Dealing with Market Fluctuations
To Ape In or Not....That is the Question :)
My texts messages and dms have been ringing off the hook recently with questions from all backgrounds of folks asking about the state of the markets. The questions span things like “Oh my god is this the end” to “So many stocks are cheap I don’t know what to buy” to “Once the Fed announces rate hikes, this will normalize” to “Let’s ape in”.
To all of them I simply say, “I don’t know”.
But clearly that’s not satisfying enough so I figured I’d write this post so I can just pass it on to folks who reach out now.
Here’s my playbook for a market selloff:
Remove emotional bias as much as possible
Look at my liquidity needs over the next 1-2 years and evaluate my current positioning
Reevaluate my portfolio in terms of fundamental performance and future drivers
Reevaluate my portfolio in light of relative valuations, and absolute valuations
Research any companies/assets that look particularly compelling on the drawdown
Act….or sometimes more importantly Don’t Act
Removing Emotional Bias
Why is this the first step? Because one thing we all have to realize is as humans we have clear behavioral tendencies. We suffer from loss aversion, overconfidence, confirmation bias and much more. Throw on top of that the actual pain and nervousness that we experience from seeing a dramatic pullback coupled with the remnants of FOMO/greed from the recent gains and you have a juicy cocktail.
So before doing anything, it’s important to try and remove as much emotion as possible. This could be stepping away from the portfolio for a few days, talking with others, practicing deep breathing…whatever works for you. For me, it usually takes about 2 days during a sharp selloff to get into this state of mind even if the portfolio continues dropping in that time frame.
Evaluating Personal Liquidity Needs
I invest my personal capital to save for future wants/needs of my family and I. Because of this, losses in my portfolio have a real cost. Say I wanted to buy a house and was counting on proceeds from selling equities or was planning a nice trip that I hadn’t budgeted for in terms of near term savings. Those things may need to be postponed, cancelled, or still may be worth doing by selling for a loss. I need to understand my liquidity position to evaluate next steps. If I have a near term need on the horizon, then I should figure out how much I want to sell for a loss. If I have no near term needs, then I can figure out how much I can add to my savings and think longer term about the portfolio.
Reevaluating Portfolio’s Fundamental Performance
Now that I have figured out if I have the ability to hold my assets in their current state, I move into looking at my portfolio with “fresh” eyes. I go back and read recent transcripts, look at financials, look at product releases, and determine if I still fully understand the drivers of past business performance and what will continue. What outcomes am I still underwriting at the current valuation regardless of where the stock/asset came from. This is fun since its a way to refresh some of my “stale knowledge” as perhaps my research waned as the asset prices went up leading to confirmation bias of my thesis.
BTW I do this for my crypto holdings too. I truly mean doing this for all assets. For me, when owning something like The Graph, I want to reread how many queries were run, what sort of use cases is the protocol enabling, how has the ecosystem evolved, and then decide if I still believe in the long term vision.
Reevaluating Portfolio in Relative and Absolute Valuations
I had a post on Absolute and Relative Valuations in the past that could be good to read. Once I’ve relooked at the fundamentals of my companies, I have an understanding of what I believe about the businesses. In the meantime, all the other businesses that I was interested in also happened to come down in valuation. So its not just a question anymore of is this company that I’m currently holding still going to do well, but also if in comparison to opportunities available, do I still believe this is the best to own. I usually have a list of companies that I loved but couldn’t touch for valuation purposes (Snowflake, Amplitude are recent examples). I still know those companies well but now have the chance to look at them at new relative valuations compared to what I currently own and also at absolute valuations. What do I expect to earn owning these businesses over the long term. In many cases, one can fall for the “used goods” syndrome where you want to dispose of what you currently own for the new and improved. Being methodical and process driven, helps avoid this.
Research Any Companies That Look Particularly Compelling
Perhaps there’s a company that looks too cheap to me, cough couch Everbridge :) If that’s the case I then want to look into why I think the company is cheap vs what the market is indicating. What did I miss, what is the market reacting to, and do I have a good view on why I should be thinking about it differently? Is this a deal that I’m getting because the market is selling everything in one area without abandon?
These are the questions I try to answer. This fits into the Relative vs Absolute comparison but I think it warrants its own bucket because of the fact that this actually looks like a potential bargain on all factors that the market is offering. There shouldn’t be many of these but if you identify a few then they’re worth spending more time on.
Finally To Act or Not
All of this work then brings me to a stage where I’m ready to Act. And sometimes like what I’m currently doing right now, inaction is the best action. After I went through all of the steps above, I realized that I think my current portfolio of companies and assets is still quite attractive and something I want to own for the long term even in comparison to other movements in other companies, securities, assets, etc. Therefore, I’m sitting on my hands as I don’t have any near term liquidity needs and luckily have enough cash savings for now to cover what things may come up.
In other scenarios I did act. For example, in March 2020 when the market tanked, I sold a lot of companies that I didn’t think would benefit from the new environment and up-leveled my portfolio for what I thought would.
In general, the key to figuring out what to do during a market selloff is to control the immediate impulses. Try to get to as neutral of an emotional position as possible so you can try to approach the situation from a rational point of view. All of our biases will be still be there trying to exert their influence, but if we have a process that we follow, we will be in a good position to figure out what is the best course of action.
WAGMI!
(We all are going to make it for the non-crypto initiated :)