

Take for example 2014. That year the market returned a pretty solid +13.7%. The interesting thing was that the positive return came in just 10 days. If you would have missed the best 10 days that year you would have ended up with a -3.1% return. Most of the “best days” came after a little market volatility. Here’s a snapshot of the some (not all) of the volatile 2014 moves.

returns

 

 

 

 

 

 

 

Now I’m not saying that we will finish 2016 up 13.7% like 2014. I merely am attempting to show you that if you follow the psychological cycle shown and sell at those moments when the market is down 5% or 10% you will miss those days when the market is up 8% and 14%. This concept of buying high and selling low is a recipe for disaster.

Now, the optimism, here are three reasons why we are so optimistic . . . and you should be too!

  1. There is too much fear and pessimism in the market right now. The pessimism we are experiencing right now rivals that of 2008. Think about that for a moment.

We have an economy that . . .

  • Continues to grow (discounting the manufacturing sector which has struggled the service sector continues to show great strength which accounts for approx.. 70% of the economy)
  • Has low inflation and interest rates
  • Has positive yield curves for lending

The pessimism of the market is doesn’t match reality. Reality is much stronger than people realize. Remember what Sir John Templeton and many others have said, “Invest at the point of maximum pessimism.”

  1. There are some fantastic businesses (aka stocks) that have been sold off and are available at discounted prices.

The market has sold off almost everything including some of our favorite businesses. (The average S&P stock is down approx. 25%.) We will continue to look for, and buy, those businesses we love that the market hates in the short term, believing that in 2 – 3 years from now they will be worth much more (buy low sell high).

One of our favorite investors, Howard Marks, said this regarding buying assets at depressed prices:

“When everyone believes something is risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all. Broadly negative opinion can make it the least risky thing since all optimism has been driven out of the price.”

Now if that doesn’t put a smile on your face right now we don’t know what will!

3. Options can be used to make additional income and to hedge a portfolio.

First, income. We have been selling covered calls on as many of the stocks as possible. This has helped us generate additional income (and offset losses) on those stocks that have gone sideways or down. In a way we are creating our own dividend on these stocks and ETFs. This additional income can be used to re-invest in those businesses that we love which will, if the stock does what we believe it will, compound your returns quicker. If done correctly, a little bit of pain can actually turn out to be a great thing for your returns years later.

Now hedging. Some of our favorite options strategies are bearish in nature meaning we make money when the market falls. (For those familiar those strategies include long puts and long put vertical spreads.) In some, not all of the portfolios, we are short areas of the market that we believe are weak. This has allowed us to make money as the market falls which offsets some (certainly not all) of the losses on the rest of the portfolio. The goal is similar to that of covered calls, if we can make some additionally money on the downside, then re-invest that money into some of our favorite businesses, in 3 – 4 years we feel that it will put you that much more ahead.

Summary

In summary, please understand that the market cannot go up every year. There are normal pauses and corrections in the normal bull market. We believe that is what we are experiencing now. The fundamentals are strong relative to the pessimism that we are experiencing. We also believe that with a little bit of patience and the right mentality, this pause and correction can be taken advantage of to help boost portfolio returns 2, 3, 4 years from now.

We will not and cannot let a 3, 6, or even 12 month down market derail the long term plans of our clients.

 

 

 

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Categories: Strategy.