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Cash Flow, Timelines and Emotions

Cash Flow, Timelines and Emotions

July 15, 2022
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Scott Smith, our Owner/Advisor has some encouraging words to share about the current Bear Market and investor emotions. 

The current Bear market hitting stocks is the 6th one that I have experienced as an advisor.  My first was the Dotcom bubble in 2000, which was closely followed by market turbulence following the terrorist attacks of September 11th in 2001.  Then came the housing market crisis of ‘07-’08. 2018’s trade war and interest rate-fueled drop technically avoided the bear definition, but only barely.  More recently there was of course 2020’s pandemic-driven selloff.  Each one of these periods of market decline had its own circumstances, but they also had a lot in common – most notably that they all recovered. 

 

What is a Bear market?  Bear markets are commonly defined as a drop of at least 20% in a broad market index. They occur with a rather surprising frequency (as noted above), but there are also numerous market driven corrections of 10%-20% which frequently hit the markets. In fact, there have been 39 of them in the last 72 years.  You would think something this common would eventually lose its power to unnerve investors, but after 30 years in the business I realize that is not the case.  Each time can feel like the “first” and the “worst” all at once -The ugly reality of opening a bad month’s account statement feels very real. 

 

Yet, through all the market volatility I would argue that on any given day the stock market is mis-priced, even when things are going well.  The value of any stock is always too high or too low, and if it happens to be “correctly priced” it is by accident and quickly passes.  As soon as a statement is printed it is already outdated, but the emotions emoted from the pages can be very hard to ignore.

 

The emotions that come with the volatility are really the dangerous part of market drops.  Objectively, since every correction and every bear market has recovered, logic would dictate that trusting a well-built portfolio to weather the storms and ride out the volatility is the obvious choice.  As we’re all too well aware, our emotions can be a very loud interference to logic.  I have long believed that the real value that we bring as advisors does not necessarily lie in the technical aspects of investing as much as it does our ability to act as a “firewall” between our client’s emotions and investment decisions.  When it comes to making good investment decisions, emotions simply are not our friend.

 

As someone who has spent over three decades (32 years this December) learning about the emotions of investing, I have concluded that the key to getting through the volatility is to have the correct focus and ask the correct questions, and I believe the list of questions is very short:

 

Is there anything that I need to sell right now?  I believe the answer to this question comes down to cash flow, and in fact I think all financial planning comes down to cash flow in some way.  Do you need to sell anything right now to take cash from your accounts?  Time horizon and cash flow are directly related to risk tolerances and to portfolio construction.  A twenty-year-old can take a lot of risk in a 401k because the time horizon is so long.  But a retired client drawing income does not want to be at the constant mercy of a 100% stock portfolio.  Therefore, proper planning and portfolio management dictates that liquidity and cash flow be a central priority.  If your current portfolio has enough low risk, low volatility and dividend producing positions to fund known cash flows for a year or more, then there is absolutely no reason you would need to sell good companies during a downturn.  Your well-planned cash flow allows the portfolio time to recover from the storm.  You don’t need to sell at or near the bottom.

 

Is there anything I should sell right now?  To be blunt, I believe the answer comes down to whether you are holding losers.  When I say losers, I mean companies or securities that have little prospect of recovery.  I mean bad companies.  I do not mean good Blue Chips with strong cash flow who never missed a dividend payment.  It is a mistake to hold onto a loser with no prospects, and equally a mistake to sell good companies because of a temporary problem.  If the first question of cash flow has been properly managed, then the important value of a stock is its 2-3 year forward outlook.  Sometimes we need to ask, “Do I think we have a future?” and if the answer is yes, you plan for it.  You don’t dump quality companies because valuations are artificially low.  If you hold quality, you should not sell at or near the bottom.

 

I understand that I am oversimplifying a subject that is complicated.  But when emotions threaten reason, proper perspective and focus are essential, and obeying simple and straightforward principals can help us do that.  Simplicity brings clarity, and right now given the state of the world, clarity is needed.  As we navigate through the current market volatility, these two simple questions should remain in focus.

 

If you or someone you know has questions about the current market
state or need some financial guidance, please give us a call. We are
here and ready to guide you through this.


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