March 16, 2020
Mark Minchin
Making rational decisions in irrational times

Should I sell now and buy back in later?

Share markets are breaking records daily right now. On Friday we saw our own share market plunge nearly -8%, only to recover +13% to round out the day up nearly +-5%. This made Friday the biggest intraday swing we’ve ever seen as well as the biggest day by volume traded on the ASX.

Then, later that evening (Friday), the US stock market went up +10%. Another daily record.

At the time of writing, our local market is down nearly -10%, representing possibly the biggest counter move, following a positive lead set by the US in the prior trading session.

This morning we received news that the Federal Reserve has cut the US cash rate by 1% to a historic low of 0.0% to 0.25%.

Governments all over the World are talking with each other in broad based conference calls. Some of these calls have included leaders from Brazil, Italy, India, Germany, Canada, Australian and others – all on the one call. They are working together to make plans and learn from each other in order to combat the health crisis as well as keep the World’s economic wheels turning.

Virtually all governments have already announced massive stimulus measures, albeit many are still trying to establish how they can spend the funds most effectively.

With all the uncertainty, and extreme volatility, many investors are asking themselves if they should sell their shares now, with a view to buying them back later when there are signs that things are returning to normal. In this edition of Insight, we provide investors with a framework through which to answer this question.

Making rational decisions in irrational times

In times like these we are prone to self-doubt. We can find ourselves questioning the very bedrock of our own investment philosophy. Things that only weeks ago were certain in our minds have become uncertain.

These inner debates we have with ourselves are catalyzed by the insecurity that comes from seeing our savings plunge in value. We feel vulnerable and wonder whether our hard-fought savings will be able to provide for us in the way we planned.

These insecurities have a habit of seriously shortening our field of vision. Whereas in calmer times we can think about our investment strategies in blocks of decades, during periods of great uncertainty – we tend to think only about “what will my portfolio be worth tomorrow?”.

This emotional response is well documented in the field of behavioral finance. Evolution has ingrained in us a “fight or flight” response that is evoked by fear. The more acute the fear, the more profound the response.

This fight-or-flight response starts in a part of our brains called the Amygdala and when this occurs our senses are heightened, our heart rate rises and the slow thinking parts of our brain are shut down in favour of the reactionary, fast acting ones.

During this response the parts of our brain that process and consider information rationally are shut down in order to provide more “current flow” to the parts of our brain that act quickly and instinctively – using short-cuts rather than considered thought. This chemical response has helped our species survive through the generations – “run now or you’ll be lunch”.

In order to make good investment decisions we need to combat this instinctive response. Investing is different to avoiding lions.

The key to doing this is to slow down and consider things carefully and unemotionally. We need to “pan-out” from the day to day and consider the bigger picture.

Start by asking yourself these questions and try and answer slowly, unemotionally, and rationally:

  • How long is the COVID-19 pandemic likely to last?
  • Will it run for a year, two years, ten years?
  • Will capitalism survive the pandemic?
  • Will people continue to fill trolleys with toilet paper indefinitely?
  • Will Australian businesses survive – supermarkets (Woolworths, Coles), hospitals (Ramsay, Primary), toll roads (Transurban), airlines (Qantas), miners (BHP Billiton, Rio Tinto), technology companies (Xero, Real, banks (Commonwealth Banks, Westpac) telecoms (Telstra) and utilities (AGL, AusNet).
  • Will the workforce and supply chains be permanently impacted by the virus, or will they be disrupted for a period and then begin to run normally as the virus subsides?
  • Will scientists and epidemiologist ever come up with a vaccine for COVID-19?
  • Do I have enough cash for my immediate needs? 

If you found yourself feeling that it is likely, in time, that this too will pass – then you may be in a good frame of mind to consider the next and inevitable question:

Should I sell my shares now and buy back in later when things settle down?

If we accept that capitalism will continue, that the financial system will survive, and that in time our quality companies will prosper once again, then selling now with a view to buying back in later could be a very risky thing to do.

If the timing of the “sell-out” and the “buy in” are not executed well, then investors can be unnecessarily exposing themselves to a permanent loss of capital. Something that may be even less tolerable than putting up with the daily gyrations of prices.

To explain, let’s consider shares in the Commonwealth Bank. In February these were trading at around $91, yet today they are trading at around $61.

Let’s assume our sensible view is that CBA will outlive the current pandemic, but we want to avoid having to go through the heartache of the daily ups and downs during the crisis. So, we decide to sell our CBA shares today for $61 with a view of buying the same shares back later, once COVID-19 has settled down and we can see a path to normality.

What are the chances of us affecting this “sell now buy later” strategy without suffering a permanent loss of capital?
 That is, if we assume we own 100 shares that are worth $61 x 100 = $6,100 today, what is the chance that we can buy the same 100 shares back later, once things have settled down, for no more than $6,100?
 To answer this question, we need to consider what we think the share price of CBA will be in the future, when things have settled down a bit and we are feeling more confident about the future.

Stocks are always priced with reference to certainty. If certainty is high, we tend to pay more for the investment because it’s a “safer bet”. When certainty is low (i.e. risks are high), then we generally aren’t prepared to pay as much.

The same goes for CBA and COVID-19. As uncertainty recedes, so the price will rise. It is this price-to-certainty relationship that makes it very unlikely that our “sell now and buy back in later” strategy will prove financially rewarding. Indeed, studies suggest that these kinds of strategies are much more likely to result in permanent loss of capital when compared to the long term buy and hold approach.

That is, if we sell now at say $61, and make the decision to buy back in later, when we are feeling more confident about the outlook, then chances are the market is feeling more confident also. It follows that CBA is unlikely to still be trading at the “fear and panic” price of $61, and more likely to have risen to a price that better reflects the change in sentiment – say $80.

Sadly, at $80 our sale proceeds of $6,100 will only buy us 76 shares. So, all we have done through our “got to act now strategy”, is given away 24 shares (permanent loss of capital).

Ultimately, we all feel a bit helpless in times like these and inevitably we have a desire to do something, anything, to make the fear subside. But when you deconstruct these emotions rationally, often you realise that the itch to want to sell something is only for the the sake of action and control. Its probably not worth the risk.

If you feel the compulsion to do something to take control of your financial situation, then perhaps its time to take a fresh look at your spending – see what you can do without for a while, until you feel more confident again. 

If you remain anxious, please call your adviser to talk it over. 

Making rational decisions in irrational times

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