A Sane Response to Market Panics

blue and yellow graph on stock market monitor

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Stocks have panicked twice during the last few weeks. The first downdraft came on Monday, August 12 on the news that China had allowed its currency, the Yuan, to fall sharply against the dollar.  The Dow Jones Industrial average fell some 400 points that day.  All day, people asked each other, “Is this the big turn?” In the days following, the market recovered the lost ground.  On the following Wednesday, August 14, the Dow Index crashed again  –– an even more dramatic 800 points –– on news that, first, already weak European economies might actually have shrunk slightly and, second, on renewed awareness that long-term bond yields had fallen below short-term note yields in what is termed a yield curve inversion and which is a classic sign of an impending recession.  But before the week was out, markets had all but recovered that lost ground.

There is a lesson here about the largely emotional behavior of investors and pricing stocks on a day-to-day rather than a fundamental basis.  Actually, there are at least four lessons:

  1. Headlines intend to inflame readers, and fear is the ultimate clickbait. China, in allowing the Yuan to lose value against the dollar, was not, as was so frequently described during that panicked day, a sign of resolve or a trump card (no pun intended) played in its trade war with the United States.  A little reflection, which was something investors did in subsequent days, revealed that Beijing’s gesture was more a sign of weakness than anything else.  It showed that China could not successfully match the United States tariff-for-tariff, as it had earlier in this conflict.  In the teeth of that Monday panic, if investors had just waited for the market close to think about reality instead of giving in to fear, they might have used the retreat as an immediate buying opportunity, or simply saved themselves needless anxiety.
  2. There are no foolproof indicators. During the second panic, many guests on CNBC and other financial news outlets spoke of the wonderful forecasting record of yield curve inversions.  No one used the word “foolproof,” but it was all but implied. If, however, the yield curve indicator is really as good as people said that day, we would all be billionaires, because market forecasting would be as easy as, let’s say, falling off a log. Since everyone is not yet a billionaire, we all have reason to doubt the claims that commentators made for the yield curve that afternoon.  Further, if yield inversions were really that reliable, the market would have long since fallen, because the curve had moved in and out of inversion since May of this year, when I first wrote on the subject and itemized how many times the yield curve has given false signals.  I’m not saying that people should ignore yield curve indicators.  On the contrary, investors should pay close attention and look for corroborating evidence, but panic should have no role in that effort.
  3. Markets, especially in the short run, feed on themselves. Not all sale decisions reflect a careful consideration of the fundamentals.  Program trading often relies on algorithms that use recent trends to forecast the next few hours.  When markets fall dramatically, for whatever reason, these asset managers sell, adding momentum to the down move.  (They can do the same on the way up.)  Adding more impetus to any downward momentum are sellers who had bought on margin (credit), and who must often sell into a sudden price drop to avoid a margin call that would force them to put up more money to support their position.
  4. It was not new news that European economies were weak, as was Japan’s. This information is valuable and it suggests that the U.S. recovery will increasingly face headwinds, unless these foreign economies pick up.  But that warning is an alert, and not a sign to panic, especially because the news is rather old. 

So, shut off the TV if necessary.  The way to deal with such events is to wait for the close of trading. Weigh what news there is –– if it really is news –– against the flow of information from the last few weeks and months. Only after you have done this review should you decide if your long-term plan (stressed so frequently in these posts that a hyperlink would go on for several lines) warrants action.  Perhaps, if that basic plan calls for you to commit idle cash, you might use the downslide as a buying opportunity, not to time market ups and downs, but to do what you needed and planned to do anyway, when the time was opportune.

 

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