An undercurrent of uncertainty continues to prevail in capital markets, and with good reason. Trade war escalation, the risk of currency crisis contagion, central bank deleveraging and macroeconomic slowdowns in various parts of the world all contribute to the unease. While the stock market as a whole has remained quite bullish, signs of stress and concern seem to be showing more and more. That has led to fears about increasing volatility.
What should investors do in the face of such threats? Thankfully, Warren Buffett (Trades, Portfolio) has provided some guidance on what we mortals can do in times of growing uncertainty and volatility. In this research note, we discuss three useful admonitions that investors ought to keep in mind in these uncertain times.
Keep some powder dry
In Berkshire Hathaway’s (BRK.A, Financial) (BRK.B, Financial) 2008 annual letter, Buffett had this to say about drops in the stock market:
"This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions."
When the market gets choppy, or turns downward, buying opportunities appear. When the stock market takes a correction, many attractive companies may begin to look quite cheap.
When the opportunity presents itself, seize it
When the market takes a hit and those opportunities emerge, investors must have the courage to seize those opportunities. As Buffett put it:
“Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.”
Timidity is a common human failing. Our natural aversion to loss can force us into lockdown mode when we see the stock market drop. Our fear can override our good sense, preventing us from taking advantage of irrational prices while they are available. If investors can overcome that psychological barrier and continue to think rationally, they can take full advantage of opportunities when they emerge. And such opportunities are extremely rare. We have, after all, been in the midst of one of the longest bull markets ever. If and when there is a correction, there may not be another for many years. Be ready!
Be wary of leverage
The subject of Buffett leverage is one we have touched on a number of times. We have suggested that leverage can be useful and have pointed out that, despite his admonitions against using leverage, such as trading on margin, Berkshire engages in a fair amount of leverage using its “float.” Buffett’s latest warnings about the subject come from his 2017 shareholder letter:
“There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren't immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary.”
This is, after a fashion, the flipside of the previous two points in this research note. While keeping some dry powder handy and knowing when to dive in and start buying bargains is important to taking advantage of rare opportunities, being leveraged can blow up positions and leave investors scrambling. Using margin during a time when the market is high and volatility is emerging is, therefore, dangerous when used incorrectly. It can force an investor into a reactive rather than an active stance. That makes it almost impossible to actually take advantages of such opportunities.
Disclosure: I/We own no stocks discussed in this article.
