What to Do with Your Growth Stocks in Case of a Market Crash

A little over a week ago, the S&P 500 was riding high after advancing for nine of the previous 13 trading sessions. The S&P was well atop its rising 25- and 50-day moving averages and trading just below all-time highs. Investors were relaxing a bit after the April/May correction that sank some growth stocks and pulled the index back from its stubborn 2,100 resistance level.

Then boom, boom, boom, faster than you can say “Brexit, Fed and Presidential Election,” the market was back below 2,100 and below its 25- and 50-day moving averages. And investor anxiety spiked. (Here’s a daily chart of the S&P 500 with its 25-, 50- and 200-day moving averages.) 

Given the way the market has acted over the past year-and-a-half, you can’t blame investors for being jumpy. Over that time, the market has followed every one of its rallies—October/November 2014, February 2015, October 2015 and mid-February through mid-April 2015—with either a major pullback or a long period of sloppy, range-bound trading. 

Behind all this tension is the fear of another market crash.

Investors who have been in the market for 20 years or so (which is to say, those who are getting close to retirement) still have the scars from both the Tech Bubble meltdown that started in 2000 and the 2008 bursting of the Housing Bubble. (Here’s a chart showing the trials the Nasdaq went through, including its failure to permanently get back on top of 5,000. That’s 16 years of no net progress.) 

Those twin events have created a kind of permanent post-traumatic stress disorder for equity investors. You don’t have to scratch too deep in the psyches of today’s investing veterans to find a layer of sweaty anxiety about the potential for big downside moves. 

Many veterans have reacted by avoiding the markets altogether. Individual ownership of stocks hit an 18-year low in 2013, and hasn’t increased since then. So, while around 52% of American families have some exposure to the stock market (via 401(k)s and IRAs), most of that money defaults to ETFs and index funds. I think that’s sad. 

I’ve also seen stories about a surge in sales of fireproof safes in Japan. The thinking seems to be that if having money in a bank isn’t going to pay anything (and with interest rates in negative territory, it may actually cost something), you might as well keep the cash in a safe place. And one major investment house says that cash levels among investment managers are at their highest levels since November 2001. Even the pros are nervous! 

With all that background out of the way, we get to the Big Question: Is the Stock Market Going to Crash? 

First comes the mandatory disclaimer (which is more than you will get from the sensational click-bait alarmists of the financial internet). I have no certain knowledge of what’s going to happen in the market, and neither do the people who are predicting its demise. 

What I do know for sure is that markets are in a long-term uptrend (sideways-to-up, if you want to slice hairs), and I don’t see any potential catalysts on the horizon that look like market back-breakers. 

But I don’t have any more insight into what the market will do than any other non-economist. And my many years writing about growth stocks have convinced me that trying to predict the market is a useless activity. 

What isn’t useless is planning for how you will respond when the market does whatever it does. Do you have a plan in place if a crash does come? Do you know what to do if the market shakes off its recent weakness and heads to new all-time highs? 

The answer, at least for growth investors, is to watch the market for weakness. You don’t have to predict it, just watch it. 

If the market actually starts to break down, the only decisions you need to make are about the growth stocks you own. 

Since you have already made a habit of recording the buy price for each of those growth stocks and have calculated the 5%, 10% and 15% loss limits, you are all set. When the market (as represented by the S&P 500, the Nasdaq and the other major indexes) falls below its 25- and 50-day moving averages, you start to monitor your stocks like a helicopter parent. And if any stock shows abnormal weakness, tripping one of your stops, you sell it. Maybe you do some preemptive profit taking when the market changes from bullish to bearish. But you certainly don’t hold any stock that falls out of bed. 

Brilliant! This strategy relieves you of worrying about what might happen in the market. It grounds your investment decisions in reality and keeps you in sync with the market. And you can happily watch any market correction from the safety of cash, which is a great comfort. 

This strategy has very little to do with the parts of your portfolio that have income stocks, core holdings, dividend stocks, value stocks or any other longer-term strategy. You manage those holding using the rules for that strategy. But for your growth stocks, Cabot’s time-tested system—market goes up, you get in; market goes down, you get out—can give you the confidence to aim for big returns, knowing that you won’t get blind-sided should some prophet of market doom accidentally get a prediction right. 

Fortune Cookie 

Here’s this week’s Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion buttons here. 

“Beneath the rule of men entirely great, the pen is mightier than the sword.” 

-Edward George Bulwer-Lytton 

Tim’s comment: I was in Washington DC, gazing at the multitude of quotations on the ceiling of the Library of Congress last week, when I found this. The latter part of the quotation is famous, but the former is not, even though it narrows and refines the sense of the famous part. I see little connection to investing, beyond the hope that if the world can eventually be ruled by men (and women) entirely great, military budgets will shrink, and with them, the opportunities for investment in the sector. 

Paul’s comment: Bulwer-Lytton is famous mostly among literary types for writing, “It was a dark and stormy night …”, the opening lines of his 1830 masterpiece Paul Clifford, a notoriously bad novel. He is also the inspiration for an annual competition that bears his name to see who can write the most convoluted opening sentence for a hypothetical bad novel. But his famous sentiment about the relative power of writing instruments and weapons is a good one to keep in mind in this chaotic world. Ideas (the pen) win in the long run, but unless good people are governing, force (the sword) is the one to bet on in the short run. As Tim says, there’s not much grist for the investing mill here, but what the heck.

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