lundi 4 novembre 2019

Waiting for the next correction

Currently, the stock market (S&P500) is more or less at it's all-time high. 

I'm preparing for the next drop. Actually, I'm looking for a drop of the market of 15% or more. Then, I'll buy stocks. I may even use margin, for the first time of my life.

Because since 2008, I've only bought regular stocks. Never bought anything else. Never shorted a stock. Never used margin. Nothing else than stocks, sometimes bad stocks, sometimes good stocks.

So, here's what I'm planning to do at the next correction:

I'll probably use margin for the first time of my life. For those who don't know what a margin is, here's my novice view on it:

When you open a margin account, you can buy stocks with money you don't have, if you put a specific amount. For instance, I could put 5000$ and use a margin of 5000$ (ratio 1:1). I could go as far as 30% personal funds and 70% margin, but I wouldn't start too agressively.

With a margin, you pay interest on a debt you have to reimburse over time. But with the money borrowed, you can buy stocks and make a profit. However, as much the returns can be very interesting, a negative performance is also amplified and you could also experience a margin call, which is a kind of mini-apocalypse for a portfolio. It means that, if the value of your stocks drop a lot, the institution that offered you the margin may sell stocks without your authorization. 

Some people recommend to NEVER EVER use margin. Some other people believe that it's the only way to get great returns over time and to achieve some financial independance. I believe that the truth is somewhere in the middle. But five things are sure for me:

1- Never use margins if you're a novice investor. Use it only if you have good knowledges about stocks and investment.
2- Never use margins if you're insecure about the stock market or if you'll have trouble to sleep after using it.
3- Never use margins for other things than great quality businesses. 
4- Never use too much leverage. I plan to get a margin equivalent to 10% maximum of my portfolio. I'll start that way and I'll see over time if I expand it. Mistakes will be less harmful if I start slowly. 
5- The best way to use a margin (that's what I'm planning to do) is after a severe market correction. Because stocks will be cheaper and your return will benefit from the rebund of the market. Obvisouly, we never know how long or how big a correction will be, but after a 15-20% drop of the market, it may be a good moment and that's what I'll be looking for. 

For instance, Berkshire Hathaway would be a great candidate for a stock bought with leverage. You won't get a stellar performance with BRK, but the 8-10% annual return may be amplified by the use of leverage. At the opposite, If you use leverage with weed stocks, you're a stupid gambler and you expose yourself to very big losses. 

Any opinion on margin/leverage?

Some people use it?

4 commentaires:

  1. A 15%-20% drop wouldn't be enough for me to use margin. I would like a bigger buffer of safety if I were to use borrowed money to invest. That's just me though.

  2. Does this mean that you are hoarding cash at the moment and will not be buying MTY or contributing to your TFSA etc. until the crash?

    Speculating with margin is not for me, at least not at this point in my life. I have been told stories of people who have been wiped out because of margin call and destroyed their whole lives because of it (divorce, suicide, etc.). Some of these people were super rich, successful doctors and other esteemed professionals and community leaders.

    I have not compared the interest rates, but I would be probably more comfortable with a mortgage "margin" in the long term future. If you have a job and own a house, I think it would be more favourable to refinance you house to access excess equity and use it to buy beat-up stocks during a recession. This way, you will not get a margin call and be wiped out due to some one day fat-finger or out-of-control automated algo trading hiccup (with everyone in ETFs and high frequency trading who knows what might happen... would you use a stop-loss limits if using leverage?). To get a new mortgage takes quite a bit longer and there might be some penalties but they might be worth it in the long term.

    I would guess house-backed rather than stock-backed loan would be considerably cheaper. We are already at rock bottom interest rates. If we have an economic crash right now, central banks will have to resort to negative interest rates and helicopter money. This would mean very bad excess liquidity for banks and thus very favourable mortgage rates. This would mean refinancing your existing mortgage might be a wise decision during the recession anyways. It would also protect keeners like me who tend to pile into the market too early and catch falling knives. Central banks overshoot with interest rates, acting retrospectively, while stock market is prospective. As a result, by the time central banks will be lowering rates, the market might already be nearing or be past the worst.

    Also, depending on your net worth distribution, accessing house equity might yield more liquidity than a pure margin. Even though you might be able to get up to 70% margin from the broker, this only applies to big, highly liquid companies. The broker might impose different house limits on the actual margin for each specific stock - ie you might not be able to get high margin to buy CSU or LAS since the broker might have hard time liquidating a larger position if you would get a margin call.

    I also have a question about market crash: Do you know of any empirical evidence whether it is better to buy good quality companies during a crash or is it better to sell all of the good companies and instead buy the most annihilated cyclical stocks, hoping for a rebound? Good companies can take advantage of bad times to make bargain purchases and thus can grow earnings as well as modestly improve multiples during the recovery. However, bad companies would have their earnings as well as multiples destroyed, meaning they would have a lot higher short-term appreciation potential BUT they might never recover (like pharma or energy in the recent past). When speculating and trying to time the market, it would be obviously very important to only pick both good and cyclical companies with very good balance sheets.

  3. Don't cross over to dark side lol. Don't use margin. Play it safe my friend.

  4. Due to my personal circumstances I don’t use margin but I could see someone experimenting with it…that’s how we learn…by trying new techniques out.

    Actually my Brookfield holdings employ leverage in a way that I could never emulate (non-recourse lending). So that being the case I guess I’m already applying leverage but in a indirect way.