I wrote previously that you must always have a buy rule and a sell rule when you invest.
Sometimes, as an investor, even if you do everything right, the world can punish you by throwing an unforeseeable disaster in the way of your stock market holdings.
This is called Systematic Risk – or basically an unpredictable, unforeseeable risk that affects whole segments of the market and cannot be controlled for.
A friend of mine from school days asked me what could destroy my investment thesis in shipping. I told him maybe a natural disaster that destroyed the company’s fleet, global war, or a major financial meltdown.
I was wrong.
It was the Wuhan Coronavirus.
The Wuhan Corona Virus hit mainstream media with strength approximately around the start of the Chinese New Year.
- News of China commencing mass city lockdowns,
- people collapsing on streets,
- nurses having meltdowns on their social media
- citizens risking being caught by the police urging for worldwide pressure on the Chinese government
- and day long queues outside clinics
- as well as a hospital filled with dead bodies on the floor and staff clad in protective gear filled twitter. (search #coronavirus)
The stock market, as can be expected, reacted negatively almost immediately, oil related and shipping related stocks immediately took a severe beating, dropping 5-6% every day since then.
What was previously 30-50% gains between a mix of Options and Shares on my shipping stocks are now about 15%-30% of losses (from my original buy prices).
Having said that, I felt there are some important lessons to reinforce during this time of uncertainty. Let’s take a look at the 4 main options you can take if you are invested, and if the Wuhan Virus(systematic risk) has affected your stock holdings.
#1 – Don’t Panic
The easiest way to lose more money than you already have is to panic and sell/buy/trade the news. I think this is folly unless you’re a seasoned veteran of the stock markets with a keen sense on the pulse of the buyers and sellers in the market. And even then the chances are slim you’ll make good money back.
Stay calm and re-evaluate the situation first. This brings us to our next move.
#2 – Buy More
This is obviously the first and most instinctual move. If the company was previously a screaming buy, and share prices have run up from when you bought (but not yet hit selling target prices) then the first thing you can do is take advantage of a situation like this and buy more stock to increase your potential gains. Frankly speaking, most worldwide viruses tend not to destroy the economy. And if it does reach the level of the Spanish Flu, I think we have more things to be worried about than the stock market.
#3 – Sell to Cut Losses
Sometimes, the systematic risk in question is a hurricane. Or a tsunami. Or insert random natural disaster affecting businesses. Or war.
Sometimes, these negative news have serious downside momentum. For example, the Wuhan Virus itself caused most oil related and retail related names to sharply fall while causing the prices of $APT and $LAKE to sharply rise in response.
Most of the time, these events do nothing but create temporary plunges in prices for you to take advantage.
Other times though….
Sometimes, the systematic risk is big enough that it changes the fundamentals of the company you bought shares in, and while it is painful, you should cut losses and move on if the fundamentals have really been corrupted irrparably.
Naturally this is hard to tell. The effects of the virus for example are not clearly seen in companies we invest in. We can only speculate as to the extent of the damage cause to business operations. Take some time to verify the facts and don’t be rushed about it.
If there is a strong degree of certainty that the demand for the product or service your invested business provides is affected, and there is no recovery possible, it might be best to sell.
Again, re-evaluate if your original thesis has now been destroyed by this new event. Most of the time, I will say with certainty that such events (SARs, or the Corona Virus or the US killing of an Iranian General) are mostly blips in history that will do no significant damage. Most of the time, the damage is when you panic and sell, locking in losses and missing out on the eventual gains.
#4 – Did You Hedge?
Hedging is something unique you can do with options. In the US markets, the minimum shares an investor can purchase is 1 share. An option secures a hundred shares at a fraction of the cost, the downside is if everything goes well, you lose the option. The upside is that if your investment idea goes to hell in a handbasket, you’re covered. You sleep better at night basically.
That also means that if you want to insure your position, you can buy Puts (the right to sell your shares at a certain price by a certain date) on shares you own to hedge against downside risk.
#5 – Are there opportunities?
This goes back to preparedness. Are you prepared to take advantage of a stock market downturn? Or a temporary downturn?
I know investors who were late to the shipping party and have bought in at recent new all time lows. These are the same people who saw the opportunity but had the presence of mind to not invest when the price had already run up.
In other words, they kept an eye on certain companies and tracked their prices with an app (either google or seeking alpha) and then moved only when prices were down again. Given that the market is volatile, these chances can come and go. You need to first do the work and to be prepared ahead of time. Find companies that can be good investments at lower prices and move in when the time is right.
#6 – A Note on Diversification
If you are wondering why I haven’t mentioned diversification, it’s because I don’t really diversify. I just can’t believe in it all that much. If you know the value of what you’re investing in, all you have to do is allocate appropriately and wait.
I think patience and panic are what kills most retail investors.
At maximum, I tend to just own 5-10 different companies at a time.
I only invest in the very best ideas I have and I don’t think that investing in a subpar idea is a wise move.
Unless your best ideas already have plenty of money in it, I think it’s better to keep buying more of your best idea until you’re satisfied.
My approach is to find sharply cyclical/counter-cyclical companies with deep value strategies and a clear inflection point run by management with skin in the game and a balance sheet that can handle a financial meltdown. By definition, most cyclicals provide services or products that are needed. Shipping. Oil. Uranium. Commodities. Mortgage Repo/Financial Services. Real Estate.
Cycles come and go and these companies will have their turn in the sun.
This means a lot of the time, all I need to do is sit and wait in the right opportunities. This also means that a lot of the time, for years in fact, I might look like a crazy fool.
I’m ok with that. Virus or no virus.
You shouldn’t let a virus or a panic push you either.
Remember, if a global event is big enough to destroy most markets, you’re best off finding a bunker to hide in anyway and the stock market should be the least of your concerns. If this event doesn’t have that sort of power, all you should be doing (provided your buy thesis is intact!) is moving on with your life.
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