Some Thoughts on Market Panics

When the market pulled back in early 2018, I had just started writing publicly. It was my first chance to write an article offering my take on what investors should do during market declines. And I wanted to take advantage of the opportunity, so I brought out all the plays from my stay the course playbook. I talked about how stocks are the best long-term investment there is, and I threw in a chart to prove it. I talked about how market corrections are fairly common and found a couple of charts to back that up too. I even reminded people that volatility is par for the course when you invest in the stock market. I basically wrote the textbook stay the course article.

Looking back on that article today, I can’t necessarily take issue with anything I wrote. I still think the long-term case for stocks in a compelling one. I also think significant declines and volatility are the price you have to pay for those gains. But despite that, if I had to write that article again today, I would do it very differently. The reason is that it lacked a true appreciation of what it is like to endure market declines. It also lacked a recognition of the human emotions that can wreak havoc during periods of market panic. With that in mind, I thought the current market decline might be a good opportunity to give it another shot. So here is my second shot at a list of things to keep in mind during market declines.

Staying the Course is Really Hard

It is so easy to understand the stay the course argument when you look at this:

It is much harder to understand it when you are looking at this:

The first chart is a long-term chart of the S&P 500. In that context, every decline looks just like a blip on the radar. In retrospect, every bear market was a buying opportunity. But during market declines, investors aren’t feeling what is in the first chart, they are feeling what is in the second one. They aren’t feeling the small blip in the much bigger picture. They are feeling the major pain that goes with their hard-earned money being lost.

It is very easy for all of us who make the stay the course arguments to live in an emotion free world where all that matters is long-term data. But I think in many ways that does a disservice to those who follow us. There is nothing wrong with feeling like you want to panic and sell during times like these. There is nothing wrong with questioning your long-term strategy, especially if it is a strategy that is making things worse by underperforming the market like value is now. Those are perfectly normal things. Even those of us who seem robotic in our adherence to the stay the course strategy feel all those things. All of us panic. All of us have times we let our emotions get the best of us and make bad decisions. I think my first article missed that point. It missed a true acknowledgement of how tough market declines can be. Daniel Crosby put it better than I can this week on Twitter when he said the following:

So even though I wouldn’t change the advice I gave, I would change the level of compassion and understanding I gave it with.

None of Us Know the Future

As I am writing this on Monday March 9th, the S&P 500 is down a little more than 19% from its highs. We touched bear market territory this morning, but have come off those levels. We could be in a situation where most of the pain of this decline has already been felt. We also might be in a situation where there is a lot more to come. I don’t know which situation we are in. And neither does anyone else.

When I wrote my previous article in 2018, it seemed prescient. Shortly after it was published, things went back to normal and the bull market resumed. That wasn’t because of any skill I had, though. It was purely a matter of luck.

What I think I was missing from that article was an acknowledgement that stay the course doesn’t mean things can’t get worse. When these types of articles are published near market bottoms, they seem like good advice, and when they are published when there are much bigger declines ahead, they seem uninformed. But they aren’t really different in either case. This decline we are in now may get much worse before it gets better. And if it does, it won’t make the advice to stay the course any less valuable. The reality is that none of us know when this or any other decline will end. If you think you can time that, you are better at this than I am. But either way, it is important to acknowledge that advice to stay the course can look pretty dumb when it is given well before the bottom ends up coming. It isn’t intended as a prediction that the worst is over, though. It is more an acknowledgement that there is no way to predict that in advance, so enduring the pain is the strategy with the highest probability of long-term success.

A Little is Usually Much Better Than a Lot

Despite all the evidence that you can’t time market bottoms and that making changes during times of panic hurts returns, sometimes things are just too much for some investors. Although it may be great to live in a theoretical world where this never happens, that just isn’t reality. In these cases, a minor mistake is much better than a major one. What can really kill long-term returns are binary decisions made in high stress situations. Cashing out a portfolio in early 2009, after the market had dropped by nearly 50%, is a great example of this type of thing.

What I have learned throughout my career is that taking a little risk off the table or raising some cash during market panics is ok for some people. A small change can often prevent a big mistake. For example, a 10% reduction in equity exposure can sometimes help avoid a decision to go completely into cash. It is easy for those of us who advise clients to sit here and say that any change made during a period of market decline is a bad one. But I have learned over the years that sometimes a small incorrect decision can be a good thing if it prevents a larger one.

A More Realistic Approach to “Stay the Course”

In the end, I remain a big believer in long-term investing. I think the stock market is the best place to build wealth over time. And I believe that success will require you to endure the pain during times like these. But time has also taught me that theory often doesn’t translate perfectly into the messy world of managing money. So I will continue to try to be that guy who tells people to stick to their investment plan during times like these. But I also hope I can do it with a little more flexibility and empathy than I have in the past.