Some Scares Turn Into Market Crashes and Others Don't
As the stock market stays near all-time highs, it’s normal to feel like a market downturn is around the corner. There are always new fears, some warranted and others not so much. Right now, it’s a mixture of unsustainable earnings, scary AI scenarios, and unsustainable government debt. Staying up to date on all those concerns can help you understand what investors are thinking, but it doesn’t tell you what to do about it (hold steady or sell) or when to do it (now or later).
Financial spreadsheets can model a lot of things, but you really can’t model panic, which is a human reaction. Sometimes big events turn into non-events that investors look past. Other times, real panic sets in, and selling brings even more selling. The size of the story and the size of the damage are often loosely related.
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Here are two examples in each direction (small event, big panic / big event, small panic)
Small event, big panic
On October 19, 1987, the Dow fell more than 22% in a single session, still the worst day in its history. No recession or company collapse. Several institutions running hedging strategies tried to sell into a falling market at the same moment, and early program trading amplified the cascade faster than human traders could keep up. Psychology set in, and people sold without really knowing why.
Big event, small panic
In June 2016, the UK voted to leave the EU after the polls and betting markets said it wouldn't. U.S. stocks dropped more than 3% in a day, and plenty of thoughtful people called it a lasting hit to global growth. The entire decline was erased in about two weeks.
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So how should investors protect themselves from future panics? To start, by not trying to predict every panic. When scary headlines roll out, deciding whether you are looking at a Brexit or a 1987 event is a coin flip. Any investment plan that depends on getting that call right is not a good plan.
The useful question is much more boring. How much of your money needs to be liquid and safe for the next few years of spending, so that a decline of any depth or length never forces you to sell? Going back to 1987, what made that day so violent was that many large institutions had built strategies that required them to sell into a falling market whether they wanted to or not.
The diversification, the rebalancing, the cash we set aside for near-term withdrawals, all exist so that when the next panic arrives, you get to watch instead of joining it.
Happy Planning,
Alex
This blog post is not advice. Please read disclaimers.