The World Share Market Changes Direction

Leaving work on Thursday was a weird experience. The major U.S. indexes had been up all day, and put on a little burst of speed in the final half hour of trading to finish with gains of well over 1% for the day. Emerging markets stocks (at least the American Depositary Receipts that I follow) and other world share markets were also up nicely. A good day all around. 

But as I left, I had a feeling that Friday was Christmas, but I didn’t know whether I’d be getting presents or just a lump of coal. 

The reason, of course, was that when U.S. markets rang the closing bell at 4:00, there were still two hours before the polling places in Great Britain closed and the news blackout on how the Brexit vote was going could be released. 

So, what I knew as I packed up on Thursday was that on Friday, world share markets would be changing direction, but not which way they would be headed. 

So now we know. 

Britain has voted to leave the European Union and equity investors around the world are not pleased by the news. On Friday, the major U.S. indexes opened lower, oil prices dipped and defensive sectors like gold were up. Investors were clearly running for the safest positions they could find. 

All of this turmoil isn’t happening because investors know what the consequences of Brexit are going to be. It’s the uncertainty that’s causing the stress. 

The easy stuff was priced into the market well ahead of the Brexit vote. We knew that the British pound would be significantly devalued, for instance. 

But the global economy is enormously complex, so there’s no way of telling what Brexit will mean for imports, exports, trade barriers, London’s position as a leading financial center or any other meaningful measure. If these effects could have been calculated beforehand, the market would have priced them in. 

For your personal stock portfolio, there is similar uncertainty.

World share markets are like a supercomputer that’s ingesting massive amounts of chaotic and contradictory data and producing one simple number, which is the price of a particular issue. 

For instance, just before the market opened on Friday, iShares MSCI Emerging Markets ETF (EEM) was trending down by almost 6%, while PowerShares Golden Dragon China ETF (PGJ) was down just over 3%. So even if the future was uncertain, investors believed that the outcome would be worse for emerging markets as a whole than for Chinese ADRs specifically. 

The market’s job is to discount (calculate the value for) everything that can be traded. And at any given instant, even if opinions about the future vary from wild optimism to deepest pessimism, the market coolly reduces all that data to one number. 

Cabot’s growth stock analysts (me, for example) don’t have any particular insight into the future. As a matter of principle, we don’t even try to predict market behavior. So you won’t get any advice from me as to where this obvious change of direction in world share markets will end up. But I can tell you with great confidence the two or three things you need to be doing to protect your portfolio from what’s happening right now. 

First, and definitely the most important, is that you need to have loss limits on every individual stock in your portfolio. And you need to use them. Without fail. Note: This doesn’t apply to your index funds or other mutual funds that consist of a basket of equities. The event risk for that kind of issue is much lower than it is for individual stocks, and they are part of a coherent strategy. Your portfolio should involve several different strategies, and you should follow the rules that apply to each one.

For your individual shares, however, nothing is more vital than cutting losses short. Know your loss limits and use them! 

Second, by selling your worst performers and raising cash, you are lowering your market exposure and insulating yourself from market volatility. A 30% to 40% cash position will allow you to enjoy life much more when markets are on the rampage. 

Beyond that, there’s not much to say. Deadline events like the Brexit vote can have a major effect on the world share market, but they don’t completely alter economic reality. Keep handling your stocks the way you always do, and keep an eye on the market. 

And if you want a trusted ally to give you sound advice, Cabot’s advisories have a wealth of experience to put at your service. Whether it’s growth stocks, value stocks, options, small-caps, income or emerging markets stocks, we’re a trusted partner and a great antidote to market jitters. You can find out more about us by clicking here. 

Fortune Cookie 

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

“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” 

-Henry Ford

Tim’s comment: Ford neither said nor wrote that; that is a paraphrase by U.S. Congressman Charles Binderup of Nebraska. What Ford did write, in his 1922 book My Life and Work is this: “The people are naturally conservative. They are more conservative than the financiers. Those who believe that the people are so easily led that they would permit the printing presses to run off money like milk tickets do not understand them. It is the innate conservation of the people that has kept our money good in spite of the fantastic tricks which financiers play—and which they cover up with high technical terms. The people are on the side of sound money. They are so unalterably on the side of sound money that it is a serious question how they would regard the system under which they live, if they once knew what the initiate can do with it.” 

Today, 94 years after Ford’s book was published, we are only eight years removed from the depths of a deep economic crisis. Was unsound money one factor? And is our current fixation on the actions of the Federal Reserve unhealthy? Ford’s comments are interesting! 

Paul’s comment: I’m never surprised when a quote is attributed to a famous source who never said anything of the kind. Whether it’s just faulty recall or an attempt to give the quotation a little extra cachet by attributing it to famous or more-credible source, all quotes and authors have to be taken with a grain of salt. 

But whoever said it, the notion that the general population would be horrified by what bankers, financiers, hedge-funders and others in the money industry get up to is absolutely correct. If you just think about high-frequency trading, mortgage securitization and the amount of leverage used during the Housing Bubble, you’ll probably agree.

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