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Stock market slumps – keep calm and HODL?

In the cryptocurrency investing world, the expression “HODL,” or “holding on for dear life” has become a catchphrase for holding onto your investments, no matter what difficulties come your way in the market.KerimDerhalli, CEO and founder of Invstr, looks back on times of market volatility and asks whether “HODLing” is ever the solution.

When the stock market falls, people always look for someone to blame.

Once upon a time, hedge funds were the culprit.Now, they have been underperforming the market for so long that it seems people have lost interest in them. Most notably in 2010, when the Dow Jones Industrial Average Index plummeted by 6% in a matter of minutes, we had flash crashes caused by high frequency traders.

The most recent sell off in the market is being blamed on insurance companies and volatility traders, in particular those who sold volatility expecting that the market would keep on going upwards in a straight line. These so-called inverse volatility funds managed by Credit Suisse and Nomura are reported to have lost up to 90% of their value – so much for traditional wealth managers.

The trigger for the market sell-off was the unexpected rise in US wage growth to 2.9%. After ten years of unprecedented fiscal and monetary easing, it seems that inflationary pressures may finally be picking up in the US. When combined with probably the worst timed tax cuts in history, the prospects for significantly higher interest rates become a distinct possibility. In a stable environment, inflation of three percent would suggest nominal interest rates of 5-6%. If that ever materialised, we should expect the market to be 40%– or more.

So, what are we to make of this sell-off?

Firstly, be thankful that it hasn’t been greater. The list of political problems is getting longer not shorter: Korea; Brexit; Germany’s struggle to form a coalition government; upcoming elections in Italy that could de-stabilise the EU; the prospect of NATO allies fighting each other in Northern Syria and a growing risk of the civil war morphing into a super power conflict – not to mention trade wars looming between the US and China.

All things considered, we should actually be grateful that the market chose to focus on 0.2% higher-than-expected wages instead.

I often hear that investors should ignore market movements and invest for the long term, which is nonsense. I left Japan in 1989 when the stock market was at an all-time high of 38,000 and,29 years later, it is still 45% lower than this peak. Anyone who had “HODL’d” in Japanese equities would have lost a fortune, not to mention the opportunity of using their money elsewhere.

The answer is never to be complacent. The answer is to be as well informed as one can possibly be and to look after your investments as if your life depends on them. The starting point is to figure out where we are in the market cycle. Are we still in the early stages of an economic upswing, or further along? Are companies able to earn higher profits at a rate that will more than offset the possibility of higher interest rates or not? Is the market still fairly priced? Are there plenty of people who are still waiting to buy equities? Is the technical picture constructive?

I am afraid to say that the answer to all of these questions is not positive. We are clearly in the very late stages both of the economic recovery and the market cycle. The probability going forward is that higher corporate profits will fail to rise at a rate that is sufficient to offset the lower present value of those earnings as interest rates rise. The US stock market is trading at its second most expensive levels after the internet boom, owing to the fact that it has sucked in hundreds of billions of dollars in retail savings. Technically, there is a chance that the market rally that began in March 2009 has already ended and that we are headed for much lower prices.

Paradoxically, I still believe that there is a chance that the recent sell-off was just a warning shot. We could spend the next several months in a large consolidation period that frustrates both bulls and bears and ultimately see anew high in prices.The likely path of that consolidation period will be unpredictable price swings that erode both financial and emotional capital.

If you must invest, be nimble. Take profits frequently and don’t get sucked in to long term investments. If you do prefer to HODL be ready for an emotional roller-coaster ride. If the market does eventually make one new last high, don’t start to believe that we are entering a new global paradigm.

Think of Japan and SODL. Sell Out for Dear Life.