Volatility spikes

Well the market correction is finally upon us. I’ve been flagging that a correction might be on the cards for the past couple of weeks, so I can’t really say it was totally unexpected. However, the speed and severity unfortunately has caught me off-guard and I went in to this week near fully invested. In hindsight, I should have been more cautious and kept hold of more cash, rather than just hoping to deal with it when it came. Lesson learned hopefully, but it’s useless dwelling too much on the past. What’s needed now is a game-plan for how to make the best of the current situation.

Why is this happening?

The sell-off seems to be fairly indiscriminate and is affecting most shares, cyclical and growth included. There are only a handful of businesses in positive territory in the FTSE today, and many of these are horrible businesses that have recently had profit warnings or are in financial distress (e.g. Capita, AA). Less liquid small caps and higher valued shares seem to be a bit more affected as you would expect. The one bit of good news for me is that the market sell-off has been accompanied by a rebound of the dollar against the pound, though this is only a small mitigating factor and I’m not sure how permanent this respite will be.

There don’t seem to be very strong fundamental reasons for shares to be selling off so much, as macroeconomic fundamentals are still largely positive. The main factor seems to be the prospect of higher interest rates, which would affect share price valuations. However, this seems more a fear than a reality at the moment. Clearly, the current sell-off is mainly sentiment driven. I don’t think this could really be described as the bursting of a bubble, as shares do not really appear overvalued. That said, the shift in sentiment seems to have been fairly severe, so it would be unwise to assume this will be a temporary dip. I’m pretty confident that high volatility will continue over the coming weeks.

What should I do?

In periods of high volatility, I don’t think that continuing to follow a momentum strategy is really a very good idea. This carries a significant risk of selling out on the lows and buying the highs.

The other extreme is to ignore the market noise and stay fully invested. This is the conventional wisdom, and for good reason. I believe poor market timing around periods of high volatility is a key reason why the majority of private investors do badly. Staying invested is a sensible approach and I want to be careful not to deviate from it too much.

That said, I think there may be a middle road of selling just a few stocks to raise some cash as a partial hedge against further falls. This feels like a sensible compromise to me. As well as providing a partial hedge, it also provides an opportunity to rotate into higher conviction and more defensive stocks that I’m more comfortable holding through further volatility. Also, having a bit of cash on the sidelines feels a lot better psychologically, as it makes me more ambivalent about whether the market rises or falls.

To benefit from this approach, I need to make sure I do actually buy back again if and when further falls occur. I definitely need to avoid getting sucked in to buying a short term rally. Patience and nerve are key. I think markets are likely to be volatile for at least a little while, so there should be more buying opportunities on the horizon. I’m not going to try and call the bottom, but will aim to spread my buys over the next few big down days. There is a risk that the markets bounce sharply and I don’t get another chance to buy back at lower prices, but I think this is a risk worth taking.

Trade plan

I sold out of some of my lower conviction holdings. I sold Alphabet for a 3% loss and Burford Capital for a 6% loss on Monday. Alphabet’s recent trading update was a little weak and I’m less comfortable with Burford’s valuation, given that its profits are probably ‘lumpy’ and so may fall in the short term, following some outstanding years. I sold my largest position Games Workshop for a 75% profit today, as the share price has been weak for a while and I was expecting more than the ‘slightly’ ahead of expectations in Monday’s trading update. I also sold Liontrust Asset Management today for a 6% loss, as it’s likely fairly sensitive to wider market falls.

I’ve narrowed my watchlist into a temporary ‘bargain bin’ of higher conviction stocks to buy if they are sold off indiscriminately in the coming weeks. I’m looking for stocks with recent positive news, that look undervalued relative to growth and where the share prices have held up relatively well so far. I’m also particularly interested in smaller caps. There may be some good opportunities coming up where small illiquid shares sell off a lot because of a lack of buyers.

This is what’s on my ‘bargain’ list at the moment:

  • Keywords Studios
  • RWS Holdings
  • Accesso Technologies
  • AB Dynamics
  • Boohoo.com
  • NMC Health
  • DotDigital
  • Microgen
  • Trigano
  • Amadeus IT
  • AO Smith
  • Priceline
  • Accenture
  • Activision Blizzard
  • Adobe Systems

I’m going to keep revising this list over next few weeks, particularly as and when any good trading updates come out.


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