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Getting the sell decision right

It's tempting to sell out when markets are plummeting. But there are good reasons why you should resist the urge.

A headline from The Sydney Morning Herald website:

"UPDATE Australian shares had their worst day since the crash of 1987, losing more than 8%, as mounting recession fears sent equity markets tumbling around the world."

Economic forecasts are being downgraded by the minute, international travel is close to a standstill and global supply chains have collapsed. As for going to the local supermarket, well, if you've ever watched clowns push shopping trolleys through a minefield you'll get the idea.

Yes, the virus is spreading, and many countries seem desperately unprepared. The US, a country with 27 million people without health insurance, decided against using the World Health Organisation's test kit, shipped to almost 60 countries, and went with its own (botched and delayed) version. It lost 6 weeks to get a grip on the spread of the virus, which is now firmly established.

As for Australia, on Sunday an impressive 90,000 people gathered to watch the cricket, a day before three schools were shut down in Sydney and Melbourne and the country registered 80 confirmed cases. When I told an Asian-based fund manager that lived through SARS of this yesterday, he was incredulous.

Chaos hits markets

And now the chaos has finally reached the sharemarket. Yesterday, a number of members contacted us with a view to getting out altogether, (to be fair, others were suggesting we do the opposite). 

What action you take is of course your decision. What we would like to highlight is that the quote above was written on 10 Oct 2008 - GFC prime time - with the headline Worst day in 21 years.

That wasn't close to the market bottom but since then the ASX 200 is up 45% when inflation and real interest rates have been tumbling. That's not so bad.

Selling out sounds attractive because it removes the need to 'do something' in the face of panic. Unless we're sitting in front of Netflix, doing nothing is surprisingly hard for everyone except teenagers. Being hard-wired to act, selling scratches the itch.

The problem is that getting that decision right is a virtual coin toss, with a slight bias in favour of stocks going up over the long term, albeit not in a straight line.

James Carlisle recalls a story from the truly awful mid-1970s UK when the FTSE doubled in a matter of weeks. "After a 10% gain, the old hands were mumbling about 'dead cat bounce'; after a 20% gain it was 'Bugger. I'll wait till it dips again and then buy back in', which it didn't. After the market doubled, the fund managers who'd sold out and missed the rebound got their marching orders."

Why is this so difficult?

Selling out and then trying to buy back in at lower prices involves two consecutive decisions. Assuming a probability of 70% of getting each decision right, the probability of getting both right is less than 50% (70% x 70%) - no better than guessing. The more consecutive decisions you have to make, the lower the chance of getting them all right.

Emotional baggage

That's one way to think about it. Another is to consider all the emotional baggage involved in selling compared with buying. When buying a stock, the future beckons, not yet sullied by crap managers, disappointing results and the rude interruption of reality. The possibilities are tangible and exciting because they haven't yet happened.

When selling, that future is behind you. The only thing left is the baggage; am I missing out on future gains? Am I happy to pay the tax? What would I buy instead? I can buy Xero but I can't buy toilet paper. Is this the end?

Questions like these play on our minds, twisting our synapses, eroding our capacity for sensible decision making. Often, the primal desire to act emerges from the mist. As one member commented yesterday, 'Sell quickly."

What seems obvious when emotions are running hot usually isn't. As with the coronavirus, life has a way of surprising us. It's easy to think this all looks as though it's going to get worse, and it might. But selling now to buy back in at lower prices is much less likely than we think. That is not to forecast a rebound but to note the human capacity to overestimate our own abilities, although I am a really good driver.

If there is any tendency among retail investors, it is to buy high and sell low rather than the other way around, and this is how it happens.

It takes costly raw experience to learn the lesson that markets eventually recover. It also takes a dash of over-confidence to believe you can sell now and buy back in at a lower price, implying an uncanny ability to time markets.

Sadly, like those 1970s UK fund managers stumbling to work in their suited flares, none of us possess that skill. And if you do, why are you reading this when you already know I'm wrong? [The rest of you will just have to wait - Ed].

Deploying cash

We don't know your psychology or your personal circumstances, nor are we permitted to give personal advice. But we can tell you how we are approaching the current market.

Member Toby K wrote yesterday that, "Profits/losses are only realised if sold. Surely if you can afford to hold, this is a time to hold a high quality business with the potential to accumulate more approaching should you have the cash available."

That's the approach I'm taking, continuing to hold on to the high quality businesses I already own, selling out of any stocks I shouldn't have bought in the first place, ready to deploy cash as prices fall. I'm confident others in the team are doing likewise.

That doesn't mean it's right for you, or that I'm right at all. But if history is any guide, high quality businesses emerge from difficult periods in good shape and their share prices recover, often more quickly than you'd imagine. Sometimes, though, it can take years, which is why we need to be prepared to wait it out, letting history unfold in our favour rather than trying to write our own (potentially costly) version of it.

John Addis is the Founder and Editor at Intelligent Investor. To access more share research, start a 15 day free trial.