Ed’s Daily Notes for July 8th   5 comments

Bloomberg: A Correction Is Coming

If you are concerned about a correction looming on the horizon, Barry Ritholtz has some good advice:

Traders concerned about an imminent drop of 5 percent to 15 percent can take steps to reduce risk. Lighten up your exposure by using less leverage. Carry smaller overnight positions. Look at your position sizing, especially in light of correlated assets.

The approach for investors is very different: Anyone with a longer-term time horizon should look at a correction as an opportunity. Use any market decline to rebalance adding to those asset classes that have fallen. Review your portfolio, looking for holdings to trim or eliminate beforehand.

Investor changes, unlike those of traders, should be far more incremental. Less is more when it comes to making alterations to well-thought-out plan.

My view is we won’t see a correction of greater than 5% until we get a serious “black swan” event. I see the market as extremely vulnerable to a black swan right now, because the light volume driving markets up would get swamped in a sell-off. Also, with the Federal Reserve slowly withdrawing liquidity, there will be less and less liquidity being pumped into equity markets, so even the low volume we are getting now will eventually fall even more.

I am not predicting a black swan event, but rather saying the possibility of one is significant enough to consider it in your investment strategy.

Currently, my strategy is to continue to build cash in my long-term 401(k) portfolio (although I continue to reinvest dividends), as I maintain a strictly conservative daytrading strategy with my short-term IRA (no overnight positions).

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5 responses to “Ed’s Daily Notes for July 8th

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  1. Ed, if we do get a 5 or more percent correction are you bullish on the overall market recovery?

    • Bill,
      It depends on why the market is correcting. If it’s just a technical correction, the market can continue as before. If the market corrects because the Fed is pulling liquidity, then I doubt it. If we get a black swan, all bets are off.

      • Thank you. So I guess going into the winter we’ll have to watch and see if hiring continues and of course winter is slow so may not know anything till 3rd quarter. No fed money election year sounds boring.

  2. Ed, need a definition: What do you define as a black swan event and have we had any black swan events in the last ten years and if so what and when?

    • The Lehman bankruptcy qualifies, although that could have been considered just one part of the collapse of the housing market. That may be the best example.

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