Investing with market cycles

Source: Photo: calzone

As I write this, the S&P is up practically 40% from its November 2008 lows and much of the stock market pain endured in the 2008 collapse has been alleviated, if not eliminated.  So what have we learned from this bull and bear market cycle?  The two key pieces of investment knowledge I’ve learned are also tried and true adages repeated in many a book on money management and beginner’s finance.

(1) Asset allocation.  If I had more of my money in bond funds and bond ETFs, my overall portfolio would not have seen as much of a decline and I wouldn’t have been so concerned about my portfolio’s future or the merits of even trying to invest at all.

(2) Keep enough cash on hand for the times when the stocks you watch go “on sale.” These stocks will present good enough nominal value so that you can snap them up before they jump back.  This tenet assumes that you’ve done your basic research and due diligence first.

Whether or not we’re currently in a bear market rally or the beginnings of a real recovery, the markets are up in nominal terms.  I want to share with you some thoughts on what I think you should try to take advantage of when this happens for any extended period.  I also want to suggest what it might be good to do when markets are significantly down.

It’s going to sound dangerously close to “timing the market,” but timing the market is not exactly what I mean here.  I’m not talking about trading market cycles.  I’m assuming you’re basically a buy-and-hold investor like me, since most readers of personal finance blogs — if they invest in the stock market at all — also seem to be.  This isn’t about “timing” in the sense of trying to isolate an exact turnaround moment or the lowest/highest prices.  This is a much broader view of very large valleys and peaks that for most people would be impossible to miss.  Cyclical investing takes a view of the larger undercurrent of what is happening in the economy and not the daily ups and downs. There’s not a literate soul in America, I’d guess, who doesn’t know the economy went through a major upheaval over the last 7 months.  And besides, even if you’re not a trader either, you still want to buy low, sell high, right?

Even if all you invest in are mutual funds or index funds, these comments should apply to you too.

Your Portfolio Looking Good?  What To Take Advantage Of When Markets Are Up

OK, let’s get practical.  Forget about why.  Stocks are up.  Unless you’re a strict dollar-cost-averager (and you might still also have a dollar-cost-averaging plan going on in your portfolio), now is not the time to be adding to your stock portfolio (unless an individual stock on your watchlist is for some reason not performing along with the market).  Consider these financial moves instead:

  • Revisit your foreign currency needs.  Do you frequently need to buy euros, pounds or Yen?  Wild swings in the markets produce shifts in currency balances.  In a risk-taking climate, some currencies naturally fare better than at other times.
  • If you have been waiting to cash out of certain stocks or funds, now is a good time while prices are back up
  • Thinking about buying gold? Up markets are better to do it in, since they often go hand-in-hand with consumer confidence and risk-taking.  Don’t wait to buy gold until fear sets in and even your neighbour is talking about it.  You might have some very long waits.
  • Make use of rising dividends and use the cash you would have invested in order to work on other aspects of your portfolio: savings, debt payments, emergency funds, home repairs.
  • Rebalance your portfolio – with any major shift in the markets, take a look and see what’s out of whack.  If stocks are up, it might be a good time to buy bonds.
  • Start developing some side income and/or increasing your main income – whether it’s a small business or other project – so that it’s there for some more income security in tougher times.

When The Economy and the Markets Are A Mess

If dividends have been suspended or cut, jobs are disappearing and home prices have fallen, you’re in a downtrend.  The downtrend might also only apply to a certain sector or region.  But in general, doing many of the opposite things done in an uptrend make smart choices here.

  • Currency: you might want to wait before converting your money, depending on which currency benefits when.
  • Stock watchlist: what’s on sale?  Find out why and do your research.  Still a good stock?  Load up!
  • Don’t sell your gold.  Gold acts like insurance.  Hold on to it.  It’s probably rising in value if the economy looks scary.
  • It’s always a good time to live below your means, but in harsh downturns it’s even more important.
  • Think about selling all that “stuff”  you don’t really need anymore as a way to make more cash.

The above schema is basically a “store your nuts for the winter” financial model.  But it’s built on logic in addition to mere fear or insecurity about the future.  For those die-hard “this looks too much like market timing” critics, I would only suggest that you can probably modify this model so that, say, half your portfolio is done through dollar-cost-averaging (eg., same amount invested every month) and the other half based on overall market trends if you can sleep with the extra layer of “active” investing it implies (even though, like I said, this is not a trader’s model – this is just about when to buy your stocks). Stock market cycles present an opportunity for wealth building, if you keep your head around you.

What do you think, do you already put something like this into practice?  Can you think of any good revisions/ suggestions to add to it?  I’d love to hear your feedback.