It is always a good time to be in the market, Just don’t give your money to a Financial Advisor. Some may ask, what about recessions? Yes, recessions make the stock market lose value -lot’s of value- but whether you catch the market before the recession or after, with the right strategy, money can be made when the market moves in both directions. Making money in the market doesn’t have to be unidirectional; You don’t have to stick to the Stock Market either, the Bond Market can also help make profits. Since most investors follow mainly stocks and bonds, we’ll concentrate on those two types of securities. We’ll also concentrate on maximizing capital gains, not income. We promise, this is not another article in the internet that will smothered the reader with Warren Buffett quotes.
Best time to Buy, Worst time Sell; Best thing to Buy, Worst thing to Sell
An opinion on what is the best time to buy or sell is incomplete without saying what we believe is the best thing to buy or sell. One “Financial Truth” is that some types of assets may gain value while at the same time other types of assets may lose value.
Case and Point, the likely Best time to buy stocks is also the likely Best time to Sell Bonds, and that happens deep into a recession, where the majority of investors are selling like there’s no tomorrow and all hope for a recovery is gone. This is the time where Selling your Bonds and Buying stocks is very likely the best course of action. Below is a chart showing interest rates (Fed Funds Rate) and the return of the S&P 500 (We adjusted the returns along with using a log scale on the right side of the chart for the S&P to allow us to superimpose the graph with the Feds fund rate).
Notice that many times, when the economy is deep into a recession, the fed funds rate are also at their lowest compared to their respective recent history and that the stock market is also at it’s lowest compared to it’s respective recent history.
Why is selling Treasury Bonds a Good Idea? Assuming an investor had bought bonds some time before the recession hit (and if lucky enough, right before the recession hit), then selling at the end of the recession is probably a good idea in terms of capital gains because the price of a Bond moves inversely to the interest rate. Essentially, if you buy bonds just before the recession you would be buying them when the interest rates are high, and you would be selling them after the recession is over, when the interest rates are low, therefore, the price of the bonds would be higher at the end of the recession than they were just before the recession hit.
One thing about bonds is that the coupon rate and the maturity of the bond affects how much the change in interest rates will affect the bond price. There’s also a big difference between corporate and US treasury bonds as well as their credit rating. In other words, implementing the strategy is not that easy for the average investor.
Obviously, the worst time to sell Stocks and Buy Bonds is the opposite of what we explain above. That is, the worst time to sell stocks is at the very end of the recession and that is also the worst time to buy bonds. This seems to be the most common course of action the average investor makes, and that is usually a double-loss of money.
Some readers might be saying “Sure, in hindsight, it’s 20/20”. And we would agree. You can’t buy stocks at the very bottom when they are cheap and sell bonds when they are at the very top when they are expensive. Some loss of capital will happen because investors won’t be able to get the optimal prices (unless they are extremely lucky). But, if an investor understands The Economic Cycle he will be better prepared for the things that will eventually happen. If that investor employs the services of a professional money manager, Not a financial Advisor, then the investor will be prepared psychologically and understand the actions the money manager will take on the portfolio… Assuming of course the money manager knows what he’s doing.
OK, here’s the only quote from Warren Buffett in this entire article:
Best time to Sell, Worst time to Buy; Best thing to Sell, Worst thing to Buy
On the opposite spectrum, the likely Best time to Sell Stocks is, obviously, before the recession and that is also the best time to buy bonds (again, not just any type of bond, as previously mentioned). And mirroring what we said above, the worst thing to buy would be Stocks before the recession and sell Bonds before the recession.
Once again, we ask ourselves, how likely is it for us or anyone else to be able to time the market so perfectly that we’ll be out at the top and in at the bottom? Very unlikely. Chances are, you’ll lose some money as the stock market goes down but recoup some of that money by purchasing bonds (or shorting the market) as they increasing in price as the interest rates (The Fed Discount Rate) are lowered. Eventually, you’ll lose some of the money on bonds when the interest rates go up but you’ll know it’s probably a good time to buy stocks, and so you’ll make up some money purchasing stocks and eventually you’ll have, very likely, another extended period of stocks gaining value. We strongly encourage our readers to look at our article What to Expect when Expecting a Recession
Bi-directional
So far we’ve been talking about profiting mainly through buying something. Either buying and holding stocks while getting rid of Bonds or buying and holding Bonds while getting rid of Stocks and these two strategies depend on whether the investor is making these transactions before or after a recession. There’s another way to make money when the stock market is crashing during a recession. In the chart above, the market dropped quite a bit in the last two recessions; these losses could have been turned into profits. However, remember that nobody, unless extremely lucky, can catch the market at the very top and at the very bottom so in reality it’s unlikely that even the best of professional investors can turn all of those losses into profits; if someone can turn even half of those losses into profits, then that investor is doing exceptionally good.
Before we go on, we want to once again warn that everything we talk about requires an investment manager or extensive knowledge of how the market and the economy works, and that statement couldn’t be more emphasized when it comes to strategies involving investing when the market is taking a dive. If the investor is not a money manager then those strategies can destroy a portfolio so quickly the investor may not have time to blink. That being said, even when a professional is involved, client suitability may prevent even the professional from attempting such strategies on the investor’s account.
One relatively easy and safe way to profit from a drop in the stock market is by “selling” the market synthetically by buying put options. Nowadays investors can buy put options on virtually anything: Stocks, Sectors, indexes, etc. Options themselves are a very complicated topic but the quick explanation is that essentially when an investor buys a put option his buying a contract that says he is allowed (but not required) to sell a pre-determined amount of shares at a certain price at any time he wants but the caveat is that the contract has an expiration date.
For example, Shares of XYZ company are trading in the stock market. The investor buys put options to give him the right to sell 1000 shares of the company for $90 per share and pays $5000 for those options (i.e. for the contracts). The contract expires in 3 months. If the shares of XYZ company drop to $80 anytime before the 3 month expiration date, then the investor can exercise his right to sell the shares for $90 per share. His profit would be ($90-$80) x 1000 – $5000 = $5000 profit, not including transaction costs, fees, and commissions. What happens if the Stock actually goes to $95 and the contract expires? The investor loses 100% of his money, the original $5000 he spent to buy the contract.
In the hands of an investment manager, buying puts is a relatively safe investment because the possible maximum loss for the investment is known and is limited. In the hands of an inexperienced retail investor, options can destroy a portfolio. In fact, there are more advanced option strategies that would further prevent a professional investor from blowing up his portfolio.
Something that is riskier and more expensive than buying put options is selling the stock short. The investor would borrow shares from the Broker and sell them in the open market. Example: Investor sells short stock at $100 per share. Stock price falls to $90. Investor goes into the open market to buy back the shares and returns them to the broker. He made a $10 profit per share, not including fees, commissions, etc. However, if the stock price rises to say $150, then now the investor buys the shares in the open market for $150 and returns them to the broker, for a loss of $50. As one can see, theoretically speaking, if the stock price climbs to infinity then the investor loses an infinite amount of money (in real life, the broker would force the investor to buy back the shares and return them at a huge loss).
