Pros just bought stocks while retail investors sold … the market perspective to remember … how convicted are you about your stocks? … you must prepare today

During the recent market turmoil, mom ‘n pop investors sold about $1 billion worth of their stock.

At the same time, what did institutional investors do?

They bought $14 billion.

If that doesn’t raise an eyebrow, consider this…

For retail investors, their recent selling clocked in as a -2.5 standard deviation move below the 12-month average for stock market orders.

But for institutional investors, their buying registered as a +2.9 standard deviation move above the 12-month average.

What’s behind this enormous differential?

Analyst Adam Khoo has a theory:

Short term price movement is largely manipulated by market makers and algos (and later justified by ANAL-lyst using bullshit reasons) … e.g. driving prices down to scare and force weak holders to sell… it’s like a game of poker… bluff the weak hands to fold their cards so the pros can grab their money and their shares more cheaply.

Today, let’s look at how to prevent this.

Whether Khoo is right or not, preventing a shakeout in your portfolio requires you to remember the most important truth of investing…

You don’t own a “stock.” You’re a partial owner in a business.

This distinction is critical.

In the short-term, prices can wildly decouple from the value of an underlying business. So, if price is your central focus, it’s entirely reasonable that violent selloffs would shake you out of your position.

But if your focus is on the underlying business itself – and assuming the business remains healthy – then the stock price is just an indicator suggesting one of three things:

• Buy more of the business if you want (when prices are abnormally low)
• Skim profits from your stake in the business if you want (when prices are abnormally high)
• Do nothing (when prices are somewhere in the wide middle, i.e., the majority of the time).

But what about stop-losses?

Stop-losses are another critical part of investing. If you’re a regular Digest reader, you know I’m a staunch advocate of using stop-losses. They prevent small, acceptable losses from snowballing into massive, portfolio-busting losses.

But stop-losses must be tailormade to each unique stock you hold. For example, a 35% stop loss might be appropriate for a volatile biotech that moves 10% a day, but it would be far too high for a low-volatility utility company that rarely moves 2% in a day.

But there’s an entirely different aspect of stop-losses that most investors miss…

Conviction.

Are you making a trade where the outcome is less certain? Is your “buy” decision based on a few technical indicators that can change quickly? Is your planned hold period just a few weeks or months?

If so, your conviction is wholly dependent on price and your indicators. That’s fragile conviction.

So, if price and your indicators move against you, you need to honor that shift via your stop-loss – and do so fast.

But for a company that you believe is a multi-year (or decade) hold, your conviction should be influenced far less by price, and far more by your awareness of the company’s operational strength.

You could take it one step farther. For certain stocks that you believe will be the bedrock pillars of your portfolio, your stop-loss could be qualitative, not quantitative.

In other words, your reason for selling wouldn’t be a depressed stock price; instead, it would be a material change in the business’s operations or ability to perform in the marketplace.

Examples of such “material changes” include a new technology that changes the game for your company, or perhaps new crippling legislation, or maybe an operational misstep so severe that it’s irrecuperable.

So, does that mean you should never reference a stock price as a basis to sell?

No. But you should be able to connect a falling stock price to that tectonic shift in your company’s operating landscape. If such a shift hasn’t taken place, then how do you know that the lower price isn’t simply a rare gift to buy more shares of a world-class company?

Take Coca-Cola…

Last fall, Coca-Cola investors found themselves at the bottom of a 17% pullback

This is an outsized move for the blue-blood beverage giant.

So, if you had purchased Coke as a trader earlier that spring, or if you had focused on fears of softer sales volume due to the explosion of weight loss drugs like Ozempic, then your holding conviction likely wouldn’t have withstood the selling pressure.

Like the mom ‘n pop investors who sold earlier this week, you might have jettisoned Coke from your portfolio.

On the other hand, if your focus was on Coke’s core operations and wide portfolio of products (many of which aren’t impacted by weight-loss drugs), then its price decline would have carried a different interpretation…

Opportunity.

Here’s what we wrote about Coke last October after suggesting readers should consider buying into the pullback:

Readers who viewed KO through an opportunistic trading lens are enjoying profits on a stock that is most certainly not going belly up because of a weight-loss drug.

Keep in mind, beyond its sugary drinks, Coca-Cola has an enormous portfolio of brands including Dasani, smartwater, vitaminwater, Topo Chico, BODYARMOR, Powerade, Minute Maid, Simply, innocent, Del Valle, and fairlife. Terrified investors who sold KO due to Ozempic fears seem to have forgotten this.

But…other investors’ fear is our advantage…

Since that Digest, KO shares are up nearly 30%, outpacing the S&P over the same period.

But what if Coke had continued to trade flat or down?

It would have been a good thing – and too many investors completely misunderstand this.

Let’s step back a moment…

Financial talking heads love to point toward the long-term average yearly return for stocks, which is about 10%.

What many investors don’t realize is that this 10% average assumes you reinvest your dividends. Without dividend reinvestment – looking at price action alone – that average return drops to 5.8%.

Don’t miss what this means. Roughly 40% of the S&P’s long-term returns come from dividends.

Now, there are two huge implications…

• First, stay invested to benefit from the power of long-term compounding (assuming you own quality stocks).
• Second, welcome lower prices in quality stocks because your dividends will buy you more shares of the business when prices are low.

Back in 2012, an analyst named Joshua Kennon analyzed Coke’s long-term returns with and without dividend reinvestment since 1962.

“Thomas” was the hypothetical KO investor who did not reinvest dividends. “James” did reinvest his KO shares.

Here’s Kennon:

Over the past 50 years, [Thomas] collected $136,270 in cash. That is more impressive than it appears because $1 in dividend income back in the 1960’s had significantly more purchasing power.

Adjusting for inflation, the current dividend equivalent of the cash income he was paid is $193,350.  On top of this, his 131 shares of Coca-Cola have grown into 6,288 shares of Coca-Cola with a market value of $503,103…

[James] reinvested all of his dividends over the years. He never added to nor took away from the position over than those reinvested dividends. 

Today, James is sitting on 21,858 shares of Coke stock with a market value of nearly $1,750,000.  His annual cash dividend income is nearly $22,000.

And how do you be more like James than Thomas?

By remembering that you’re a business owner, not just stock-price watcher.

What all this means as we bring the discussion back to today’s volatile market

Yesterday, the Nasdaq gave up a 2% gain to end the day down 1%.

Even though we’re enjoying a great rally as I write Thursday, yesterday’s reversal is troubling. It suggests heightened risk of more weakness to come.

Keep in mind, we’re headed into the worst time of the year for stock market returns. Historically, August isn’t a great month for stocks, but September is downright awful. If we were to annualize September’s average return, it would come in at -13.5%.

Then we have all the various market overhangs we’ve covered in the Digest in recent months which we won’t rehash today.

The takeaway is we might be in for some significant downward volatility.

This means you and I have some decisions to make right now…

Will we take the time to truly understand each of our stocks, therein either increasing our conviction in holding them, or helping us recognize that we’re not all that convicted?

In the first case, greater conviction should enable us to sail through painful market corrections without handwringing and sleepless nights.

In the second case, lesser conviction should point us toward the need to identify and implement appropriate stop-losses…which should enable us to sail through painful market corrections without handwringing and sleepless nights.

In either case, our goal is to avoid what happened earlier this week with so many scared mom ‘n pop investors – getting shaken out of quality stocks because the Big Boys want to profit from fear.  

Bottom line: A little preparation today will make all the difference tomorrow.

Have a good evening,

Jeff Remsburg