In the current environment, should I sell or keep my investments?
Invest in the current socio-economic environment
Structural changes in the socioeconomic environment cause changes in the levels of central bank rates
Do we live in an unrealistic world? Going over some of the events in the near past, we have observed an investment of the yield curve with possible recessionary implications, belligerent trade rhetoric between the US and China, technical recession in Germany, contraction of corporate profits, the tedious path of BREXIT, the debt situation in Argentina, the bankruptcy of Thomas Cook and a possible political trial against Trump, among other events. However, even in this environment, most of the main stock indexes are close to or have achieved new highs of the year.
It is not surprising that this climate generates doubts or reflections, and this question seems valid: Should I keep my investments or should I sell and leave? In reality, there is no simple answer since there are nuances and opportunity costs that imply different responses depending on the investment profile.
It is not only about what the market outlook is like since this is only a management starting point; asset allocation and a portfolio’s risk management are a core part of the investment process and, in this regard, there are no single or universal formulas appropriate for all investors.
To put it in context with a simple example: a hedge fund could impose limited losses on its investments, change its mind with some agility, etc.; and this situation would be diametrically different from, for example, a pension fund that has management mandates adjusted by actuarial calculations according to the flows that pensioners will need. Decision-making is different in both cases and different options do not mean that someone is taking an incorrect decision.
What is more, weighted or relevant? The opportunity cost associated with being out of the market or the cost of facing a correction and loss of equity?
Although the above applies to institutional investors, individual investors face additional challenges since they must balance the cost between financial capital and mental capital, which are different for each investor. Again, between these two cost perspectives, it is not possible to have a unique answer to the question of staying in or leaving equity investments.
The cost associated with mental wear and tear is part of financial literature but this concept garners little appreciation and is scarcely applied in everyday life. Keep in mind that financial psychology has taught us that the pain of a loss of investment is more intense than the pleasure of profits, so a priori it makes the opportunity cost (mental capital) of no longer winning cheaper than maintaining a position and suffering the losses. However, it is also important not to be tempted to take profits without a plan to invest again since, as we have observed in recent years, there are investors who have only considered the markets’ return to their trend bullish as a distant-future situation, and this has ironically generated new bullish movements driven by investors who are afraid of losing the rally.
Is glass half empty or half full?
The bad: Financial literature mentions that one must let winning positions run and cut losses quickly, but that aphorism does not take into account aspects such as valuation. From this perspective, market valuations continue to be demanding in long-term metrics (although the last few years have been exactly so), so potential returns could be limited.
The good: some variables suggest the possibility of a recovery in activity (some analysts even begin to mention a synchronised global recovery) and that should be reflected during the first quarter of 2020; central banks continue in an accommodative mood; trade tensions between US-China have lessened; and expectations are rising that various economies will embark on fiscal stimulus measures.
If equity has not fallen with the deterioration we have experienced since autumn last year, what will be the reaction when the macro variables or business benefits improve?
Is it wise to take benefits after an extremely positive year?
As you can imagine, there is no single answer. The individual answer should probably fall on the financial and mental cost. So we repeat a question mentioned above, what do I value the most? The opportunity cost of no longer earning in the market or the cost in my portfolio if the markets reverse the trend? In this regard, make sure you have a sufficiently robust methodology to reach sufficiently objective conclusions while trying not to mix feelings or mood with investment decisions as we mentioned in a previous article.
Remember not to judge your decision by the result outcome bias but by the decision-making process that led you to take a course of action, an important process when external factors and uncertainty are part of the formula. Nassim Taleb mentions that “an error is not something that will be determined after the fact, but in the light of the information available up to that moment”; in other words, a bad result cannot be automatically classified as a bad decision (and vice versa).
If the environment generates concerns either because the assets have exceeded initial expectations or because the assets have not reacted to the fundamentals that one initially raised, an important decision must be taken; hence we urge you to consult with your financial advisor, who can show you alternatives and products that allow you to more efficiently tackle your investment decision-making.
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