Investor Considerations On The Recent Market Decline

In recent weeks major stock market indices around the world have declined leaving investors worried and many wondering what to do (buy, sell, or hold).  Panic in the stock markets have been triggered by the ongoing euro zone debt crisis, U.S. debt ceiling issue, a weak U.S. economy, and the recent U.S. ratings downgrade.  I hope to add some perspective for investors to consider, that may help provide some rational and purposeful direction.

 

S&P Ratings Downgrade Of U.S.

On Friday August 5, 2011, ratings agency Standard & Poor’s (S&P) decided to downgrade the sovereign rating for the US from AAA to AA+.  Investors reacted with panic and have continued to exit the market en masse. But the downgrade is really nothing new.  I am actually wondering what took them so long in the first place, as it seemed they were already set on doing so for a long while?  But what impact does the downgrade actually have?  Nothing material has actually changed with the U.S. debt situation or their financial position.

 

Impact On Companies & Consumers?

The actual impact will depend largely on what happens to yields in the bond markets.  If yields increase, then the cost of borrowing increases in general.  However, investor reaction has actually driven up the price of government bonds and therefore lowered the yield.  Borrowing costs will become cheaper, if these yield levels are maintained.  This is not bad news for businesses or consumers looking to borrow at low rates.  Given the weak U.S. economy, it is also unlikely that the U.S. will raise rates any time soon.  Mores stimulus may be on the way, and the government has said it will do whatever it needs to, to ensure credit markets remain liquid (so that borrowing can proceed and the economy can continue to run).

The financial position, profits, etc, of corporations in the U.S. and other nations all remain relatively unchanged so far.  The only longer term concern is that uncertainty may affect consumer confidence and thus their spending behaviour.  If spending is reduced, corporate revenues may experience some decline.  How likely that is to occur and to what degree is anyone’s guess.  However, economic uncertainty is nothing new, and has been with us since 2007.  I expect that consumers will continue to hold off on large purchases (as they have been during these uncertain times), but spending habits will remain relatively unchanged.  If we do see consumer spending decline, it will likely be a moderate decline from today’s levels as people have already been saving more and being more cautious with spending.

 

Considerations For Investors To Buy, Sell, or Hold?

Should an investor buy, sell, or hold their investments?  Investors should first consider what their investment plan was and what they were trying to do with their portfolio.  What was the investment thesis for each investment that was made.  Has the reason for purchasing the investment actually changed or just the price?  Is there any substantial change in competitiveness, long term growth, or financial position.  Most likely the answer will be no.

BUY Considerations:
Prices are off 52 week highs, but on a broad basis they are not anywhere near bargain levels in my opinion.  I only see a few bargains in a very small group of names, but those opportunities existed even before the recent decline.  If you had your eye on a few companies, but was waiting for better pricing, now may be a good time to consider adding them (if they meet your cheapness criteria).  But you may find it still might not be cheap enough at these levels. Keep a look out on potential opportunities as they may arise.  At a time when investors are fearful, it is time to be greedy!  But that does not mean being hasty!

SELL Considerations:
Stocks are not overvalued or even fairly valued. There is no advantage in selling at mediocre or depressed prices, as you are not making the best gains that you will be able to. Assess your investments to see if they are still making profits.  If they are, you might as well allow them to continue.  If you are worried and are thinking of selling, evaluate if the rating change affected the profits of any of the businesses you hold?  Has the market price decline reduced profitability? You’ll likely find that your businesses have not been affected in any significant manner.  In this case is there any benefit in selling?   Now, if the debt levels or competitiveness of the investments you hold have suddenly worsened over the last two days, then it may be worth selling.  I doubt this will be the case.

HOLD Considerations:
If there are no material changes in your investments that warrant selling them, and stocks are not cheap enough to buy, then it makes sense to hold and continue searching for opportunities.  There is no point spending on stocks if they aren’t cheap enough (even if off 52 week highs).  There is no reason to sell profitable businesses if you are not getting full value or more for them.  Why sell a business that is financially healthy and whose outlook remains positive or unchanged?

 

Opportunities?

Each investor is different, and has various investment criteria.  Currently, I don’t see many new bargains that emerged as a result of the recent decline. In general, it looks like stocks (or the ones I’m interested in anyways) have retreated to prices only a few months earlier (beginning of 2011). The only area that interests me at the moment, and where I see deep value are with the junior miners. They have been doing great work, excellent results, but have been ignored by investors.  But its the same story with them – prices are not that much cheaper than they were a few months back.

In general, there does not seem to be any advantage in buying at today’s prices versus buying at prices at the beginning of the year. The discount to intrinsic value on most stocks are still too small for my 50% margin of safety.  I’d like to see deeper discounts before any broad based purchasing.

Many quality names have not seen stock prices move into bargain territory.  If we look only at the P/E ratios of Royal Bank [RY] and TD Bank [TD] for example, they both declined from around 15x only down to about 13x.  Another example, looking at Canadian real estate trusts such as Riocan [REI.UN] and Calloway [CWT.UN], are both still trading above $22, which is a bit higher than where they were at the beginning of the year.  Looking just at the P/FFO metric alone they not at bargain levels.

Uncertainty Brings Opportunity:

That being said, when there is mass uncertainty and a large concentration of fear, opportunities will present themselves to savvy investors.  Although no huge ones have presented themselves yet, investors should remain on the lookout, as things can change quickly and unpredictably!

Keep a short list of names you are interested in, and determine what margin of safety from their intrinsic value you are willing to accept.  When they reach that price,  be ready to purchase them.   Investors should also consider the classic shopper problem, that better prices may follow, but also an equal likelihood that prices will rise (less discount).  Therefore investors should decide ahead of time how to best capitalize or pass on opportunities that arise, while weighing the cost of waiting for or forgoing possible future ones.

 

FULL DISCLOSURE: I am long Riocan and Calloway.  I do not hold Royal Bank or TD.  I do not intend to buy or sell any of the mentioned stocks within the next three days.

Thanks & Happy Investing! — The Investment Blogger © 2011

Author: The Investment Blogger

I’m a private investor, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

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3 Comments

  1. For me, I will wait patiently until the price reach its bottom. And then, buy it after there is a reversal signal from the current down trend.

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      • Risk averse is definitely a safer route. Is passive investing really risk averse, or just aversion to effort in determining exactly what the risks are and their impact to individual investments? Passive investing in index funds and ETFs, which have been very popular, didn’t help investors much in the severe market downturn. They received the full impact of all the risks in the market. Though actively not purchasing when overvalued, and then purchasing quality on the cheap afterwards would have averted risk of investment loss.

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