Share markets have dipped violently in recent weeks as long-term bond yields increased and investors feared inflation would force interest rates up.
First-time stock investors have had a great time since March, so it might have been a bit of shock to them that share prices can actually depreciate.
Even for veterans, it can be hard to think of a firm course of action when markets start crumbling.
Panic can set in, and you can end doing some foolish things.
So it’s a great time to bone up on a definite 5-pronged strategy, as Marcus Today director Marcus Padley set out earlier this year:
Sell down to take a break
Padley told investors in a Marcus Today newsletter in January that he doesn’t mind individual retail investors selling during a market correction.
“There is nothing wrong with selling,” he said.
“It can be cathartic and will leave you going to bed tonight hoping the market falls over. Take a break. It has been a good run.”
Cash is the only true defence for retail investors, according to Padley.
“Buying… defensive stocks, that go down less savagely in a correction, is for fund managers, not individual investors.”
Assume sell-off is temporary
Having said that, Padley would think any sell-off in the coming weeks is “just the herd dropping its pants for a moment”, rather than a structural correction.
“So if you sell, you are being cute,” he said.
“If there was a new element — a war, a virus mutation, a trade dispute, it could well develop. But a shorting fiasco in small US stocks, a couple of lazy results in the US…it’s not enough to start an actionable correction.”
So if you actioned the first step, then it’s more for psychological comfort.
“At the moment the main reason to sell is short term — for peace of mind, to take a break, to take a profit, to re-assess,” said Padley.
“Not because there is an earnings risk event developing.”
Take the profits and run
If you’ve had a nice run with a stock that could be vulnerable to a market correction, then take the profit and walk out the door.
“Check your list. Any fliers on infinite PEs?” said Padley.
“They will be sold down first/hardest if it happens.”
We all know the stocks in our portfolio that now have astronomical price-to-earnings ratios. If not, it’s time to work out which ones they are.
Sell to buy
As a fund manager, Padley’s team would never sell to “take a break”. But they will sell to free up cash to buy bargains.
“Any short term correction will quickly become a buying opportunity in a vaccine rollout world recovering from a pandemic,” he said.
“If you’re fully invested, as we are, you need cash. You need to sell something, to exploit buying opportunities in stocks you like. That’s about the only thing that would drive us to sell. Not fear — but opportunity.”
As previously mentioned, buying defensive shares in times of market distress is a risky move he would not recommend to a retail investor.
Nevertheless, it is something professionals do, and is an option.
“The obvious moves for fund managers that are judged on relative performance is to get more defensive. Defensive sectors will presumably outperform in a falling market,” he said.
Some retail investors who attempt this might go okay, but likely not.
“You may even make some money in a correction — but it’s a low odds game for individuals, trying to make money in a falling market.”
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Returns as of 15th February 2021
Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.