Rookie investors will often say something like this: “PMIs are tanking, GDP growth is decelerating, labor market is loosening, sentiment is awful, stocks are down…so we should sell stocks of companies with high cyclicality, high operating leverage, and high financial leverage!”
That is Rookie Investor Mistake #1. Because more often than not, that is the precise moment when you should be thinking about holding onto existing positions and initiating new positions. That is often the moment when you want to be getting into the crappiest, most financially and operationally levered businesses. The difficulty arises because the rookie (and many veterans too) fears there’s no bottom to the decline, that this downturn is going to get much worse, that stocks could go down another 50%. Even when historical perspective would suggest that things would start getting better over the next while (let’s say 1-2 years) instead of devolving into the next Great Depression.
By contrast, selling cyclical would be the correct thing to do if PMIs were peaking (e.g., at around 60), GDP growth was never better (perhaps in the vicinity of 4% for the U.S., 7 or 8% for China, 3% for Europe, 2% for Japan), there were too many jobs and not enough people to fill them, lots of exuberance in the markets, and stocks at all-time highs. Unfortunately, the right time to sell is precisely when things feel amazing, everyone is bullish, and Cramer is backing up the truck on Caterpillar. For a lot of people, selling at the peak takes courage, a good look at the rearview mirror (i.e., looking back at prior cycles), suppressing greed, and realizing that this time is not different.
I would note that for some investors, particularly seasoned ones who’ve had professional training at a proper firm and who are naturally value-oriented, the opposite is true: they salivate at the prospect of selling when multiples are high, dividend yields are compressed, and stocks have doubled or tripled. But I wouldn’t call them the majority.
Which brings us to the question: where are we today, ten years into a recovery from one of the worst global recessions in history? The answer isn’t straightforward, in spite of the yield curve having inverted, U.S. unemployment at cyclical lows, and earnings growth OK in many parts of the world. But that’s a topic for future posts.
