As is often the case after an extreme stock market selloff, some investors are prone to second-guess themselves. “Why didn’t I sell before the market dropped?” is a common question after a market downturn. Many of the usual responses are really meant to provide perspective on the current crisis: Recalling that an individual’s personal financial plan accounts for a certain level of portfolio volatility, reviewing how long-term stock market returns historically outperform cash and bonds, and avoiding emotional decision-making in favor of a more rational long-term approach. While all fair, these points often leave investors feeling unsatisfied in part because the question wasn’t truly answered.
So why didn’t more people sell before the market fell? To start, it is important to recognize that before selling stocks, an investor also needs to consider the conditions under which he or she would want to buy back into the market. So, the decision to sell really involves two decisions: one to sell, and another to buy again in the future. A thoughtful investor would not just sell but would also have a pre-determined catalyst (or catalysts) for when to repurchase the equity positions.
The decision-making models for doing this are difficult to implement. Technical factors are often part of the process but, on their own, they often lead to false positives. That is, investors sell only to rebuy the market at a higher level once the ‘sell signal’ changes to a ‘buy signal’. This is called getting “whipsawed” and it is obviously a risk whenever selling the market. Adding macroeconomic factors and investor sentiment indicators can improve results but whipsawing is still a common outcome. Keep in mind that many of these signals and systems are generally most useful under normal business conditions as they rely upon the mechanics of a standard business cycle. Truly, tactical market selling is very challenging to do even under ideal conditions.
Now, let’s consider the current set of circumstances. Rather than movement based on the usual economic and corporate metrics, recent stock market action has been essentially tied to tariff policy and its likely impacts. In this environment, technical or fundamental indicators aren’t especially helpful in terms of understanding where the market is headed in the short or intermediate term. If we needed any proof of this, just a few days back (April 9th), the market gained 10% when retaliatory tariffs on all countries save China were delayed for 90 days. This is just one in a series of market movements that show that tariff policy, rather than traditional gauges, are driving the stock market at the current time.
So, as a thoughtful investor, if I sold stock, what would be the catalyst for buying back into the market? Rather than relying upon actual data, I would need to make a bunch of ill-informed guesses about the direction of tariff policy: What is President’s Trump’s endgame? Will tariff deals with the U.S.’s trading partners be forthcoming? Will these deals be agreed upon quickly, before there is more substantial economic damage and further impact on market sentiment? What is the likelihood of permanent large-scale tariffs between the U.S. and China? What is the potential timing and outlook for de-escalation between the U.S. and China? To what extent will the U.S.’s trading partners take actions to insulate themselves from future exposure to U.S. tariffs? Guessing the answers to these questions is speculation – it is not the basis for a buy-sell decision-making paradigm.
What’s that you ask? You saw that a bank or investment house said there is an elevated risk of recession now? Doesn’t that count as (or at least rely upon) economic evidence? Well, not really. These investment gurus are just pointing out the obvious – that the odds of ‘good’ versus ‘bad’ outcomes are shifting towards the negative. The market has already incorporated this shift in odds, which is why it is well off its highs from earlier this year. This economic outlook is more of a current barometer of market pricing rather than a meaningful forecast. They might as well have said that there is a 50% chance that the market will go up and a 50% chance that the market will go down. Not too valuable generally, and definitely not helpful in determining when to sell the market and when to buy back in.
Ultimately, tactical selling and repurchase decision-making is difficult even under optimal conditions, and the current environment is far from optimal. Rather than trying to make decisions based upon guesswork, we recommend strategies that rely upon historical data, statistics, and an understanding of risk premia: Constructing portfolios that are truly diversified, using private and liquid alternative categories, including hedged equities or defensive equities in the asset allocation, and employing managers with flexible mandates. These approaches are based on more concrete foundations and may be more worthwhile for investors than guessing when to sell and when to buy back into the stock market.
The views stated in this letter are not necessarily the opinion of Cetera Advisors LLC. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.