The pangs of stock picking in a declining market

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I SUSPECT THAT it’s not a common feeling, but part of me is excited about the stock market crash. This is the part of me with a personal account wallet. I have long term financial goals. I want to own equity risk, even if others shy away from it. If I can buy cash flow at lower prices, I’m happy. But another part of me, the professional who invests in others, is anxious. I’m trying to merge these two selves. It is not easy.

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In my lifetime, there have been three bear markets in which the overall value of stocks has halved. Maybe this episode will be as bad or worse. I do not know. I can say this, however. For a long-term investor who doesn’t have to worry about the perfect timing, there should be opportunities to buy good stocks at attractive prices. As a private investor, I can wait for the risky bets to pay off eventually. My clients may not be that patient.

No one knows how this pandemic will play out. A lot of people claim to know, of course. A few of them will be right, by chance or by judgment. It is also the business of scientists and economists. The biggest idea I got from economics is that asset prices are set at the margin. The on-screen share price is where the most desperate seller and the bravest buyer are willing to do business. When the ranks of the first group overtake the second, the result is a rout or capitulation, in terms of the market.

Every recession is unique. This has the impact of a natural disaster or a nuclear accident. But every recession is also the same. You can never be sure how deep, how long, and what scars it will leave. China has just experienced its deepest recession in a century. This is scary. But 2008 was scary. The dotcom bust was scary. I was a baby in 1974, but my old boss told me it was scary. That’s right, that’s another kind of scary. I call my parents every day to see how they are doing. I didn’t do this in 2008. (I also didn’t trade stocks in my pajamas on a weekday.) It could be a wild recession. But it will be like other recessions in that there will be a recovery.

In the meantime, stock prices may continue to decline. I understand why people sell. Many are forced to do so. They may have borrowed to buy stocks and called on their loans through nervous lenders. Fund managers who have promised low volatility should reduce their equity risk. But surrender is more than that. It is the dumping of stocks which have already fallen considerably. Individual investors are subject to it. But why would a professional do it? Well, sometimes you sell your hiccups so you don’t have to tell the business risk manager or your clients anymore. Owning a stock that is going to zero is too horrible to consider. So you sell. And sometimes you sell things that as a private investor you would keep or duplicate. Customers want you to take risks. But they don’t like what risk-taking looks like when it doesn’t work. Try to explain, after the fact, why you bought a stock two weeks before the company went bankrupt, because you estimated that if it survived or was saved you would make ten times your money.

I’m lucky. I was in the top quartile of title pickers. So I gained the confidence to make risky bets in a declining market. A good portfolio during a recession is not necessarily a good portfolio for economic recovery. I know that at some point I’m going to have to change course. I would have to be a genius to perfectly time this change. And I am not a genius. The best I can hope for is not to be too wrong.

My instinct is to go against the grain, to buy what other people hate now. Some industries, like petroleum, are outside my comfort zone. The policy of OPEC are too messy for me to understand. But I have an eye on mining companies with attractive dividend yields and low leverage. If the Chinese economy rebounds, they will benefit. And, yes, I absolutely watch the airlines. One or two national champions are doomed to be saved. In the right situation, I could make a lot of money for clients. A dislocation on this scale will eliminate the weakest players in each industry. The best companies will come out even stronger. I hope I picked the right ones.

There will come a time when the market will look at the bigger picture: bad companies eliminated; even lower interest rates; fiscal policy in preparation; cheaper stocks and changes direction. I have to be ready for this. The S&P 500 is US equity capital. He will survive (or almost). People will want to fly, stay in hotels, and go back to restaurants and cafes. I must always keep this in mind. I feel bad. But this is the game I chose to be in.

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This article appeared in the Finance & Economics section of the print edition under the title “Capitulation”


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