Think quick to stay ahead of the game
WITH the dust settled on yet another footy season, it is worth reviewing some of the lessons from the West Coast Eagles AFL grand final victory that are applicable to the markets.
There has been no single catalyst for the recent market correction but uncertainty on the impact of trade wars, to US midterm elections, to the China growth outlook coupled with a domestic economy that has been impacted by a royal commission, a slowdown in credit growth and a property downturn have all contributed to the market weakness.
The VIX benchmark measures the market’s expectation of volatility.
Colloquially known as the “fear index”, it is at its highest since February, when the short VIX trade unravelled.
While the price of volatility is high, the key danger is that underlying volatility is actually higher and if this is priced into the market then increased uncertainty means increased risk.
In these types of markets you need to protect capital and manage downside risk.
Similar to the strategy the Eagles used in the Grand Final, the focus should be on three Ds — Defence, Decisions and Diversification.
Sometimes the best form of attack is defence.
West Coast won the Grand Final via a combination of desperate defence and good decision making in the face of a first-quarter onslaught by the Magpies.
Unless investors are able to short stocks, it is hard to get a negative correlation in a portfolio. However, investments can be defended by purchasing products such as put options or “bear” Exchange Traded Funds (ETFs) that will increase in value if the market declines.
They come at a cost, but will mitigate downside risk and provide some insurance in volatile times. With elevated volatility, selling covered call options can often provide the premium to help fund these strategies.
It is important to have a realistic investment approach that allows you make informed but timely decisions.
You also need to be flexible enough to adjust when the environment changes.
When the West Coast game plan and strategy didn’t work they had to adjust quickly or risk losing the game.
In volatile markets investors need to have the ability to be flexible if conditions change. Investors need to be actively making good buy and sell decisions.
The inability to control emotions, particularly those of fear and greed, can often lead to losses and now is not the time to have your head in the sand. Investors need to speak to their advisers or fund managers to understand what decisions are made on their behalf.
Diversification means reducing risk by investing in a variety of assets.
West Coast had a diverse list with a high skill level.
However, there were key players in the backs — Jeremy McGovern, midfielder Luke Shuey, and Josh Kennedy in the forward line. They all had nervous moments early but were crucial to the end result.
Similarly, having appropriate diversification in a stock portfolio means holding high-quality shares in key sectors and ensuring you back them in turbulent times, as long as the investment thesis remains intact.
Alternatively, rather than doubling down on loss-making positions in the hope they come good, consideration should be given to cutting losses and diversifying into new positions. Momentum stocks and value traps need to be treated with caution.
In this market, doing nothing gets you nothing.