​When Investing, Rely on Quality and Value

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I always find it interesting when I hear market observers characterize the markets as struggling. At the risk of splitting hairs, markets don’t struggle, but market participants do, because they don’t like change, explains long-term investing expert Kelley Wright, editor of Investment Quality Trends.

The thing is the markets are dynamic, and with a steady influx of data and news they are always changing whether it is recognizable on the surface or not. While perhaps simplistic, markets either trend up, trend down, or get locked in a sideways trading range.

Up and down trends are pretty easy to understand: In an uptrend, investors are confident and want to put money to work; In a downtrend investors lack confidence, become risk adverse, and take money off the table.

A trading range can indicate several things. One is a lack of conviction by both bulls and bears. Another is that markets are consolidating recent gains or losses.

In this current instance my belief is that the markets are simply correcting. What is important to understand is that the markets aren’t correcting on a price basis alone, but on a sentiment basis as well, which is a more complex situation.

Think about it, from the general election in 2016 to mid-January of this year the market had been in a sustained uptrend with a never-ending series of new high-water marks. In mid-January, however, that uptrend came to a screeching halt.

Why is that? My thought is there was a change in sentiment. Not from bullish to bearish mind you, but the exact opposite. The entire uptrend from November 2016 to mid-January 2018 was achieved on a backdrop of negative sentiment. I know, it’s counter-intuitive, but Mr. Market is insidious this way. He’s perfectly fine with the markets trending in a sustained direction if the majority of investors are skeptical and not buying into it.

Once the majority capitulates and goes “all in,” however, he likes to pull the rug from beneath the markets’ feet. This is exactly what happened in January - bullish sentiment not only increased it recorded a six-year high, and bearish sentiment declined to almost ground floor levels.

From a behavioral finance perspective this is the perfect scenario for a market reversal. Contrary to popular belief I believe this is a very healthy development for the market going forward.

First, it puts some fear back into the market, which is a good thing. It’s one thing to have confidence, but it’s another thing to be cocky. An investor who exhibits hubris is surefire to wind up in Mr. Market’s crosshairs, and his aim can be lethal.

Fear does much more than mete out punishment for bad behavior, however. As fear moves through its successive stages – mild, moderate, severe, panic, and finally hysteria, it promotes an increased degree of selling at each respective stage. At some point the selling becomes indiscriminate, the “baby with the bathwater” syndrome.

For the value investor with the ability to understand that value lies in the dividend and dividend yield as opposed to price alone, this is a welcome occurrence as it provides the opportunity to acquire shares of high-quality stocks when they represent good value. Additionally, fear is necessary to drive bearish sentiment to a majority-held level, which is where corrections end and uptrends resume.

Given that it took many months for sentiment to reach the bullish extreme area, it may take a while for it to unwind. To manage expectations, I anticipate continued volatility with wide intra-day price swings in the major averages. I further anticipate a series of multi-day rallies followed by a series of multi-day declines.

Eventually this action will wear investors down until they throw their hands in the air and say to heck with it. That will mark the bottom of the correction and the uptrend will resume, but the majority won’t believe it.

Based on my comments above you can surmise that I don’t see a bear market developing in the broad market at this time. My lone caveat is that assessment would change if the Dow were to close below 20,000, which would indicate there was something more serious afoot.

We don’t invest in the indices, we invest in individual stocks. In that vein there are companies that are being sold off for what I believe are the wrong reasons, and there will probably be more to follow.

This is not unusual, in fact it is perfectly normal. And, as value investors we should view these as opportunities to buy rather than reasons to sell. Stocks typically represent good value when they are unloved.

In my estimation this correction will be the last good buying opportunity of this bull market. Once the uptrend resumes its ascent will take us to the ultimate top of this half-cycle, which I believe won’t be until some point in 2019 at the earliest.

As such, I suggest you take a hard look at your portfolio to determine where there are holes to be filled. If you are underweight, or more likely unrepresented entirely in a sector, now would be a good time to put a list together of stocks you would like to own given the opportunity to acquire them at good value.

If you have existing positions you wish you had bought more of, you will probably get an opportunity to add to them before this correction is over. In closing I would suggest there will be a lot of hyperbole to both the upside and the downside before this correction concludes.

As best as you can try to ignore this noise. At the end of the day there are only two things you should rely on in your investment considerations. One is quality and the other is value. Anything beyond those two attributes simply muddies the water. That is all, now soldier on.

Kelley Wright is editor of Investment Quality Trends.

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DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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