Stock Trading Blog
Stocks haven’t done much so far this year. The S&P 500 is up just 2.8% while the Dow Jones is actually down around 1.4%. Volatility has ranged from extreme lows to extreme highs this year alone but currently stands at a mild 13.37. The stagnation of US markets has led some investors to think outside of the country for profits.
Going international instead of staying domestic could open up new possibilities for investors. There are additional benefits gained by broadening your investment environment, such as diversifying against interest rates and economic events that impact only the US. But it also opens you up to new risks like foreign exchange currency loss. Understanding the risks and benefits of both strategies will help you maximize your profits while keeping risk at a minimum.
There are a lot of benefits to be gained by staying in the US for your investment portfolio. For one, you are far more likely to be familiar with domestic companies and economic policies that allow you to employ strategies like sector rotation in your portfolio.
Diversification can be attained in a domestic portfolio by holding stocks of different sizes in various sectors. Additionally, many US companies derive much of their income from overseas operations, giving investors international exposure without having to invest directly in foreign markets.
It’s also more difficult to invest in foreign companies as opposed to domestic ones. Financial information can be harder to come by, while accounting practice differences can make analysis a challenge.
There are a number of advantages investors gain by broadening their investment portfolio to include international stocks. They reduce the risks of negative economic events that affect only the US and gain the diversification of foreign economies.
Investors can also take advantage of different economic growth rates. The US is a large well-established economy, which makes it stable but also gives it a relatively small GDP growth rate. Foreign economies may have much higher GDP growth rates, giving investors higher returns.
It also adds a new layer of diversity to an investment portfolio. Different interest rates and political environments reduce the risk that a US-only portfolio has. Severe domestic market drops can be counter-balanced with a well-diversified international portfolio.
For investors that choose to stay domestic for their portfolios, it could be helpful to add at least a few international assets to the list for diversification purposes. Noted investor and founder of Vanguard John Bogle is known for his belief that investors don’t need to seek out international holdings for diversification reasons, but the advent of globalization may make this an outdated notion. Investors should carefully weigh out the pros and cons of staying domestic or going international and decide which best suits their investment goals.
Investors don’t have to look very far to find investment advice. From the tip given by a co-worker to the myriad of financial advisors available, there’s plenty of material on the subject out there. But unless you fall into the standard risk tolerant category, you might be missing out on a more efficient investment plan.
Some investors discover that standard portfolio design doesn’t suit them. Moderate returns and a relatively stable account balance can sometimes lead to boredom and apathy. Investors may decide to do something else with their money after a while and give up on the idea of investing altogether. Instead, they need a more aggressive strategy to keep them involved.
If the idea of extreme volatility, swings of 10%, 20%, or more, in your portfolio doesn’t keep you up at night, you might fit the description of someone who should be investing aggressively. The risks might be higher, but so are the potential returns.
Not for the faint of heart
Aggressive investors sometimes have a harder time designing a portfolio than conservative ones. That’s because there are far more resources and articles geared towards balanced or conservative investors. Professional advisors also tend to discourage aggressive strategies in an investment portfolio. While they might design something they consider to be aggressive, it often falls short of what more risk-tolerant investors have in mind.
One of the key aspects of aggressive portfolios is their stock-to-bond mixture. A hard and fast figure for how much stocks and bonds should be weighted in a portfolio is hard to give because an investors time horizon plays a large role in how much risk should be taken. The longer the maturation date of the portfolio, the more risk can be taken.
A simple rule of thumb is to subtract your age from 120 and the resulting figure is the percentage of your portfolio that should be in stocks. For example, if you’re 35 years old, you should have 85% of your portfolio invested in stocks and 15% in bonds.
Of course, there’s another strategy that’s considered extremely aggressive and incredibly easy to set up. If you have a long-term investment horizon, twenty years or more, you could simply invest in an S&P 500 index fund. Returns over its entire 90-year history have averaged out to be 9.8% on an annualized basis. Considering that in the past 20 years stock mutual funds have only averaged 5.19%, there’s a strong case to be made for index investing.
Even the most aggressive investor needs to stay diversified. While some noted investors like Warren Buffett don’t actually follow a diversification strategy, unless you have sophisticated market knowledge and can analyze stocks on a professional level, you might want to hedge your bets. Being aggressive in your portfolio shouldn’t mean that you resort to gambling.
There’s a new frontier market opening up with unlimited opportunities for virtually every sector of the economy. It’s still unrealized as of yet and very few companies have even begun exploring its endless possibilities. It’s the new economy of outer space.
Like the paradigm-shifting industries of electrical power and computer technology before it, space is the next stage in human development. It’s an untapped goldmine of new opportunities and ideas with very few companies actively engaged in it. But it’s not just going into orbit that offers possibilities; space can also inspire new technologies and applications back on Earth.
Space as an industry
The idea of space as a commercial opportunity is a relatively new one. Until recently, space travel was solely seen as the realm of governments and science experiments. But space has already yielded a number of commercial successes via NASA spinoffs. Memory foam, cochlear implants, LASIK, solar cells, freeze drying, and much more all owe its existence to space exploration. These discoveries have led to a number of products and services in virtually every segment of the economy and contributed to everyday life on Earth.
Numerous companies and industries have benefited from space travel and new technologies are developed every year. Space is becoming more accessible to the public now, too, thanks to companies like CubeSat which allows for a cost-effective way to get science experiments and other projects into orbit around Earth.
Companies like SpaceX, Virgin Galactic, and Blue Horizon are the current leaders in space commercialization but still primarily caters to agencies like NASA to service the International Space Station. Other companies like Orbital ATK are also heavily involved in space by manufacturing satellites for communications, scientific pursuits, and defense purposes. For investors though, there are few, if any, pure plays on space travel at the moment.
While still somewhat far-fetched, other companies are preparing for a future in resource mining. Planetary Resources and Deep Space Industries are two companies built on the idea of mining asteroids. Despite data that shows even a single asteroid can contain more gold or platinum than has ever been unearthed in human history, the real mining operations would likely be for water and other gasses used in rocket propulsion.
The economics of space is heavily limited by the cost involved in accessing it. Breakthroughs in propulsion mechanics and launch capabilities will undoubtedly drive its popularity for the mainstream investor for the next decade or so. But as we expand ever further into space and begin building permanent habitats outside of Earth’s atmosphere, the business of space will become more commonplace. In a few decades, space may become a standard segment of the economy alongside industries like technology and consumer staples.
There a number of well-known metrics investors use to determine whether or not a stock should be purchased. Price-to-earnings analysis, dividend discount models, and modern portfolio theory are all commonly used by investors to place a value on a prospective stock. But there’s another metric that’s slowly taking over as the preferred method for valuing a stock – free cash flow.
Evaluating a company based on how much free cash flow (FCF) is available often gives investors a better representation of how the company is actually managing its finances and what investments the company is making into its future growth. Rather than just looking at basic P/E and PEG ratios, investors use the free-cash-flow yield in place of the price-to-earnings ratio to value a stock.
The basics of FCF valuation
Free cash flow is a measurement of how much money a company has left over after all expenses and capital expenditures (funds that are reinvested) are calculated. There are several ways FCF can be calculated but the simplest is to subtract capital expenditures from cash flow from operating activities (earnings before interest and taxes plus depreciation minus taxes).
To get the FCF yield you only need to divide FCF per share by the current price per share. The higher the ratio, the more attractive the investment and vice versa. Because FCF analysis takes into account capital expenditures and other operating costs, many investors prefer it over earnings since it paints a more accurate picture of a company’s finances.
Positive FCF means that the company has room for future growth and the ability to reinvest profits back into the business. A negative FCF means that the company doesn’t have enough income to manage its current expenses. However, investors should note that many fast-growing companies may start out with a negative cash flow until the company grows large enough to take advantage of things like economies of scale.
FCF is also harder to manipulate. Earnings can be manipulated more easily through things like share buyback programs which lower the number of total outstanding shares and thus make earnings per share seem higher. For these reasons, investors tend to trust FCF analysis more than EPS analysis.
As with any metrics used to value a stock, investors shouldn’t rely on just one method. While FCF helps investors get a better and more accurate reading of a company’s fundamental performance, it still works best when used in combination with other valuation methods. While a high FCF yield is usually a sign of strength for a company, growth stocks may not have a high FCF yield – it may even be negative. Investors should keep in mind what metrics are most important when evaluating a potential investment.
It takes more than simply following the ups and downs of the S&P 500 or Dow Jones in order to be a successful investor. You need to be aware of current events and track changes as they occur in order to know where the economy is and where it might be headed. Failure to do so could result in unexpected losses due to a changing economic environment that could have otherwise been avoided.
One way investors can check in on the market is by paying attention to economic indicators. These reports essentially take the temperature of the market and tell investors where the economy is currently at as well as giving them clues as to what might happen next. But with dozens of reports released in any given month, it can be a full-time job keeping up with them all. Luckily, there is only a handful that investors really need to pay attention to.
Creating an economic watchlist
There are numerous economic reports and charts available to investors that make it difficult to know which ones are important and which are merely informative. Investors should tune out most of the reports that come in and focus instead on those that really matter. Reports that show the current strength of the US economy, workforce, or marketplace are the ones that will make the most difference in a portfolio.
Here’s a list of the top three economic indicators investors should watch out for:
GDP – Arguably the most important piece of data an investor can have is the most recent GDP (Gross Domestic Product) report. This report is a macroscopic view of the US economy and gives investors a look at where the economy was at and where it might be headed. It’s a lagging indicator meaning it gives investors a solid look at where the economy was in the past quarter or so but also helps chart out long-term trends.
Unemployment – Another critical piece of data for investors is the unemployment numbers. The number of jobs added or lost in the US economy gives investors an idea of how strong the market is. Jobs gained generally indicate a growing economy whereas jobs lost could indicate economic weakness.
Inflation – Inflation is one of the trickiest indicators to understand but also essential in order to design an appropriate portfolio. Rising inflation indicates a healthy economy that’s growing, but too quick of a rise can also spell trouble for stocks that might not be able to keep up with the changes. Conversely, falling inflation is usually an indication of an economic contraction and investors may want to prepare by investing in defensive stocks.
Investors should be careful not to put too much emphasis on any one indicator. Oftentimes economic indicators can tell conflicting stories about the economy. Investors should take all the information presented and filter out the inconsistencies to paint a clearer picture of what’s going on economically. Taking a long-term view will help smooth out trend inconsistencies and help you become a better investor.
Picking the right investment for your portfolio isn’t always easy. You want to keep diversification alive by selecting stocks from different economic sectors. And while most investors cycle through various sectors as the economy ebbs and wanes, there’s one sector that seems to make it into almost any portfolio – gold.
Gold, along with silver and platinum, are popular investment choices for investors. Their use as a safe haven asset means that precious metals stocks can be part of a defensive portfolio while mining companies can often make for solid dividend-paying stocks.
Precious metals can play a number of roles in your portfolio. Understanding how they provide value is the key to maintaining healthy profits.
Key metrics for precious metals
While ratios like price-to-earnings or price-to-sales are important for most stock sectors, they don’t mean much when it comes to precious metals. Instead, inflation, interest rates, and the US dollar become the primary considerations.
One of the biggest misconceptions about gold is what economic factors actually make it relevant as an inflation hedge. As a safe haven asset, gold is used as a default investment to protect investors against virtually all types of risks ranging from geopolitical to economic. But gold is most often quoted as being the go-to inflation investment.
However, gold isn’t an appreciable investment like a stock. Gold doesn’t produce earnings or yield dividends – it simply holds value in a way that’s separate from currency. Precious metals are best used as wealth-protectors that aren’t correlated with the economy or market performances.
As far as being an inflation hedge, most investors pick gold and silver without giving it a second thought. But precious metals are only good as inflation plays when inflation is higher than interest rates. As long as interest rates are higher than inflation, investors are better off investing in assets that actually appreciate in value. But if interest rates can’t keep pace with inflation, then precious metals like gold are the better option since wealth preservation takes precedence over price appreciation.
One of the most overlooked aspects of investing in precious metals is the difference between mining companies and junior mining companies. It’s a critical difference that can mean boom or bust in your investment portfolio. A mining stock derives income from their operations, whereas a junior mining stock is an exploration company that seeks out new locations for ore. The latter is far more risky since there’s a lot of money that goes into the process considering that a potential mine site could turn out to be worthless.
Mining stocks aren’t the only way to play precious metals though. ETFs and mutual funds are also viable options. They might invest in an index of mining stocks to help you stay diversified, or they might invest in futures contracts. Regardless of the path you take, adding precious metals into your portfolio can be a good risk mitigation strategy that will help your portfolio stay afloat in difficult economic times.
The stock market is a dynamic entity. It lives and breathes like an organic being, but instead of oxygen and water, it feeds off of the business cycle. Certain sectors outperform or under-perform depending on where the business cycle is at which gives investors an opportunity to profit by following along.
One of the most common investment strategies is known as sector rotation. Stocks are bought and sold as certain sectors move in and out of favor correlating with the business cycle. Regardless of what stage the economy is in, there are always certain sectors that stand out as being clear winners while others typically lag behind and should be avoided.
For investors, following the business cycle eliminates some of the guesswork involved in investing and can help mitigate risks in their portfolio.
The business cycle and the market
The business cycle is what economist call the change the economy goes through over time. It happens in several stages: early cycle, mid-cycle, late cycle, and recession. For each stage, certain sectors of the economy benefit more than others making it a good baseline for portfolio design. Below is a breakdown of each stage and what sectors outperform or under-perform:
Early-cycle phase: This phase is marked by economic recovery, usually from a recessionary phase with economic growth turning positive. Monetary policy eases and credit becomes lighter. Business sales growth rises while inventories are generally low. Sectors that outperform during this phase include consumer discretionary, technology, and industrials. Under-performers include energy, telecommunications, utilities, and consumer staples.
Mid-cycle phase: The mid-cycle phase is usually the longest phase of the economic cycle and is defined by consistent economic growth while business inventories and sales reach an equilibrium. This phase doesn’t have many clear winners or losers but technology and industrials seem to perform better than most while materials historically lags.
Late-cycle phase: In this stage of the business cycle economic activity can be described as “overheating” with high inflation and tighter monetary policies aimed at restricting growth. Materials, energy, and healthcare are the best performing sectors while consumer discretionary and technology tend to lag the most during this phase.
Recession phase: The recession phase is arguably the easiest to identify as economic activity turns negative while credit becomes difficult to procure and business profits fall. Sales growth stagnates while businesses burn off high inventories in anticipation of a turnaround. Sectors that benefit during a recession are consumer staples, healthcare, telecommunications, and utilities. Industries to avoid include technology, industrials, and materials.
One of the oldest investment strategies “buy and hold” seems to fly in the face of sector rotation since stocks are held over a long period of time regardless of what stage the economy is in. There are several competing theories that favor one strategy over the other, but ultimately it comes down to investor preference. If you have the time and ability to dedicate to your investment portfolio, sector rotation may be something to consider. However, if you don’t have that kind of time and you have a long-term investment horizon (a decade or longer), then buy and hold may be a better choice.
Designing a portfolio usually involves a mixture of stocks and bonds. While other asset classes can be added to the mix, a typical investment portfolio is broken up by these two main asset types. Stocks offer greater returns but carry a higher degree of risk while bonds have a lower risk profile but come with lower returns. Getting the right mix is where many investors run into trouble.
Having a portfolio that’s too heavily weighted in stocks can result is greater-than-expected losses and volatility which can quickly derail a retirement plan. On the other hand, loading up on too many bonds means that your portfolio will likely under-perform expectations leading to a lower retirement balance than planned. That can mean having to work for more years to compensate or reducing your retirement plans.
In order to figure out the right balance, you’ll need to figure out what your goals are, when they need to be realized, and how much risk you can handle.
Figuring out your risk tolerance baseline
Life is not static – it’s a dynamic progression that changes and grows as you approach retirement. Plans change, sometimes for the better and sometimes for the worse. As such, you need an investment plan that allows for adjustments but still helps you reach a long-term goal.
One classic rule of thumb to figure out what stock/bond allocation is right for you is to subtract your current age from 100. Whatever the result is should tell you what allocation to use. For example, if you’re 40 years old, you should have a portfolio with a 60% stock and 40% bond mixture. But that’s for more conservative investors. Those with a higher risk tolerance should subtract from 115. That would give the same investor an allocation of 75% stocks and 25% bonds.
Subtracting from 100 or 115 will help you design a portfolio based on your age, but it’s not a catch-all for risk tolerance. There are numerous free risk assessments online like this one that can help you determine what your actual tolerance really is. There’s nothing that says you can’t adjust your allocation to be even more or less aggressive than the age-based model.
Finally, you can do a quick calculation to figure out what allocation you need by estimating the expected returns from stocks and bonds and what return you need to have. For example, let’s say you need to achieve an 8% return to reach your investment goals. If your stock portfolio should give you a 12% return and your bond portfolio will give you a 5% return, then some quick math tells you the right allocation is 43% stocks and 57% bonds.
While getting the right allocation helps you reduce risk while meeting your long-term investment goals, there’s nothing wrong with changing the formula. You may find yourself more or less risk-averse later on meaning that the plan needs to change to compensate. The rule of thumb based on your current age is constantly being readjusted and many advisors now recommend being more aggressive as you approach retirement than they used to. Don’t be afraid to switch gears as needed in order to reach your investment goals.
When designing an investment portfolio, diversification is a critical component. Holding stocks in various sectors helps mitigate risk without compromising returns. But not all sectors are created equal. Depending on where the business cycle is at, certain sectors may outperform or underperform the broader indexes.
Cyclical industries behave in patterns that are relatively easy for investors to predict. Other sectors such as pharmaceuticals and biotechnology aren’t correlated with the markets at all and follow their own microeconomic patterns. The best portfolios usually have a representative from most, if not all sectors of the economy but one sector seems to be taking over in terms of importance to other stocks and the market in general.
In the past five years, the S&P 500, an index made up of 500 stocks from various economic sectors, has risen about 78%. Over that same time period, the NASDAQ, an index known for its strong grouping of tech stocks, has gained more than 132%. It’s clear that the technology sector is becoming more than just another sector of the global economy – it’s becoming the defining sector.
The new technological paradigm
There are certain moments in history when a business or idea changes the way we look at the world. These disruptors often cut a path of destruction for those companies that aren’t able to adapt in time but create opportunities for others.
There’s a list of industries that are either defunct or at the very least on their way out thanks to technological disruptors. Paper has given way to electronic forms of communication, coal is becoming obsolete in the face of cheaper, cleaner sources of energy, and even space is becoming more and more accessible to commercial interests.
But while the world might be caught in a technological renaissance, not every new product is guaranteed to be a winner for investors. 3-D printing promises to be a huge benefit to sectors like biotechnology and manufacturing, but it’s not the 3-D printing companies that ended up on top, it’s the companies that adopted the technology for themselves.
The headlines constantly reveal technological breakthroughs that promise to be paradigm-altering by some of the biggest names on Wall Street like Amazon, Google, Apple, Facebook, Tesla and more. And while these giants lead the way, it’s the companies that will benefit from technology-inspired cost reductions and innovative new products that will soar higher over the next decade.
While technology is quickly becoming a vital part of every industry, investors should pay careful attention to industries that are set to benefit the most rather than directly investing in technology companies themselves. There’s a saying on Wall Street, “when everyone is digging for gold, it pays to be the one selling the shovels.” In other words, it may be the industries supporting the changing tides that will offer the most opportunities for investors rather than directly investing in the tech companies themselves. Still, for long-term investors, it might not be a bad idea to pick up a few shares of stock from companies like Amazon or Apple.
Volatility is back in the markets and corrections seem to be happening more frequently this year. There’s been a flurry of activity early on this year with rising oil prices, a new Fed chairman, tariffs, and a possible trade war. The eight-plus-year long bull run may be facing its last days, or it might just be a temporary correction before heading even higher.
Whatever fate lies in store for the markets this year, investors need a plan to avoid making critical mistakes. Panic is the biggest enemy for investors. When stocks are plummeting, the knee-jerk response may be to sell and get out, but keeping calm could be the key to maintaining profits.
Portfolio defense 101
Protecting your portfolio against sudden unexpected downturns is a must if you want to maintain healthy long-term returns. Down markets can be scary, but having the right strategy in place can help you weather any storm.
Regardless of how the market is performing, investors should focus on fundamentals rather than technical trading patterns. The intrinsic value of a company remains the same whether it’s in a bull market or bear market. By focusing on things like financial statements and company growth, you can avoid short-term trends and market fads.
Another good defense against downturns is making sure your portfolio allocation is correct. The mixture of stocks and bonds tends to get off track over time because stocks rise more than bonds. A portfolio originally set up as 60% stocks and 40% bonds can turn into 70% or 80% stocks in a few years if left unchecked and subject you to more risk than you want.
Finally, options are a great way to mitigate risk. Simple strategies like covered calls or hedging against a position buy a put help minimize losses. A covered call involves selling a call on a stock you already own. You’ll miss out on larger-than-expected upsides but still keep some profit. More importantly, you’ll get upfront profits from selling the call that helps mitigate losses potentially seen on the stock itself. In the case of a put, the profit gained from a falling stock below the put’s strike price will limit the downside risk to the difference between the price of the stock when you purchased it and the strike price of the put.
One of the most important rules for investing is to remain calm even in the midst of a market panic. Those that panic don’t make good decisions and many savvy investors such as Warren Buffet buy and make big moves in the markets when a sell-off is underway.
When the markets dip 10% or more, you might be tempted to sell out of your positions and wait on the sidelines until the danger is over. But all this strategy does is guarantee the loss already sustained and could prevent you from profiting from the rebound. In other words, stay invested for the long term and don’t stress over temporary downturns in the markets.
Diversification is a word that investors hear every day in the markets. It’s an important concept – “don’t put all your eggs in one basket.” To most, it simply means choosing a mixture of stocks and bonds and ensuring that the stocks you hold are from various sectors of the economy and come in varying sizes from large cap to small cap. But these changes are only superficial, there’s still one more layer that tends to be overlooked – investing overseas.
Domestic market risk is what happens when a portfolio consists only of US-stocks. That means any event specific to US markets like an unexpected drop in GDP or political event will impact US stocks far more than those situated outside of the US. For investors to be diversified against regional-specific risks, there needs to be an inclusion of international holdings.
Ways to invest internationally
Picking an international investment can be a daunting task. It’s hard to perform due diligence on a company you have never heard of with limited information to go on. Unless you have unique knowledge of foreign companies, investing overseas is considered riskier than investing domestically.
But that doesn’t mean there aren’t ways to invest. Investors have several methods to choose from to gain international exposure.
Mutual funds are one of the best ways to gain international exposure. That puts the responsibility of research and balancing of international stocks solely on the shoulders of the fund managers who have in-depth knowledge about ex-US investments.
Another great way to get access to overseas stocks is through ETFs. These funds trade like stocks making liquidity a non-issue and give investors the ability to choose a basket of international holdings instead of having to narrow it down to just one company. Investors can even choose regional specific ETFs or take a broader approach by investing in several countries at once.
Finally, you can invest directly in international stocks via ADRs. Short for American Depositary Receipt, ADR’s allow foreign companies to list their stock on US exchanges. Companies listed as ADR’s have to meet certain listing requirements set forth by the SEC making them safer for investors rather than attempting to invest directly in an overseas company listed on their exchange.
Not all investors believe international investments are necessary. Legendary investor John Bogle, the founder of Vanguard Group, thinks that there’s no reason for investors to chase returns overseas – there should be plenty of opportunities for profit in the US alone.
However, diversification by including ex-US stocks isn’t something to dismiss out of hand. It can effectively hedge your portfolio against certain risks while boosting returns in high growth countries. By utilizing mutual funds, ETFs and ADRs, investors have a plethora of options to pick from.
Bear markets are the bane of every investor’s portfolio. They can strike quickly without much warning and turn a profitable year into a disaster. Panic sets in fast and the markets become a mad scramble to sell stocks before everyone else to avoid taking on even more losses.
There are few things in the markets scarier than watching the indexes drop more than a percent day after day. Bear markets bring with it large swings in volatility which can be disconcerting to even the staunchest investor. But with volatility comes profitable opportunities for those that have the ability to think differently. In many cases, not only are bear markets not something to be afraid of, but something to look forward to.
Combining offense and defense
Whether it’s a bull market or a bear market, each sector of the economy and its associated industries don’t all perform the same way at the same time. In other words, not every industry will be undergoing a bullish upswing or bearish reversal at any given moment. That means even in the midst of a harsh sell-off, there will still be attractive profitable industries investors can take advantage of.
Another way to look at a sell-off or bearish reversal is to view stocks as if they were having a sale. Some companies may be going on sale because they genuinely aren’t worth as much but far more often you’ll find that stocks are simply caught in the grip of bearish selling momentum that has nothing to do with the state of that particular business or even industry.
Savvy value investors like Warren Buffet thrive during bear markets because they’re making moves and buying quality stocks for far less than they could during a bull market. Once the smoke clears and the markets begin to recover, these stocks can produce returns far in excess of the S&P 500 average.
While opportunities can be found during bear markets, one of the best ways to prevent taking on larger-than-expected losses is to remain diversified. It can be tempting to sell some or even all of your holdings and wait on the sidelines for the danger to pass, but that can mean guaranteeing losses and missing out on the subsequent upside swing once the bear market reverses course.
Arguably, the best way to handle bear markets is to simply power through them. Historically, bear markets only last 18 months while bull market average 97 months. That means as long as you stay invested, it might be a better strategy to simply ride out downturns and let the stronger long-term trends define your gains. Having a long-term strategy means being able to weather market downturns with relative impunity.
The markets have become a volatile place of late triggered by a host of catalysts like rising interest rates and high stock valuations. Adding fuel to the fire is Trump’s newest policy of tariffs aimed at combating the United States’ trade deficit and retaliating against China. The result is heightened fears of escalating tit-for-tat maneuvers that could end in an all-out trade war.
A trade war is a bit of a mixed bag for markets. Certain industries will obviously be impacted while others may escape relatively unharmed. A trade war will certainly impact markets in a broad way, though, and many unrelated industries could see increased volatility as a result. You can be sure it will impact your portfolio, but there are steps you can take to minimize its impact and even benefit from upcoming changes.
Your war portfolio
If a trade war does break out, there are a number of things you can do to protect your portfolio and even benefit from the increased volatility. As with any major market-moving event, staying focused and avoiding panicked decisions is the best advice. That being said, here are several things you can do to prepare for a trade war.
The first move you should make ahead of time is to re-balance your portfolio. Over time your allocation between aggressive assets like stocks and conservative ones like bonds tend to get off track. This happens because with more volatility stocks tend to gain or fall more than bonds thus throwing off your portfolio weights. If a trade war does happen, you’ll want to have your portfolio properly adjusted to avoid larger-than-expected losses.
Along the same lines as re-balancing your portfolio, you should also make sure you’re properly diversified. Spreading out your investments in different sectors and stock types means minimizing negative impacts. If you want to take it a step further, you could also look into investing in stocks that are benefiting from current trends that won’t be adversely affected by a trade war like the falling US dollar.
Certain sectors like financials won’t be affected by a trade war and could, in fact, benefit from it. Technology too should be able to thrive despite any tariffs or regulations because the industry isn’t built on international trade. Companies that do business in the US and don’t manufacture overseas are also good bets as they avoid any negative impact tariffs have.
Whether or not a trade war will happen shouldn’t impact your long-term portfolio strategy or goals. You might want to think twice about purchasing a stock that will be directly impacted by a trade war, but you shouldn’t let it affect how you invest. Make sure you keep your portfolio properly balanced and don’t let short-term volatility derail your long-term investment plans.
You don’t have to look far to find advertisements claiming 1000% returns or higher trading penny stocks. They sell for just pennies, as the name implies, giving investors the impression that they are cheap and therefore have more possible upside movement.
It can seem tempting to buy thousands of shares of a company’s stock that sells for just $0.01 a share and imagine that it’s not really that risky because you’re not spending much. And because it doesn’t take much, these stocks can easily rise in value creating huge gains for investors. But far more often these stocks lose value or even go bankrupt. Investors should take extreme caution when considering a penny stock for their portfolio.
What penny stocks are
Stocks like General Electric or Amazon trade on exchanges such as the NYSE or the NASDAQ. These exchanges have certain requirements and regulations in place to ensure that stocks trading on them meet guidelines like financial accounting standards and proper reporting to protect investors from fraudulent activity.
Penny stocks, however, trade over-the-counter on what’s commonly called the pink sheets. They do not need to meet minimum requirements set forth by the SEC or file like those listed on other exchanges. These companies may be foreign-based and don’t use the same accounting rules or it may be that the company doesn’t report to the SEC. There are a number of reasons why a company may be listed on the pink sheets, but because of the lack of required information, investors are unable to do due diligence like they would on other stocks.
Scams are one of the largest risks with penny stocks. One of the most common scams is known as a “pump and dump” scheme. It happens when a stock is bought by certain parties or news disseminated about a stock in order to generate positive interest. Once the stock climbs in value due to other investor activity, the stock is sold off sending prices plummeting lower. Any unfortunate investor caught in such a scheme loses their investment.
Aside from the many dangers that penny stocks come with, there can be reasons to consider adding them to your portfolio. Some lesser known or smaller industries operate on the pink sheets and nowhere else. Some of the most popular now are marijuana companies which operate outside the US. Stocks that were once listed on an exchange like the NYSE may lose standing and trade over the pink sheets as well. While it could be due to problems like failure to report to the SEC, it could be that the stock falls below a minimum threshold and can no longer be supported on the NYSE or NASDAQ.
For investors that decide to trade over the pink sheets, they should limit their investment to a small percentage of their overall portfolio to avoid taking on undue risk. Penny stocks are highly volatile and the lack of information means that proper fundamental analysis may not be possible.
There’s a common philosophy in real estate – buy the worst house in the best neighborhood. The opportunities for profit are highest when you purchase something that needs a lot of work, but because it’s in a good location, the resultant gains are relatively easy to obtain.
The stock market works in a similar fashion, only instead of neighborhoods and houses, you have industries and individual stocks. And like real estate, values are often strengthened by the neighborhood, or industry, that they’re located in. A good stock in a poorly performing sector doesn’t have room for growth and lacks positive catalysts to move higher.
In order to maximize profits and minimize losses, you’ll need to be selective with your stock picks. That means buying only the best companies for the role they’ll play in your portfolio.
Creating a playlist
There are roughly 630,000 companies that are publicly traded in the world. Trying to narrow down that list to find the best of the best may seem like a daunting, if not altogether insurmountable task. Luckily, there is a way to make things easier.
You can start by eliminating the majority of stocks available right off the bat by sticking to domestic investments that are listed on exchanges like the NYSE and NASDAQ. Quality stocks won’t be found on the pink sheets so there’s no reason to include them in your search either. Still, you’ll end up with several thousand stocks to choose from so you’ll need to narrow it down further.
The best way to go about picking best of breed companies is to list out all the stock sectors in the market: financials, utilities, consumer discretionary, consumer staples, energy, healthcare, industrials, technology, materials, telecommunications, and real estate. You can even add a few specialty niches if you’d like such as biotechnology or pharmaceuticals. Out of those sectors, you can identify the top three contenders for your ongoing stock selection list.
Picking the top three as best in breed for your list isn’t as challenging at you might think. You start by identifying companies with brand recognition – household names like McDonalds or Disney. You can’t go wrong starting with companies listed on the DJIA while the odds are the majority of companies you’ll find that qualify as best of breed will be listed in at least the S&P 500.
It’s good to keep a short list on hand of the best stocks for each sector as a quick reference, but keep in mind that metrics and fundamentals change over time. You’ll want to update your list on a regular basis – at least semi-annually – in order to avoid making simple mistakes by not doing your due diligence. Keeping in mind the best stocks for each sector can lead to quick decisions at the moment however and allow you to perform better analysis by avoiding tedious screens that take up valuable time that could be better spent making solid investment choices.