Feb 6, 20215 min read

Time to Think About Selling

Investors will do well this year by ignoring emotions such as excitement and euphoria.

The S&P 500 has posted all-time highs multiple times since August of last year, with an overall 15.01% increase since its peak on Feb 12th, 2020 (before the crash). The NASDAQ-100 has fared even better with an eye-popping 42.47% increase since its peak on that same day. There has been a flood of new, first-time investors pouring into the market using smartphone apps like Robinhood and WeBull allowing inexperienced traders to day trade commission free as well as use advanced market derivatives to speculate on their favorite stocks. Some have done incredibly well so far, but how long will it last?

Certain sectors of the market have become a sort of online casino, with less and less focus or care on any fundamentals – with huge volumes of trades going into stocks with no particular growth prospects or profitability. The best example so far is GME (GameStop), where a cult following on the internet message board website, Reddit, influenced an incredible short squeeze pushing the stock over 3,000% from its trading averages of about $10/share to over $300/share. The “meme stock” revolution has begun, now with multiple micro-cap and penny stocks showing ridiculously high gains as speculators buy in.

As of market close yesterday, GameStop is now back to $63.77/share. Will it go higher again? Maybe, but probably not. What will happen to all of the other stocks that are at nosebleed levels? The real question is, do you want to be “holding the bag” if it falls?

Definition of Bag Holder (from investopedia.com):

“A bag holder is an informal term used to describe an investor who holds a position in a security that decreases in value until it descends into worthlessness. In most cases, the bag holder stubbornly retains their holdings for an extended period, during which time, the value of the investment goes to zero.”

Where are we in the market cycle?

This chart is wonderfully made and an incredibly accurate portrayal of the psychological impact of a typical investor during the regular fluctuations of the stock market.

I believe we are now somewhere between Thrill and Euphoria.

Not only are the popular indices (S&P 500, NASDAQ-100, for example) are at all-time highs, margin debt utilization is as well – margin is when an investor takes a loan from their broker using their existing stocks and ETFs as collateral to buy more stocks and ETFs. Investor sentiment is quite high as well with the “Fear and Greed Index” pointing to well into the green.

With FOMO taking hold of many, the market continues to rise amid looming economic problems and major red flags. What is “FOMO”? FOMO is defined as “Anxiety that an exciting or interesting event may currently be happening elsewhere, often aroused by posts seen on social media.”

What if the market crashes again and you get SIDSWIC “Sad I Didn’t Sell When I Could”? Did I just make that up – yes I did... Think of it this way though, when any asset you own is up, real estate, stocks, whatever, you only actually get to keep the profits if you sell and take the cash. Otherwise you can tell your friends that your investment property or your favorite stock used to be $xxx, but it really doesn’t matter since you’re now stuck with it.

What’s going on with the economy?

Small businesses are still closing at an alarming rate due to the severe economic impacts from COVID-19 lockdowns. Now with the Biden administration pushing for a $15/hour minimum wage increase, the prospects of improving unemployment numbers are not looking good. Businesses who are already struggling to survive will not hire more workers if they have to pay more for them - they will do the opposite by reducing workforce even more. Unemployment as reported in the media appears to be improving, however, this is not the full story. The “real” unemployment rate, as reported as U-6 is a broader definition of unemployment as opposed to the “official” reported as U-3. The U-6 rate includes the underemployed, marginally attached, and discouraged workers. As of January 2021, the national U-3 is 6.8%, but the national U-6 is 12.0% (https://www.bls.gov/news.release/empsit.t15.htm)

Mortgage delinquencies are starting to climb as foreclosure and eviction moratoriums are continually moved forward with each Federal stimulus bill passed. This builds up a stress point that will only end badly once the government stops interfering with the housing market, as people who currently aren’t able to pay for rent or mortgage will suddenly have to pay what has been deferred for now almost an entire year. As a side-effect of this situation, the real estate market has exploded as this has caused an extremely low supply of inventory coupled with historically low interest rates set by the Fed. Real estate prices in many areas are now at an all-time high.

Be Fearful When Others Are Greedy

In my previous article, The More It Falls, The More We Buy, I quoted Warren Buffett during the incredibly fast and violent market crash of March 2020. It’s only fitting to quote him again during this market melt-up:

“Be fearful when others are greedy and greedy when others are fearful” -Warren Buffett

To be clear, I’m not suggesting that you sell everything because this article is not meant to give financial advice. Also, this bull market can continue to go on for an unspecified amount of time, resulting in lost opportunities if you sell too soon. What I am saying is that if you have margin debt or otherwise leveraged by other means, it might be a good idea to think about de-risking. It might also be a good idea to think about any of the gains you made so far and if you’d like to keep them.

What are we doing in our portfolios? We’ve been systematically capturing profits since August/September of last year and setting those aside in cash. Occasionally we’ve been infusing cash back in during small pullbacks throughout the year, however, always pulling out more than we’ve put in. Exactly how much cash as a percentage really depends on the specific strategy, the underlying holdings, and the conditions of those specific sectors they are invested in. You can get more details here.

Those who have stayed focused and ignored their emotions by buying in during last year’s crash will continue to do well this year by ignoring different emotions, such as excitement and euphoria. Panic buying is just as real as panic selling. It might be good idea to take a serious inventory of your holdings and your gains across your global portfolio and make the necessary adjustments, ensuring you have enough cash to weather any future storm, as well as reducing leverage and high-risk positions.

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