How I’m Investing in Today’s MarketsWith the US markets rallying to fresh record highs this week, it certainly seems like a good time to buy dips in the market. The challenge, however, is finding stocks that don’t have a significant amount of downside risk.
Last week I wrote an article titled Will the Markets Shrug Off the Coronavirus? In it, I said that a rally to fresh record highs in February should not be ruled out. At the time, I wasn’t so sure that it would happen, especially as the markets fell sharply shortly after it got published, and I certainly didn’t think it would happen within a week.
Perhaps some will argue that investors are not fully considering the potential of the Coronavirus. I think the markets are just incredibly strong and that other factors are overpowering the impacts of the virus.
Having said that, it’s not all that easy to position in the market at this stage with the S&P 500 up over 3.5% on the week. A few months ago, I would have focused on the big names, as they are the ones that seem to be driving the markets. But with stocks like Microsoft (MSFT) up more than 16% for the year, I can’t help but think my downside exposure will be significant.
Avoiding the Temptations to Buy Beaten Up Stocks
From time to time, friends and family of mine ask for my opinion on a given stock. I’ve noticed a pattern when I investigate these stocks, buying them would be like attempting to catch a falling knife.
But I understand the reasoning. Most investors don’t monitor the markets as actively as traders, who tend to focus on trends and stocks showing strength. These investors don’t want to wake up one day to a 10% drop in their stock. Active traders have the advantage of potentially spotting a turn early and hedging their positions ahead of market-moving events.
Nevertheless, I don’t advocate buying a beaten-up stock. When the markets are as strong as they are, those stocks are under performing for a reason. Even if there is a fundamental reason to believe that the company is primed to make a comeback, the probabilities are rarely favorable and there’s nothing worse than holding on to losing stocks in a bull market as strong as this one.
Why I Like Bank Stocks
At this stage, I think it makes sense to settle somewhere in the middle between the high fliers and average stocks. I think the sector that offers exactly this is the banking sector.
The biggest appeal to banking stocks, to me at least, is that most pay a fair dividend. This provides downside protection as the dividend payment will tend to offset some losses over the long-term in the event my view of the markets is wrong, and a correction is coming.
Further, the volatility in bank stocks is much less than tech stocks, yet the upward trend is strong enough to provide conviction that this sector will continue to rally. The upside potential will likely be much less compared to investing in tech or healthcare but at least I know I will be sleeping easy at night.
In the interest of full disclosure, I am currently long Canadian Imperial Bank of Commerce (CM), Royal Bank of Canada (RY), and BMO Covered Call Canadian Banks ETF (ZWB). I plan to expand my investments into US bank stocks over the next few weeks.