Last week was the worst week for the equity markets since the 2008 financial crisis. All of the major market indexes lost more than 10% during a week where it seemed everyone wanted to sell, and no one wanted to buy stocks.
Most Floridians are familiar with the panic that happens when a hurricane is on the way. If you’ve ever visited the supermarket a few days before a major storm, the past two weeks’ panic in the financial markets should feel familiar. Most of the time, when the big storm arrives, it isn’t nearly as bad as we imagined it will be.
History of fear
Investors in the US stock market have seen dozens of traumatic events over the past 100 years. We’ve had two world wars, oil shocks, and the cold war. There have been times of civil unrest and great political disagreements. The economy has seen periods of high unemployment, high inflation, and even higher interest rates.
More recently, we’ve seen wars in the middle east and a currency crisis in Asia. After that came the tech stock bubble, and then the housing bubble which burst as the great financial crisis began. We’ve also seen dozens of minor crises, from the SARS virus to the Greek debt crisis. These events seemed terrible at the time. Some were simply speed bumps on the road to economic growth. Others did have significant real impact on the economy. During all of these events, many investors gave in to their emotions and sold stocks when they should have been looking to buy.
During the panic phase of a market correction, shares of top-quality companies decline in lockstep with the rest of the market. Most investors today buy mutual funds and exchange-traded funds, not individual stocks. When fear grips the markets, these investors panic and sell their funds. The fund managers are then forced to sell their holdings, good and bad, to raise cash for redemption requests. These waves of selling create opportunities for wise investors to buy great companies when they are on sale.
If you are concerned about your investments, the first thing to do is to maintain a well-diversified portfolio. Diversification among different asset classes provides a buffer against market volatility. The second thing to do is to take a step back and look at the big picture. Despite the recent market decline, the major market indexes are still significantly higher than they were a year ago. Economic fundamentals remain strong. Unemployment is low, inflation is low, and energy is inexpensive. Both banks and consumers are both in good shape financially. Keeping the big picture in mind will help you avoid making emotional decisions when the markets are volatile.
Avoiding overreactions during a correction allows you to take advantage of volatility. Investors who remain calm can find opportunities to buy great stocks at lower prices. The best time to buy quality companies is when they are on sale, and other investors are afraid to buy them. Wise investors understand that market panic events create opportunities. The keys are to remain calm, stay diversified, look at the big picture, and invest in quality companies for the long run.
Matthew Treskovich | CPA/PFS, CITP, CMA, CFP®, AEP®, MBA, CLU, ChFC, FLMI
Chief Investment Officer