Your Volatility Playbook

On this week’s show, Karl discusses the return of volatility.  And with it, the stock market sold off hard this week.  So, what to do?  Do you trade it?  Do you ignore it?  Karl will break it all down.

Transcription:

Hey, welcome everybody to the podcast. This is The Eggerss Report. It’s your investing playbook. My name is Karl Eggerss and we come to you every week to help you out in the world of finance, your personal finance, which covers financial planning, when you can retire, things to consider, if you should retire, social security, Roth, conversions, 401(k), should you do pre-tax or Roth 401(k), what’s your allocation, all those things we cover and then we also talk about the markets. And when I say the markets, well that was front and center this week. We’re going to get into that. Give me a call at 210-526-0057, if you would like a question answered or if you need any help in your particular situation. Our website is EggerssCapital.com, E-G-G-E-R-S-S-capital.com, and we’ve got a bunch of stuff on there.

Also, we’re on iTunes so you can give us a rating on there, would be awesome if you listen to iTunes podcasts. And then, as well, we’re on Stitcher Radio, we are on iHeart Radio, we are also on Spotify so you can find us on there as well, or you can just come straight to the website. In fact, if you want any of the stuff we do sent to you automatically, all you have to do is go on the website, go to the blog page, and sign up for it right there. Just put your name and email in and every time we put something out, you will get that. I did two radio interviews this week due to the market volatility, usually it will end up being radio and TV, for some reason the TV station didn’t call, but they usually do because they only seem to want to talk when things are going kind of bonkers, which they were this week.

So lets jump right in here as we wrap up this week. Happy Saturday morning to you. Lets first talk about what was moving this week and then we’re going to talk about, of course, the why, what you should be doing or not doing, as that’s always important. And so we’re going to tell you kind of what some of these things were doing as they were moving around in a pretty violent fashion. For the most part, we started to see some weakness recently with certain areas but it kind of came to a head this week as we saw volatility explode. Up 60, 70, 80% in that realm. We also saw a gold finally work, right. The gold miners, which we’ve been talking about on here for a while, that we liked them and we liked them because they were so hated, they really technically were setting up nicely and so we have some allocation to gold miners in our aggressive strategy. It’s not a big piece but enough to be happy on a big down day when it was up on Thursday. But for the week, the gold miners were up about 6%.

we also saw, kind of interesting if you look at what was working this week, some of the international stuff was working. And we actually went in on the melee of Thursday, we went in and bought an international, specific country, ETF on Thursday as we continued to like that area. We saw Brazil doing well this week, India doing well. Some specific countries did okay and of course, treasury bonds. Everybody’s been worried about rates going up but treasury bonds actually did well this week and rates went down slightly on the ten-year treasury. The TLT, which is the treasury bond ETF that most people trade, was actually up for the week. And as I mentioned, gold was up about one and a half percent or so. Pot stocks, they were actually up on the week as well. And then we started to see the other side, which is mostly what everything else was doing in the red. Banks got hit the hardest and especially hard on Friday.

They started out in the green on Friday after we got reports from Wells Fargo, JP Morgan. Which, by the way, we own Wells Fargo in our dividend plus strategy for full disclosure, but the banks got hit. As the earnings came out, they were pretty good. I think people were wanting to be blown away by them, they weren’t and we know we’ve had this flat yield curve and banks do very well when they can borrow at low rates and lend at high rates. And that would be a steepening yield curve. Now that’s just happened in October so if the yield curve stays steep the rest of this quarter or steeper, maybe the banks will have some better earnings but the banks are probably one of the more oversold areas in financials in general. So they had a really rough week, down 7%. The transports were down about 7%, railroads. The industrials down about 7%. Aerospace and defense, which we think is a over loved area as well, got hit hard.

A lot of these things, by the way, broke out and it’s what I call a “fake out, break out”. Aerospace and defense was flat all year long and then broke out here in the last month or so to new highs and then has reversed and come back into that box. And that area remains expensive. Insurance companies got hit. Anything high beta got hit. Obviously technology got hit, bounced a little bit on Friday, the Russell 2000 got hit down about 6%. Biotech down about 6%, it goes on and on. As far as the major indices, you know 4 or 5% and that’s including some bouncing around. We saw on Friday, by the way, we saw Dow Jones reversal up about 400 points at one point, then goes negative. So volatility doesn’t seem to be over just yet but everything down between 4 to 5% this week on average.

Now, let’s run through the week quickly and we’ll talk about what were some of the headlines, what was moving and then we’ll get into what we do about it. Monday the stock market was down early but reversed. Pretty nice reversal, just wasn’t necessarily strong enough. Bonds, rates went up and even though treasury, the ETFs were trading, the bond market was closed for Columbus Day so we kind of saw maybe a precursor to what was coming because the ETFs were trading. Tuesday the IMF, the International Monetary Fund said the world economy is plateauing as they cut their growth forecast for the first time in more than 2 years blaming trade tensions and stresses in emerging markets. So that was kind of a big deal because … And by the way, as they were talking about this, they lowered their growth rate from 3.9% to 3.7%, so again, the first downgrade of growth since July of 2016, about two years.

That was something that kind started to get the selling going. The stock market fell again but recovered but overall, the average stock was still falling so we’ve seen these days were the Dow Jones looks okay but when you look underneath the surface, a lot of internal stuff was kind of getting beaten up a little bit. And tech, continuing to get hurt, and then obviously rates going up. Now Wednesday, this was the big day. The Dow Jones fell and then it fell and then it fell and then it fell. The Dow Jones fell over 800 points on Wednesday. Obviously volatility exploded higher. The NASDAQ 100 had its worse decline since August of 2011. Remember August 2011, I refer to a lot, that was a time where markets were moving 4% per day, that would be 1000 Dow points right now, every day for four days in a row. That was August of ’11. That was when we had our debt downgrade, a lot of volatility in that period. Now that turned out to be a correction so keep that in mind right now.

Now the NASDAQ 100 was down 4.4% on Wednesday, that was a big, big drop. The S&P, this was, by the way, for the S&P, this is the 23rd correction of greater than 5% since March of ’09 low. Think about that because doom and gloom, CNBC, markets in turmoil, headlines coming across, this is the 23rd greater than 5% drop we’ve had since March of ’09 on the S&P 500. And they all kind of seem like the world’s ending, right. And I’m going to get to why I think this is happening but keep in mind that, again, we typically have some type of double digit draw down in the middle of the year. That is a normal occurrence going all the way back into the 80s. So for almost 30 years of data we can see that drops are normal, they are normal. What’s happening lately in the last years is they’re a little more violent and quicker and we’ll talk about that in a second.

We also saw an inventory build and that’s when oil started to kind of reverse. We got the volatility index over 20 and it went up over 43%, that was the 12th largest jump for the volatility index ever. But we did see gold and the gold miners up slightly. Now, this is what got the week interesting. Trump said the Fed’s gone crazy, a little loco and we … And by the way, I was asked hey, do you think this is a one day event? I said these types of drops like this are never a one day event. That doesn’t mean you can’t make money on the upside or downside, but they’re never a one day event. It shakes too many people up for selling. So think about that. Wednesday, you get home, you don’t pay attention to the markets, you look at your 401(k), you know the Dow’s down 800 and you say I think I need to take some off the table. You click a button, you move some of your mutual funds to the stable value fund. What happens? Those orders don’t get done right there because they’re not going to get done until the next close, that’s how mutual funds work.

So the mutual fund managers thus have to put in sell orders. Well they don’t have to do it immediately, they’ve got Thursday to do it. So the market opens lower, reverses, actually goes up on the day but it just didn’t feel like the selling was over and sure enough … And when it didn’t quite recover and started to fail a little bit … boom … around 1:00, 1:30 central time, all hell broke loose, to be honest and the market fell 600 really, really fast. Extreme volatility, extreme volatility. And we saw some of the biggest selling, lopsided selling, one-sided selling we’ve seen since 2015. Now, here’s the thing, when Trump said the Fed has gone crazy, I was asked to come on the radio the next morning and talk about this and the host, Trey Ware … who I’ve become friends with over the years doing his show every Monday morning if you want to listen to that, it’s usually at 7:20 central time, is when I come on for about 5, 10 minutes … and he said look, I agree with the president, the Fed needs to stop raising rates. They’re raising them too quickly and they’re going to squash this recovery that we’ve got going on. and I said I disagree.

I don’t disagree that they could squash it, I disagree that they are squashing it. Is the President setting this up to really in case the economy starts to slow, in case we go into recession at some point in the future, in case the market falls, that he can blame somebody? Is he trying to make the Federal Reserve the scapegoat? Probably so. Look, he’s a guy that borrows money. He lives a leveraged life his whole life. He’s a real estate guy. Lever up. He likes low rates. We all like low rates if we’re borrowing. If we’re lending we hate it. Of course nobody wants to see rates go up that fast, but it hasn’t been fast. When Trey told me hey I agree with the President they’re raising them too fast, I said whoa whoa no they’re not. When did they start raising them, December of 15 I believe it was. Here we are at 2.25%, 2.5%, wherever we are two years later. That is not fast. In fact, many models that I study suggest they should be at 4% not 2.5%. They’re telegraphing what they’re doing. They’re raising them .25 point every six weeks.

now, here’s the issue, and this is what I said on the show. Could they go too far? Could they raise rates too much? Yes, they could do that. They’re probably going to raise them in December. They’re projected to raise them four times next year. So could they raise them another 1.25 over the next year, they could do that. That’s only a problem if the economy starts showing more and more signs of slowing down, which there are some people pointing to some things starting to slow a little bit. Auto sales, home sales are slowing a little bit. They’re not going backwards, but they’re slowing a little bit. Excuse me. But we’re not near a recession, but people are really starting to look at yeah but are we going to be able to keep this speed up. We’ve had an injection of tax cuts. We’ve had an injection of cutting red tape. Are we going to keep that up, or are the comparisons going to get slower.

What they’re referring to is if you’re growing at 4%, and then you grow at 3%, and then you grow at 2%, that still may be okay but you’re decelerating. The stock market tends to go down or struggle when that happens. That’s something we’re going to watch, but I think the Fed’s going to watch that too. Even though Jerome Powell, head of the Federal Reserve, didn’t say that hey I’m data dependent, because that’s what Janet Yellen used to do, we’re data dependent meaning we’re going to see how it goes. J. Powell came out and said, and this was backed up by somebody else at the Fed, that, and these weren’t prepared remarks by the way, this was just off the cuff, but he said, “The economy is doing so well we’ll probably tighten past neutral.” Well, here’s the debate … So that scared people, but here’s the debate. What is neutral? Is it 4%? Is it 2%? Is it 5%?

he’s looking at a lot of different things. We don’t know exactly what they’re going to do, but I’ve been saying for a long time that one of the things that could derail this market and maybe the economy would be an overly aggressive Fed. Remember, we’ve talked about that. That could be an issue, but it’s not an issue now and the President is acting as if it’s an issue now, and it’s really not. Remember, he says outlandish things to really get people to listen and that’s just his personality, and he does it for negotiating at times, and there’s all kinds of reasons, but remember J. Powell was the smartest best guy six weeks ago, President Trump said that. Then here we fast forward and now he’s loco, crazy.

Just take all that with a grain of salt. I don’t know if all the sell off is just because of that. There was some divergences building. We talked about new highs, new lows. There was some stuff building. Nobody ever knows the Dow is going to drop 1300, 1400 points in two days, which again look at it in percentage terms. Bad sell off, but not as bad as we’ve seen in past years either, but one of these issues we seem to get two to three times a year. This is starting to feel normal is it not. I mean we can go back to January February of this year and we had the same type of deal except those were 1000 point drops, so we seem to get these.

Then you go back to 2016, really nasty nasty January, 2015 we kind of had flash crash 2.0, really nasty summer. 2014, what happened, October of 2014, four years ago, we’re ending QE. Remember that, when the market went through this hissy fit because it wasn’t going to get all the stimulus anymore. Now the Fed has been raising rates and we’re not quite at a tipping point, but maybe the market’s starting to go okay long term rates are starting to go up a little bit, about 3.25%, short term rates are going up, we don’t like this. There is an adjustment period to it, but it’s all about can the economy handle it. The growth can handle these rates. It can handle future rate hikes. That’s what we’re talking about in the fit. The President is talking about present and past, and I think he’s wrong about that.

The risk to you is they raise rates too far too fast. The other risk to you, and we’ve been talking about this for weeks, is this market is becoming expensive in certain areas, technology primarily, and you’re seeing it get hit the hardest, and I would say plain Jane industries, which are controlled by those same tech companies primarily. I saw a stat earlier this week that essentially said 40% 50% of the gains before the market peaked here last week were attributable to just a handful of companies. We’ve got that, those two areas are vulnerable, and there’s expensive areas. Here’s the thing though, in a down draft like we got this week there are areas that get beat up that aren’t justified, that should not be beat up, and that are good deals. We’re not seeing yet the divergence of okay well the expensive stuff is getting hit and the high quality cheap stuff is getting a boost. We’re not seeing that yet, but that’s your opportunity.

If you buy stocks, individual stocks, look for those cheap stocks that are beaten up already. They’ve already gone through a barren market, very low expectations. A little bit of tick up in expectations and you make a lot of money. Maybe not in the next month, but over the next two years. I think you can make some investments here. Again, be careful. If you’re talking about mutual funds looking at value verse growth, but just because it says value look inside the fund. What does it own? How does it operate? The ETF, the fund. You can obviously use stocks to do that to where you can dig down and go find some profits by the pound. That’s what we’re trying to buy. We’re trying to buy companies that are producing excellent profits that the sentiment is really bad, everybody hates it. That’s what you want to pick up right now.

I don’t want to buy a company that’s priced to perfection and relies solely on more investors coming in to buy it because they can get hit really hard, ala Facebook. Which Facebook we’ve been talking about, and look Facebook I said it was one of the companies of the fame that I was most worried about compared to I though Netflix and Facebook were the two vulnerable ones. It’s down 30% from its high, very quickly by the way. Be careful of that type of stuff, but I still don’t think we’re in a bear market. Bear markets don’t end this way. We’ve talked about that. This can be scary, but the thing is if you are not a forced seller don’t sell in this environment until you get higher levels.

Now what happens, and this is kind of a pattern, you get the first wave of selling, do you have to sell, the answer is no. Okay, then you inevitably get some type of bounce. We got bounce Friday. You may get further days of that. Sometimes, and it can take weeks, days, months, we don’t know, but it tends to test the lows. You can trade in here. And I’ve been getting a lot of questions about that. Like well why don’t we just buy stuff that’s going up and sell stuff that’s going down? Man that sounds easy. I wish it was that easy. But what happens is the stuff that’s going down can violently turn up quickly. You know emerging markets were up almost 40% in 2017. Then in 2018 they’re having an awful year. I like emerging markets. They are cheap. Everybody goes well why don’t we just wait til they start going up to buy them. Because you won’t. You won’t. By the time you feel comfortable buying them they will be 20%, 30% higher. That’s the way the markets work, so you have to buy into fear.

If you’re doing investing, see that’s the difference here, we’re talking about two different time frames. If we’re talking about trading, which is a whole nother animal, and we do some trading and we do some investing. For most of our clients we’re doing investing. We’re changing allocations, we’re managing risk, we’re getting income, but of course we do some trading. I told you on Thursday we went in and bought. There were some things we bought that were literally going down so fast that I like to say on the chart the volume, the volume bar that you put on a chart, was touching the price. That’s when I go okay we’re going to get a bounce here, and we can trade something. So there is trading and there’s investing. Investing I’m not going to get as cute with. I’m going to average into it. I’m going to buy more of it on the way down when I feel good about it. On the flip side, something’s momentum, I don’t like the value, I’m going to get out of it. I may miss some of the upside in there, but I also don’t get caught … Excuse me … with my pants down.

That’s what’s going on right now. Now, let’s talk about why these moves are happening like this. I’m not talking about rates going up and all that, just mechanically why do we seem to get more violent moves. Well number one, again keep in mind the Dow is at 25,000 so a 250 point move is 1%. 1% moves are fairly common. The fact that we went so long in the last few months without one, that was the uncommon part. Not the 1% move. 2% less common, 3% less common, 4% less common right, we know that. But in terms of the points, oh my gosh the Dow is down 100. That’s very different. The Dow down 100 is not the Dow Jones at 10,000. We’re at 25,000, 24,000. We’re in those ranges. So keep that in mind, but there is some movement going on faster than it used to.

We know it’s technology algorithms. We know there are private equity firms out there, trading firms, that they hire telecommunications people. They don’t hire Wharton business grads that are looking to find great balance sheets. They’re finding telecommunications experts and programmers to find anomalies in the market, to trade faster, to trade smarter, to do computer programming to say if you see this word, or if it hits this level and these conditions happen, sell it hard. We saw that Thursday. We saw it cascading down very quickly. Faster than any human can go in and sell stuff. That tells you that all the stuff flash crash 1.0, which was in 2010, May of 2010. Then we had flash crash 2.0, which was in August of 15. That’s probably your biggest risk right now. The risk of the market rolling over and becoming a bear market, there’s time to adjust. You can do things. You can kind of see some things deteriorating. Markets don’t peak like a mountain top and then crater.

If they do, then it turns out to generally be a correction. Could be a violent correction of 20%, which we saw in 2011 right. We saw that in 2011, a 20% drop, but it was still a bull market. I think your biggest risk is more of these flash crashes where they cascade down than anything. That can be used to your advantage to go buy some things, to trade around it. Because again, some people are getting scared out of stuff, okay? To me, I think we have a bigger risk of an ’87, not necessarily 22% in a day but a big drop. I think we have that possibility more so than we have of an ’08 happening again. Look, could the Dow fall 2500 points in a day? Yeah it could. I mean look, we’ve had … If you go back to the ’08 financial crisis, it’s pretty crazy to look at some of the days we had that we’ve kind of forgotten about. We had 10 to 11% moves in a day. I mean, wild, huge moves. Now, when we get a 2% move, that’s 500 points on the Dow, we feel like that is just enormous.

Remember, the crash of ’87 was 500 something Dow points. We had 800 this week so it’s not the points, it’s the percentage. So keep that in mind. We are seeing faster action. The machines. The algorithms. All of this stuff. That’s what … look, hedge funds use the ETF’s like you and I do because it’s easy to get in and out. There’s mass liquidation sometimes. We seem to be getting these more frequently.

Once or twice, maybe three times a year. It’s kind of a similar type of situation isn’t it? I’m not saying it’s easy to navigate and I’m not saying I like it. But, it happens violently, and people kind of are like, “Whoa.” Then, you get some real volatility the next day and then it tanks again. Sometimes the third day is the day that the gains stick. You bounce a little bit. Then you come down and test the lows at some point and then you take off from there and you have this W pattern. Right? That’s kind of what it looks like.

Now, it’s not always that way. Again, keep in mind that we could be in the process of rolling over. I don’t think we are yet. But that’s a process that takes months. So, many people believe we still have the best parts of the market yet to come. The biggest gains. And I don’t disagree with that because that’s the way typically stuff happens. You kind of get this blow off top. It runs up. And then you start getting deterioration over time. You don’t make any new highs. I don’t know if we’ve had that from a sentiment standpoint.

You could argue, “Hey, the market’s been going up.” Yes, pockets of it have but we have a lot of stuff that has not lately. And sentiment hasn’t caught up. Yes, consumer confidence is high. But again I can take my own poll because when I go talk to people they are not uber bullish, trust me. Some are but most are not. Most are waiting for the next crash. And so when they get a 5% drop they go, “See.” Well, 5%, that’s vibration. If you’re invested in the stock market, you should expect 10, 15% moves.

You remember that interview, I’ll probably play it again next week, we did about the god portfolio? A gentleman named Wes Gray wrote an article and the essence of it was he went all the way back to the ’20s and he basically fast forwarded and looked in five-year periods I think it was. And said, “What were the best performing S&P 500 stocks? And assumed I bought those and what were the worst ones over the next five years and assuming I shorted those,” so he had the perfect portfolio because he knew the results. And of course, that portfolio rebalancing that every five years knowing in advance what was going to work made 40% a year.

But the key to it was the massive drawdowns that you had to put up with to get those returns. It’s not that easy to go, “Well, I’ll just sit it out and then when the market craters I’ll just buy back in.” It doesn’t work that way. I’ve never seen somebody do it that way. Ever. Did some people get out somewhere through the ’08 process and lighten up significantly because they got concerned? Yes. Were there some of those same people that got in when things were in ’09 and ’10? Yeah, but they’re rare. Trust me. Most people either rode through the whole thing or they got out too late and they still haven’t gotten back in.

Or, what most rational people would do is have a diversified portfolio, and I’m not just talking about eight mutual funds or eight ETFs. A real diversified portfolio. They lightened up when they started to see things deteriorating. And we were talking about it at the time by the way. And then they start going back in slowly as things are getting better. But there was such violent moves and if you remember the emotion behind it. You’d have days where the market was up 6, 7, 8%. You’re like, “It’s got to be over.” And then you’d come back and you were down 15, 20% on something. You’re like, “What in the world?”

It was a really frustrating time. It was hard. So, this is not easy. Don’t beat yourself up because this is not easy. But, what happens is if you can control your emotions and have some things you’re ready to buy when you get this violent moves, great. The other thing is, go into this having an allocation in terms of how much am I even going to have at risk? If it’s 30% stocks for you, fine, you’ve already determined that that 30% is going to put up with more volatility than the 70%. You’ve already predetermined that.

So, when it happens you shouldn’t say, “Well, I need to take my 30% to zero,” because what’s going to happen it’s going to go up and that 30% that was supposed to be at risk so you could make money over the long term, isn’t. So I think people mingle. And trust me, over the years I’ve had to sit back and think about this. How much trading do you do versus investing? I’ve mentioned this before. I know a lot of these guys on TV. I’ve talked to them. I’ve met them. I’ve done interviews with them. I’ve done radio with them. They all have long-term portfolios.

They may be in funds. They may be in ETFs. They have a sliver of what they do is real hardcore trading. A sliver of their net worth. And they talk about it on TV and you get the impression that their whole portfolio is trading and when they say, “Oh, we’re in all cash right now,” they’re talking about their trading portfolio which may be 10% of their net worth. So, you can’t take your whole net worth and go, “All into the stock market and all out of the stock market.” No, you’re going to have some income-producing things. Some bonds. You’re going to have some real estate. You’re going to have some non-correlated assets.

Do you have anything that actually owns volatility? Volatility exploded this week. Do you have anything in your portfolio that owns volatility? We have some and it’s a nice shock absorber to have when volatility explodes because we have the potential to have something that’s green. So, do you have anything like that? That’s diversification. But to take your whole portfolio and say, “I don’t like the market right now, I’m going to sit it out,” you can do that. But, you may be sitting out from 10,000, 11,000, 12,000 on the Dow. Right? That’s the danger.

So, what I’d rather do is build an allocation that makes sense. And if you want to lighten up, kind of calibrate it. Allocate it. Underallocation. All those, make adjustments, great, that is what you should do based on your situation. But everybody’s different. Everybody’s different. So, we’ve spend a lot of time on that. I wanted to see here, I did have some questions. I don’t know if we’ll have time to get to today.

Yeah, we’ll save some of these for next week. We’ve been running a little long here as we enter about a little over 30 minutes for this podcast. I appreciate you listening. I hope that’s helpful. Again, in the big picture I think we are still in a bull market. There are things to watch. I think the market before this past week, by the way, we started to see some shift from growth to value if you noticed that. So, I’m watching the screens all day tick by tick, which isn’t healthy by the way for any of us.

But, anyways, so I’m watching this and you could see there were some days when the Dow was down 200. There was a lot of stocks that were value stocks that were green on the day. A lot of them. And even when it was down 300 and some even 400 you still had green on the screen which is really interesting. But, as it turned into an 800 drop or a 600 drop, then the whole screen turns red. Right?

But, it was interesting to watch. Are we starting to see some shift out of the tech into some of these value  areas? We’ll have to see how that plays out. But it’s not a day-by-day thing. It’s not even a month by month. We’re talking something that can take years. Growth’s been outperforming value for years and it’s typically been the other way around. So, keep an eye on that.

All right, hey don’t forget to share this any way you can and don’t forget to ask me questions. You can email me at karl@eggersscapital.com. If you need my help or want to discuss anything 210-526-0057. We hope you have a wonderful weekend and thanks for joining us on our little markets in turmoil special. By the way, I joke about that because when CNBC has specials at night about this there’s a kind of Wall Street knows this, there’s a high correlation that we’re going to bounce the next day when you tend to get these specials running and things of that nature.

So, anyway, appreciate you listening. Have a wonderful week and we’ll see you back her next week on The Eggerss Report. Take care, everybody.

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