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By Jani Ziedins | End of Day Analysis
Free After-Hours Update:
Thursday was another brutal session for the S&P 500, and we now find ourselves 16% under the October highs. The latest fears stem from Trump’s threats to shut down the government if Congress doesn’t fund his wall. These headlines pile on the already fragile sentiment brought on by Trump’s trade war and the Fed’s latest round of rate hikes.
October’s stock crash was initially triggered by a spike 10-year Treasury rates. The ironic thing is interest rates have done nothing but tumble since then. But despite the reprieve in rates, the market has not been able to find its footing given the relentless barrage of bad news. In addition to the problems I already mentioned, Trump’s trade war is slowing global growth, and the US had a high profile Chinese executive arrested. Mix in fears the US economy is overheating, contracting, or somehow doing both at the same time and it becomes the perfect cocktail for impulsive herd selling.
I will be the first to admit I never expected the dip to get this carried away. But this isn’t a surprise. The market has a nasty habit of pushing things so much further than what is reasonable. And clearly that is the case here.
But just because I’m bullish doesn’t prevent me from profiting from this dip. While the initial selloff caught me off guard, the subsequent volatility created a rich hunting ground. I told readers in October that too much damage was done to sentiment in the first round of the selloff and we should not expect a quick return to the highs. That told us to greet every rebound with suspicion and be taking profits, not chasing prices higher. And the same applied to each dip, rather than sell the fear, I was buying it. Buy the dip. Sell the rip. Repeat.
I was, and continue to be bullish, so that made me reluctant to short the bounces, but even just buying the dips has been quite profitable and the extreme volatility allowed me to do in hours what it took weeks to achieve in a slower market. But even though I was bullish, I still had key levels I was watching. Last week after the market closed at 2,650, I wrote the post, “What this market needs to do to keep my faith“:
“the last three day’s has seen early gains fizzle and we closed well under the intraday highs. Multiple weak closes is never an encouraging sign. And as usual, the market is giving us conflicting signals. It is up to us to determine what it means.
I really like how decisively the market held support this week. But I’m disappointed we couldn’t add to those gains and these weak closes are a concern. What does this mean for what comes next? Unfortunately, this is one of those situations where we don’t have enough information and we need to see what the market does next.
A decisive rally Friday tells us all is well and we are on our way back up to 2,800. But a fourth weak close means a near-term test of 2,600 is ahead.”
The next day the market gave up early gains and finished flat. That warned us something was wrong and we should avoid the market. A day later, prices stumbled to 2,600 support and it’s been downhill ever since.
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But that was then and this is now. What readers really want to know is what comes next.
While I like these discounts, the looming holidays complicate the situation. What would normally be an attractive buying opportunity might struggle to get off the ground since big money already left for Aspen. Their absence puts impulsive retail investors in charge and that is rarely a good thing. Luckily, these little guys have small accounts and their emotional buying and selling cannot take us very far.
We saw similar emotional selling knock 100 points off the market during the Thanksgiving week. But a few days after the holiday, the market rallied 170-points when big money returned to work and started snapping up the discounts. No doubt we could see the same thing this time around. Unfortunately, January’s reprieve is still a ways off and until then we are subject to the whims of impulsive retail traders. But as I said, the saving graces is retail traders don’t have a lot of money and it won’t take them long to run out of things to sell. Once they’re out, the selling pressure evaporates and prices stabilize.
Or we could run around like chickens with our head cut off. You decide.
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By Jani Ziedins | Free CMU
Cracked.Market University
If I asked a crowd what was the absolute worst time to start investing over the last few decades, no doubt the most common answer would be at the top of the dot-com bubble. Everyone knows the story. The tech-heavy NASDAQ peaked in March 2000 above 5,000, and it took another 14 agonizing years before the NASDAQ returned to those highs. In the meantime, the Nasdaq plunged more than 70% from those heady highs.
So exactly how bad would it be to start investing at the peak of the dot-com bubble? Let’s find out. For this exercise, we recruited Bad Luck Brian. In 2000, he graduated from college with an engineering degree and landed his first real job in March 2000. Following the advice of everyone around him, he started investing in the tech-heavy Nasdaq. He told human resources to take $500 out each month and put it into a zero-cost Nasdaq index fund.
And true to his name, Bad Luck Brian promptly forgot about his recurring investments in tech stocks. While the smart people were pulling out of their investments during the bloody tech collapse and subsequent recession, Brian continued throwing $500 away every month. He was buying the Nasdaq as it tumbled -10%, -20%, -30%, -40%, -50%, -60% and he even bought when the selling climaxed at -70%. What an idiot, right?
So given how unlucky Brian is, how horribly awful did his investment turn out? The attached chart shows his returns versus the Nasdaq. As expected, the first few years were terrible. Brian lost more than 40% his principle in those early years. But even then something strange was happening. Even though the Nasdaq kept falling, Brian’s losses were consistently smaller than the Nasdaq’s. When the index was 70% under the highs, Brian was only down 40%. While no one wants to be down 40%, that is definitely better than -70%.
And the outperformance didn’t stop there. Believe it or not, Brian’s account actually reached break-even in November of 2003, more than a decade before the Nasdaq could do the same. How could this be?
No doubt many of you already realized why Brian’s account was performing so much better than the Nasdaq. That’s because he kept buying the dip. With every paycheck, he stuck more money into the market. And the further the Nasdaq fell, the more stock Brian was buying.
If we assume one share of the Nasdaq fund cost 1/10th of the index value, with his first $500 in March of 2000, Brian bought approximately 10 shares. But the next March after the index collapses 55%, Brian’s $500 bought more than 20 shares. In fact, the Nasdaq fell so far that at one point Brian’s $500 was buying nearly 40 shares a month!
And lucky for Brian, he kept buying those discounted Nasdaq shares for more than a decade. Accumulating 20 and 30 shares per month started paying off handsomely when the index finally climbed out of its hole. By the time the Nasdaq recovered to the old highs in 2015, Brian had been able to buy so many shares at a discount that his $93,000 of invested principle was worth $204,000! The index was flat, but amazingly Brian was up 120%!
And it didn’t stop there. Brian kept plugging away and just a few years later, Brian’s $500 per month in 2018 is now worth more than $300,000! Not bad for someone who started investing at the worst time imaginable.
What can we learn from Bad Luck Brian’s? Instead of fearing dips, we should embrace them. Rather than pull back on our contributions, we should double them.
Currently, the stock market is down 15% from the highs and people are running around scared. While they are afraid prices could fall even further, I’m over here wishing we could be that lucky. Bring on those cheap stocks!
What’s a good trade worth to you?
How about avoiding a loss?
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Follow Jani on Twitter @crackedmarket
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