We here at The Long Run Blog are not here to make predictions, give direct advice or be just another source of news. However, we are here to add a rational, skeptical perspective at what goes on in our world of economics and finance. I think it is important and hopefully helpful to add perspective to the recent events.
Investors are notorious for making exactly the wrong decision at exactly the wrong time. Numerous studies of mutual fund, pension and brokerage accounts all confirm the same thing: people get greedy near the top and fear causes them to sell near the bottom. The stock market is a gauge of human emotion in the short run, not the capital allocation machine it is in the long run.
Those drilled in the "stocks for the long run" mantra will buy, while those more interested in more immediate returns will be sellers. Long-runners will be proven right- eventually- although 'eventually' can be a long, long time. The stock market did not fully recover to its 1929 levels until 1943, 14 years later. Would you have had the fortitude to hold on after being down 25%? 50%? How committed to the long run would you be in 1932, down over 60% and possibly out of work too? Most likely you would have been shaken out of the market during its worst moments. That is an important perpective to keep in mind.
Yet the time to buy is usually while everyone is panicking. On far more occasions than the few great crashes, such brief spans of panic have proved wonderful long-term buying opportunities. Indeed, the four most dangerous words for an investor are "this time its different". Why? When you cite that phrase, you are implying market history is not repeating, which has been wrong in every instance except one- 1929.
But how do you know whether this is 1929 redux or 1987 or 1998 when things bounced back in just a month or so? First, you must use the proper perspective lens and realize you can not know what the situation will be in a few months with any comfortable level of certainty. Too much is dependent on how the story unfolds- will the Fed make a mistake? How about Congress? We can't possibly know how all the players will react.
We can, however, decide if conditions are such that risk is greatly increased. For example, when the 1998 meltdown of Long Term Capital Management roiled the markets, the economy was in good shape, the dollar was stable, banks were appropriately leveraged and the only real problem were a few isolated events- Russia and LTCM. By and large the system was healthy. After 9/11, there was panic for roughly 3 weeks until people realized this wasn't the end of the world, albeit still not a good situation. Ultimately, the two month post 9/11 rally faded as the economy worsened (it was already very weak) and stocks reached new lows less than 9 months later.
Today, we have an already weak global economy, unstable and highly levered financial institutions, and unknown counterparty risk in the derivatives world. These are not healthy conditions. If an otherwise healthy 35 year old gets pneumonia, they are probably going to be fine after a short while. If an 80 year old or an overweight 45 year old smoker gets pneumonia, the odds change dramatically and at the very least, the recovery takes a lot longer.
To make the proper decisions, you must know your tolerance (or your clients). If someone saves AIG tomorrow and stocks rally for a few weeks, will you be upset at missing the rally and buy back in? Or is missing a few points on the upside worth the insurance against the possibility of a severe bear market? Are you comfortable and able to tolerate the swings?
In this moment of great uncertainty, I leave you with my perspective: This may be the only time since the Depression that conditions are unstable enough to actually result in true financial disaster. That doesn't mean it will actually happen, nor is it necessarily likely. And it doesn't mean that if it does happen it will be as bad as the 1930's. It simply means that it may be much more possible now than anytime since. What should you do under the circumstances? It depends on your individual situation and existing level of diversification. For some, this may be a total non-event. That's what good, personalized advice is for. I can at least promise the coming weeks will be exciting- at least as exciting as market watching gets.
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"...unstable enough to actually result in true financial disaster."
ReplyDeleteWhat does "disaster" mean to an average person? You make it sound like the absolute breakdown of society. How do we recognise when we've gone from potential into unstoppable disaster? How wide-reaching would such a disaster be? World-wide, or could some economies protect themselves? How do we start recovering from it afterwards?
Great blog btw.
Great question. It is hard to be clear and precise in a short space, but I will try. The short answer is we don't know exactly. When I wrote "disaster" my mind was drawing analogies to 1929 and the Great Depression. "Absolute breakdown of society" was not part of it however. World-wide? Yes. Will some economies fair better? Some less globalized economies will fair better than others, but the effects would be felt everywhere. Keep in mind, I am NOT implying this is going to happen- only that it is quite possible.
ReplyDeleteafray, as I sit here waiting for news, I wanted to add a bit about the impact to the average person, obviously to varying degrees. The impact on the economy will determine the impact on the 'average person', but two outcomes are immediately likely: a) higher unemployment b) severe losses on investments, like 401k accounts, etc. depending on what you hold.
ReplyDeleteBrett, thank you for your article. I appreciate the time you spent on it. As an otherwise healthy 40 year old without pneumonia, I’m concerned if I will be fine for the long run. Since I’m self employed, I find that I have money to invest when times are good and less when everyone is panicking. Understanding my situation, how would you suggest I take advantage of the wonderful long-term buying opportunities that you described. I’m looking forward to reading more of your Long Run contributions.
ReplyDeleteThis isn't an appropriate forum to give personal advice, particularly since I don't know your whole situation including risk tolerance. Besides I get paid for direct advice, the blog is free ;-)
ReplyDeleteYet you raise a good question that can be answered in general terms because it addresses a very common problem. If I may rephrase the situation first: it seems you have more money to invest when times are good and good times generally mean the market is higher and more expensive (but not always), yet we all want to buy when things are low and less expensive. One way to avoid buying high is to "dollar cost average". Instead of investing all of your savings at once, spread the purchases out over a set period of time. This way the funds aren't invested all at once, presumably near a peak, but spread out across different market environments and prices.
Naturally, such a strategy should be considered only in the broader context of your investing strategy, rainy day reserves, risk tolerance, appropriate allocation, goals, time frame and other factors in one's personal financial situation, so do not take this idea as a recommendation specifically for you, it is only an example of one alternative. You should have a qualified professional make a recommendation in the proper context. Besides, there are valid counter arguments that investing lump sums at once is ok too.
Thanks for the question and you don't look a day over 29 in your avatar!