A Reminder On The Risks
- The returns that we saw in 2020 are completely exceptional, and it is unrealistic to expect these kinds of returns going forward.
- We are going to have big shakeouts in the stocks in the portfolio. This is perfectly normal and even to be expected.
- In fact, volatility is the price that you have to pay if you want to achieve superior returns by investing in high-octane stocks.
- I know for a fact that we are going to have bad months and even bad years in The Portfolio.
- Bad years happen to everyone in the long term, and they are going to happen to us too, those are the rules of the game.
- I cannot tell you what you should do because I don’t know your risk tolerance level, timeframe, and other important factors.
- Even if you tell me, I am not allowed to provide financial advice.
- I am happy to tell you what I think about a stock or the market in general, and I can also tell you what I do with my own money.
- However, you have to make your own decisions based on your own needs and objectives.
- In simple terms, I provide research and ideas, but I never provide financial advice.
It is true that rates have gone vertical in recent days, so we can’t be surprised to see them pulling back somewhat. But fear can be a powerful driver, and lots of traders can start selling bonds or buying interest rates futures to protect themselves from this risk, this means that price movements can be far more abrupt than you would expect.
There is also a particular effect related to the ARK Funds. Cathie has been so successful that now ARK is the biggest shareholder in many disruptive growth stocks. When investors get scared and money leaves the fund, ARK may need to sell stocks that are already declining and have no buyers at sight.
Even worse, traders are like sharks and they smell blood. When they think that ARK is going to be a big seller in a low liquidity name, they may intensify the declines via short-selling, which would create a vicious cycle of more fear, more redemptions, and more declines.
These are all short-term factors unrelated to fundamentals, of course. But they can have a large impact on stock prices in the short term, especially when markets are so volatile and violent.
If we see top-quality growth stocks selling off because of this, it can be a massive opportunity for investors with a long-term horizon. But the hard part is knowing when the bottom will come.
High-quality stocks are changing hands these days, they are going from the weak hands – short-term traders – to the strong hands – long-term investors. This is actually good for us.
But we don’t know how much lower they have to go for the demand from long-term investors to absorb the supply from short-term traders. It is better to be patient and err on the side of caution in these cases.
Just to be clear, bonds are oversold – meaning that rates are too extended to the upside in the short term – and many stock indexes are close to support levels. Some stabilization would make sense, but fear can overwhelm all other drivers in the short term, and we still have to make plans in case we see no stabilization in the short term.
We have to be consistent with risk management principles. We have long been saying that 13K in the Nasdaq is the line in the sand to think about capital preservation. The index is right at that level, and if we break below 13K we need to preserve cash. We can either wait for a recovery above 13K or for more downside to 12K. But the point is being patient with risk management.
There is no need to rush and try to catch the bottom. Keep in mind that valuations are very demanding and sentiment has gotten too optimistic in recent months, so prices can decline more than we would expect.
It is not a good idea to catch a falling knife. Even if you have to pay a few extra dollars, waiting until the price starts to turn around generally produces better results.
In addition to the 13K level on the Nasdaq, we can also watch the $130 level in ARKK as another risk management level. We are exactly at that point right now.
Bonds are obviously a big piece of the puzzle, and a sustained move above 1.45-1.5% in the 10-year yield could mean additional problems for stocks.
For the most part, and especially if we see some follow through to the downside in the days ahead, I think it makes a lot of sense to raise cash levels to 30% or a bit more.
There is always the chance that the market can reverse higher in the short term, but in that case we can rapidly put that money to work back into the market.
There is also the possibility of using hedging vehicles such as the triple inverse QQQ (SQQQ) ETF, the ultrashort bond ETF (TBT), or even taking a short position on an ETF such as ARKK. But these moves are hard to make, and I don’t want to try to be too smart for my own good.
I still think that the odds are good that the market will do well in 1-3 years from now, even if a correction could be likely in the short term.
Hedging is hard because you need to be right about both the entry and the exit. It is one thing to buy inverse ETFs when you have a bearish outlook for the next year, but hedging to avoid a short-term correction can do more harm than good.
For the time being, it probably makes more sense to raise a bit of cash by selling some low conviction positions and then reassessing the positions depending on how market conditions evolve.
That is all for now, stay tuned because it looks like we are entering a phase of increased risk and also increased opportunity in the market.
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.