Tags: Wilderness | Economy | Investors | Markets

Don't Fret the Wilderness

Don't Fret the Wilderness

(Getty/Don Bayley)

By    |   Thursday, 16 February 2017 02:26 PM

In the 1930’s, it seemed that the best days of Winston Churchill’s life were behind him. Although a Member of Parliament, his party would be out of power for eight years. He had held various cabinet positions over the years, served in the army in World War I and even earlier before his political career. Now, in his late 50’s, there seemed to be little ahead and so much behind.

His days were spent at his home writing and painting. His speeches in Parliament, decrying the rise of Hitler, were met with scorn and guffaws. The prevailing view in Europe was that fears of another war were overblown. But the 1930’s proved to be his wilderness years—that time in all our lives when it seemed that everything we thought we knew was wrong.

But Churchill wasn’t wrong. He was just early. The facts came around to support what he had been warning about for years with the breakout of World War II. In early 1940, the existing government folded and Churchill became Prime Minister. Before the Soviet Union and America were attacked by the forces of Fascism, Churchill’s England stood alone against the evil that swept through Europe. And, improbably, the pompous, aging man was the one best fit to address the threat with an inhuman clarity and moral sense.

We all have periods in our life when we’re in the proverbial wilderness like Churchill. Maybe we feel that our best days lie behind, not ahead. Maybe we feel that we’ve made mistakes in our life that can’t be fixed. While the wilderness periods in our lives might not end up resulting in the rescue of western civilization, they’re still disheartening.

Right now, it seems we’re far from the wilderness in the land of investing. That’s because stocks continue to gradually grind and churn their way to new highs. Isn’t that where we want to be?

Possibly. But maybe not in this case. Valuations remain stretched. And interest rates are finally on the rise—something that will eventually entice capital out of higher-yielding parts of the market and into fixed income instead. We’re a ways off there—but like the game of hot potato, you don’t want to be the one getting burned.

What’s an investor to do in this pre-bubble environment? Just like speeding down a highway that you know will slow down later, the first step is to simply ease off the gas. I’m a huge fan of covered call writing for this reason. That’s when I protect an existing position by selling a call option against shares I own. When I sell the call option, the strike price is the price I’m willing to lock in a profit at. If shares continue to rally after I sell the call and I end up getting called away, then in a rising market I’ll be taking profits and raising cash on a regular basis.

That’s a good way to set up future sales at a price that seems reasonable now. Most investors see a rising stock, get greedy, feel validated as shares run higher, then lose all their gains on the next market correction. Covered call writing moderates the greed. And if you don’t get called away, you’ve managed to generate some income on the trade you wouldn’t have otherwise. In my mind, that’s a win-win scenario.

The flip side to this strategy is to sell put options on companies you’d like to own at a price worth paying. Since you’re selling options, you’ll also be generating income you wouldn’t if you just hold cash. The downside is that you might be put shares at a time when it seems the world is coming to an end. Or you may have to sit on losses for a while until things turn around. In the Braintrust, we were put shares on four different positions between December 2015 and March 2016. All of those positions were initially showing losses, but rapidly got better once the market’s recent fears subsided. Yes, one of those positions is still down from where we acquired shares—but three are showing profits. And we’ve written covered calls on two of those positions already since they’ve recovered so well.

At the end of the day, the wilderness periods in our lives are simply a time when we’re faced with more uncertainties than usual. Think about it this way: would you want to be in stocks in 1998 if you thought they were too pricy? Probably not. But if you knew exactly when the tech bubble was going to blow up, you could have stuck around another year and gotten out at the perfect time. But the perfect time is something that can only be known in hindsight. That’s why reducing the greed at today’s market prices could pay off handsomely in avoiding future losses.

When stocks do face their next correction, you don’t want to face your time in the wilderness. It’s important to have a plan now. What positions will you keep, what will you sell? What should you look for when buying? Having a plan in place now, when things look rosy, sounds great in theory. In practice, what really matters is being willing to stick to the plan when things go awry.

That’s why I get more bullish as stocks sell off. It presents more opportunities. Today’s markets are presenting a few good investment ideas here and there, and, if anything, that’s a healthy sign. It’s when stocks start to nearly all move in one direction that the yellow flags become red ones. When everything is going well, it’s only a matter of time before buyers are exhausted—and that’s when market selloffs begin.

Again, it means we’re not there yet. But as an investor who likes to think about the downside first, I can see the dangers in the market growing, just like Churchill saw dangers that wouldn’t manifest themselves until years later. There’s still plenty of time to prepare for the next market correction. Just make sure not to get overly complacent now.

Andrew Packer is a Senior Financial Editor with Newsmax Media. He currently writes the Insider Hotline investment advisory, serves as investment director for the Financial Braintrust, and writes the monthly newsletter Crisis Point Investor.

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AndrewPacker
There’s still plenty of time to prepare for the next market correction. Just make sure not to get overly complacent now.
Wilderness, Economy, Investors, Markets
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2017-26-16
Thursday, 16 February 2017 02:26 PM
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