• Dec. 7, 2016, 6:12 pm

A volatile world is sending stock markets tumbling but don’t panic

Powered by Guardian.co.ukThis article titled “A volatile world is sending stock markets tumbling but don’t panic” was written by Suzanne McGee, for theguardian.com on Sunday 10th January 2016 13.00 UTC

The Dow Jones Industrial Average is off to its weakest ever start to the year. In the first four trading days of 2016, the blue-chip index fell by more than 5%.

If you want to know how long “ever” is, that would be since 1897 – or as long as records have been kept.

The Nasdaq is faring even worse, down more than 7%. That isn’t quite a record: it did worse at the beginning of 2000, the year in which the dot.com bubble burst.

It was the worst opening week in history for both the Dow & the S&P 500 index. The former ended the week with a 6.19% loss; the S&P 500 wrapped up the first five trading days of 2016 with a loss of 5.96%, beating the previous record, set in 2008, of a loss of 5.32%. The Nasdaq is down 7.26%. Globally, paper losses amounted to $2.64tn.

 

Billionaire hedge fund investor George Soros – who memorably bet against the Bank of England and won – is drawing comparisons between the investment environment of today and the perilous situation of 2008, when US stocks were cut almost in half, from peak to trough.

But before you reach for your phone or your 401(k) provider’s internet gateway, and start selling, you might want to stop and think. You’re not George Soros, and odds are the dramatic headlines will not mark the end of the world or even the beginning of a 25-year-long bear market.

Admittedly, there is a lot to worry about on the geopolitical stage. In the Middle East, Iran and Saudi Arabia have cut off diplomatic relations. A brutal war in Yemen drags on, as does that involving Islamic State in Syria and large swaths of Iraq.

Overall, Ian Bremmer – the go-to guy if you’re trying to understand the link between geopolitics and the world of business and finance – predicts that we’re about to see “a dramatically more fragmented world in 2016, with more intra-, inter- and extra-state conflict than any point since world war two”.

In that context, it’s no surprise that North Korea decided to test a nuclear weapon, claiming the device it detonated was not an “ordinary” atom bomb but an advanced hydrogen device.

And then there’s China, which has been a source of angst for everyone in the global financial markets for several years. Last week, China’s stock market turmoil wiped out all of its gains since last summer, culminating in the rather bizarre 14 minutes of trading that was all the market managed to achieve on Thursday before shutting down for the day, after the index plunged the maximum allowable 7%.

When trading opened at 9.30am local time the selling was fast. Within 12 minutes the market had fallen 5%, triggering a “circuit breaker”, a 15-minute timeout. The idea is that overexcited sellers will calm down and become more rational. The opposite appears to have happened.

When markets reopened, the benchmark CSI 300 index took only another two minutes to fall the remaining 2% required to trigger a second and final circuit breaker. That left the world wondering if China’s leaders were in full control of their capital markets and whether the market chaos reflected underlying economic turmoil.

If you’re George Soros, or a speculator sitting on a Wall Street trading desk, or somebody else whose job is tied to predicting short-term market or economic trends, all of this stuff matters.

If, like most of us, your investments are sitting there waiting for the day you retire in seven, 10, 20 or more years, and you’re thinking that you probably should respond to the market turmoil and the gloomy comments by Soros by yanking your money out of stocks – stop right now.

I’m not suggesting this is going to be a great year for stocks. It may even prove to be a very bad year. What I am proposing is that if you’re a long-term investor, saving toward a retirement a decade or more away, you will do yourself few favors by responding to even dramatic market movements.

That’s called market timing, and in order to create wealth doing it you have to get your market decisions right at least 74% of the time, according to a study by one Nobel laureate. The top-ranked guru in one study achieved 68.2%. Jim Cramer, host of CNBC’s Mad Money, didn’t even top 50%.

Part of the problem is that you have to get not just one decision right, but two: when to get out of the market and when to get back in. Right now, when the world looks like a scary place, all your instincts are screaming that it’s time to sell. The short-term decision might well be right: the market may be in for a six-month or 12-month period of pain. But when will it turn higher? Will you be able to identify those more subtle signals correctly?

Following the crisis of 2008, ordinary investors failed to profit from the recovery – for years. The rebound began quite quickly, in the spring of 2009. But years later, investors who had sold out as the market fell – often taking losses – were still sitting on the sidelines. Out of fear or distrust, they completely failed to take advantage of the opportunity to buy stocks at some of the cheapest valuations in decades.

That’s one big reason why, if you’re going to save and invest for retirement, you’re much better off simply deciding on a long-term asset allocation that you can live with and then leaving it untouched, except to ensure that it stays properly balanced between stocks, bonds and whatever other asset classes you’ve included.

That way, you can be sure that you’ll be invested in the market every day – because missing the 10 best days can be extraordinarily costly, as a study by JP Morgan Chase recently demonstrated.

Let’s say you invested $10,000 in the Standard & Poor’s 500 Index in January 1995, and left it alone until 31 December 2014: you would be left with $65,453 at the end of that period, or an annualized return of 9.85%. (Not too shabby, when you consider the period in question includes not only 2008, but also the dot.com bust and the subsequent recession.)

Take out the 10 best-performing days of that 10-year period and the amount you would be left with is only $32,665, or an annual return of 6.10%. If you missed the 30 best days, you’d still make a profit and have $13,446 at the end of that period, but you wouldn’t have beaten inflation.

The icing on the cake? Of the 10 best days for financial markets during those 20 years, six occurred within two weeks of the 10 worst days. So as a non-market professional, if you had been frightened out of the market by a period of turmoil and volatility, there is a fairly decent chance you wouldn’t have calmed down enough to make the decision to jump back into the fray.

In light of the saber rattling in the Middle East, there is every reason not to overload your market with energy stock – although hopefully you’ve already reached that conclusion, given that oil prices have been trending steadily lower for more than a year already.

The question mark hovering over China’s economy has been there for some time, and the current drama surrounding its stock market is more a matter of emotions for those not directly involved – in contrast to the US, the Chinese market is small and what happens there doesn’t have a big and direct impact on the economy.

This a long and slowly unfolding story about how well the government can manage the fallout from much slower economic growth. And as it unfolds, you may not want to load up your portfolio with emerging markets equities, even though it’s worth noting that these could zoom back to life without notice and are still worth owning for the diversification they provide.

Market panics and dramas come and go, along with their catalysts. Can you remember all of the causes of anxiety that kept investors out of the market throughout 2011, 2012, 2013 and 2014 – everything from negotiations over the debt ceiling and Europe’s own debt crisis to geopolitical events in Egypt and the Ukraine? Probably not. If you had allowed those to keep you sidelined, your portfolio would be significantly smaller than it probably is today.

The only portion of your assets that you should allow to reflect short-term events is that bit of it that you’re likely to need in the short term. Are you planning to retire in the next two or three years? Do you need a chunk of your money as a down payment for a house this year? By all means, talk to your financial adviser – or hire someone for an hour or two – and figure out how much to pull out of your long-term accounts and how to invest it safely, where it will be less vulnerable to the kind of whiplash to which we’re vulnerable right now.

But as for the rest? When you invest in the stock market, you’re betting on the ability of businesses to continue being innovative and efficient over the years. Is what is happening in the Middle East going to alter that, fundamentally?

Or, let’s face it, in the worst-case scenario, if we find ourselves plunged into chaos as a result of North Korea’s nuclear weapons, we probably won’t care much whether we bet on stocks, bonds or cash. We may simply be regretting that we didn’t stock up on fresh water and canned food, asset classes that don’t appear in any financial adviser’s model of which I’m aware.

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One Comment

  1. Nate
    January 14, 2016 at 9:35 am Reply

    In a financial media world filled with sensationalistic headlines, its nice to see journalists sharing a long-term perspective! Investors shouldn’t be making financial decisions based on what they read in the headlines.

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