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The Stock Market Is Getting More Expensive

One of the most underrated but among the most valuable skills required to succeed in stock market investing is resilience i.e., the ability to properly adapt to stress and adversity – either in the market, or in the businesses one is owning. How easily can you bounce back from a market crash? What would be your reaction to a sharp decline in your stocks’ prices? How many ‘surprises’ can you withstand in quick succession? How safe are your overall finances in light of extreme stress on the equity component of your portfolio? These are extremely important questions you must ask yourself every time you are looking at your portfolio, or looking to spend cash to buy more stocks. Surprisingly, despite its importance, resilience is least talked about by stock market investors and experts alike, and rarely considered an important mental model in investment decision making. Most of the time, we build our lives, our jobs or businesses around today, assuming that tomorrow will be a lot like now. Resilience, which is the ability to shift and respond to change, comes way down the list of the things we often consider. And yet, a crazy world is certain to get crazier. Jobs aren’t steady anymore. The financial market has gotten more volatile. The Earth is warming, ever faster. And the rate and commercial impact of natural disasters around the world is on growing exponentially. Hence the need for resilience, for the ability to survive and thrive in the face of change. Stock Market is Getting More Expensive Certainly I am not talking about stock valuations here. Because, if that were to be the case, the BSE-Sensex’s valuation – if you go by P/E – is now cheaper at 18x trailing 12-months earnings as compared to 23x just six months ago. Noted financial writer George J.W. Goodman – who used the pen name of Adam Smith – wrote this in his wonderful book, The Money Game – If you don’t know who you are, this is an expensive place to find out. By “this”, Smith meant the stock market. The people who bought commodity, infrastructure, or real estate stocks in 2006 and 2007 because they thought they had a high tolerance for risk – and then lost 95% over the next one year (some such stocks are down 95% even after eight years) – know just how expensive the stock market can be. While speculating on such stocks, they seemingly failed to answer the questions around their levels of resilience. And thus many ended up betting their houses and other people’s money on stocks that were destined to go down the drain. Something similar has happened to the guys who were utterly charmed by “moats” and forgot the subtle difference between paying up and overpaying over the last two years. A lot of such moated darlings are down between 30% and 50% over the past six months. Those who would have borrowed money to invest in such stocks are sitting on even bigger losses and much bigger dents to their egos. You see, knowing more about who you are as an investor can make you a fortune – or save you one. Knowing how resilient you and your portfolio are to severe market downturns also solves that purpose. Can You Handle Mr. Market Well? If you have been glued to financial media or online portfolio trackers, fixated on the sight of falling stock prices over the past few days and weeks, then this should tell you something about yourself that has enormous long-term importance – you probably have too much in stocks even as you don’t have the resilience to see your portfolio value declining (and that’s why you are checking stock prices so frequently). If you feel distressed by a decline of a few hundred points on the BSE-Sensex, then you are kidding yourself if you think you can withstand a drop of a few thousand points when it comes. Benjamin Graham, the father of value investing, divided investors into two types in his book The Intelligent Investor – defensive and enterprising. The defensive investor, Graham wrote, wants to avoid “serious mistakes or losses” and seeks “freedom from effort, annoyance and the need for making frequent decisions.” On the other hand, the enterprising investor, as per Graham, is willing “to devote time and care to the selection of securities that are both sound and more attractive than the average.” So, if you are an enterprising investor, then you should observe the stock market carefully in the hope that a substantial fall will present bargains. But if you are a defensive investor, you should observe yourself carefully. If you are not nearing retirement and have many years to invest and thus ability to see through a few big downturns; If you are not investing on borrowed money; If you are investing your own money, not other people’s money; If you do not owe a lot of money by way of loans, and have sufficient disposable income that prevents you from selling your stocks to meet your needs; and If you have seen through past market crises without much psychological upheavals… …you have adequate resilience to manage any major stress that the stock market may present you now. However, if you do not meet any or most of the above criteria, then beware. Reconsider your decision to be in stocks directly. Else, maybe, trim back on your stocks to create the much needed financial cushion so that any big decline does not become an even more expensive way for you to find out who you are. Remember what Keynes said – Markets can remain irrational longer than you can remain solvent.

What I Do When The Market Tumbles

When stocks take a dive, investors call their financial advisors and ask them what they should do. I received a few of those calls this week. Most advisors respond with some version of “Don’t panic.” Here’s what I do when the market crashes: nothing. To be completely honest, I wasn’t aware that the market had fallen 8% so far in January until my wife told me late this week. I don’t watch business news – life is too short. She picked it up on CNN while she was watching election news. (I don’t follow that, either.) Here’s my theory. If you have such a high allocation to equities that market declines make you anxious, you own too much stock. Find the allocation at which severe bear market losses won’t keep you up at night. In the 2007-2009 bear market, the S&P 500 fell over 50%. My portfolio fell just 15% because I had a 40% equity allocation. As one of my favorite baristas, Mandy, would say, “It didn’t feel totally awesome.” On the other hand, I didn’t lose sleep. William Bernstein addressed this in a couple of his early books, including The Four Pillars of Investing (page 268). He suggests that the initial pass at the correct asset allocation for you be based on how much you can tolerate losing in a bear market. He provided the following table: I can tolerate losing this percent in a bear market Invest this much in stocks 35% 80% 30% 70% 25% 60% 20% 50% 15% 40% 10% 30% 5% 20% 0% 10% Every December I evaluate my finances and plan for the coming year. I calculate my desired asset allocation, which might not be the same as last year’s. If my current allocation is within an absolute 5% or so of my desired allocation, I do nothing. Otherwise, I may trade a few funds or ETFs to implement my new allocation. In reality, this rarely happens because my allocation doesn’t often stray very far. Because I am willing to lose 15% in a severe bear market, I don’t labor over my portfolio value daily. I probably check it four times a year, at most. I retired to enjoy the remainder of my life, not to fret over the stock market. Here’s some advice from other advisors I trust. Wade Pfau suggests reading this piece in the New York Times entitled, ” 6 Tips for Investors When the Stock Market Tumbles. ” It’s a good one. Dana Anspach suggests that if you feel that you must do something, instead of selling stocks, enroll in her free online class on retirement – another great idea. Joe Tomlinson and I provided suggestions in Robert Powell’s USA Today column, ” Advice for investors during crazy stock market volatility .” If you’re retired or plan to be soon, set your asset allocation to a level of equities that you can tolerate. By definition, that means you won’t feel the need to do anything at all when stocks tumble. For young people still accumulating savings for retirement, invest most of your portfolio in stocks and don’t you do anything, either. In fact, do less than nothing. Time will fix this for you. As I recall, the 22% loss on a single day on Black Monday in 1987 didn’t feel totally awesome, either, but now it is barely a blip on the history of the S&P 500. So, here’s my advice: pick an allocation you can stomach and ignore the noise. If you owned too much equity this time, gradually adjust it downward. You’ll know you’re at the right allocation when the market takes a dive and you don’t feel a need to call me. Oh, and don’t panic.

Can Grain ETFs Sustain The Recent Rally?

Taking the market by surprise, grain prices and the related investments popped lately. This is perhaps the sole good news in the investing world to start 2016 as the broader market has seen choppy trading so far. And as far as commodities are concerned, nobody knows when and where their prolonged rout will end. Lower estimates for U.S. crops showered these unexpected gains on grains. Lately, USDA reduced its numbers for the 2015 corn and soybean harvests and sharply cut winter wheat planted acreage to 36.61 million acres, which was “the smallest winter crop in six years.” The figure exceeded analysts’ expectation of a decline of 141,000 acres. Per USDA, corn harvest is presently at 13.6 billion bushels, lower than USDA’s December reading of 13.654 billion. The soybean produce was recorded at 3.93 billion while USDA’s latest reading was similar to the 2014 levels. While many agricultural commodities advanced, wheat prices soared the most in two months. As a result, the Teucrium Wheat ETF (NYSEARCA: WEAT ) , the iPath DJ-UBS Grains Total Return Sub-Index ETN (NYSEARCA: JJG ) , the Teucrium Soybean Fund (NYSEARCA: SOYB ) and the Teucrium Corn ETF (NYSEARCA: CORN ) added about 2.1%, 1.8%, 1.4% and 1%, respectively, on January 12 (read: Invest in America with These 4 ETFs ). Can the Positive Momentum Sustain? Per Bloomberg, while U.S. output may moderate, global supplies of wheat remain ample thanks to solid output in Russia, Pakistan and the European Union. On the other hand, the demand scenario is as sluggish as it has been in recent times. Global growth worries mainly in most of the developed economies and in some emerging economies too resulted in softer demand for food. USDA also pointed to this issue with “a small reduction in domestic usage and a cut to exports.” USDA lowered the export numbers for corn and soybean to 1.7 billion bushels from its previous 1.75 billion and to 1.69 billion from 1.715 billion, respectively. Still, there are a few agro-based products which could deliver decent gains to investors despite the broad-based gloom. Below we highlight those products in detail (read: 3 Commodity ETFs Defying Weakness in 2015 ). iPath Dow Jones-UBS Sugar Total Return Sub-Index ETN (NYSEARCA: SGG ) The sugar prices are expected to remain steady though most of the other commodities are finding the going tough. This is because; supply glut is an easing issue in the global market due to adverse weather. SGG tracks the Dow Jones-UBS Sugar Subindex Total Return Index, which provides returns that are in an investment in the futures contracts on the commodity of sugar. The note has garnered nearly $53.2 million in assets. It charges 75 bps in annual fees. The note was up 1.1% in the last five days (as of January 13, 2016). iPath Dow Jones-UBS Cotton Total Return Sub-Index ETN (BAL Notably, cotton price is also showing hopes on higher purchase from the spinners and exporters. Also, in India, a key grower of cotton, the central government’s move to intervene in the pricing of cotton might help in shoring up the commodity. The product has amassed about $17 million in assets and charges 75 bps in fees. BAL gained 1% in the last five days (as of January 13, 2015). iPath Dow Jones-UBS Softs Total Return Sub-Index ETN (NYSEARCA: JJS ) The note looks to provide the returns that are available through an investment in the futures contracts on the softs sector of the commodity world. Components currently include sugar, coffee, and cotton. This $2.6-million ETF charges 75 bps in fees. Though the product lost 2% in the last five days, it added about 1.5% on January 13. Link to the original article on Zacks.com