A five percent crack in the index would not have been on anybody’s mind a week ago. But, investors are spending this weekend wondering if there could be more downside in the coming week. The real story is not in the movement of the indices. The real story lies hidden in the subprime trade in stocks of micro and small cap companies with limited track record and sudden valuation expansion.
The worry is that funds and advisors have bought too aggressively into these stocks. To make matters worse, the broking industry has supported a flourishing trade in margin funding against stocks of these companies with limited scrutiny. A crack in the market usually triggers a swift force unwinding in margin trade. The structure of margin funding gives very little response time for investors to save their margin positions. We could see such a situation arise in the coming days.
For investors who stayed away from leverage and speculation, there still will be pain. Such pain will be inflicted on them by the indiscipline of others whose holdings could get sold, depressing valuations of their own holdings. Market excesses always punish everybody equally.
But, opportunity in this crisis clearly lies ahead before the disciplined lot of investors. They must buy when there is selling all around. When the holdings of undisciplined investors get sold, the disciplined investor who buys them tends to profit significantly over the long term.
“A big part of financial freedom is having your heart and mind free from worry about the what-ifs of life.” – Suze Orman