An extremely calm summer in the markets has been interrupted with some extremely sharp moves around the globe. Between Greek fiscal issues, volatility in China’s stock market and currency, perennial saber-rattling in Korea, or our very own Federal Reserve, there is plenty of blame to go around. Although the headlines change from time to time, we have witnessed quite a few panicked markets over the years and want to share a little bit about how we view these environments. The below is our “Panic Playbook.”
In order to take advantage of market volatility, investors must start with an appropriate asset allocation that will limit portfolio volatility to their comfort zone. If short-term losses exceed a comfortable level, an investor will be more inclined to sell during a market decline (who can think clearly and make sound decisions under a lot of stress?). One of the reasons that we spend so much time discussing risk-tolerance with our clients is that we do not want anyone selling during a panic.
If a somewhat “orderly” market decline turns into a panic, fear can sharply accelerate losses. Fear begets fear and sales beget sales, as well as redemptions, margin calls, and de-risking. This is sometimes referred to as forced selling, as sellers are forced to liquidate holdings regardless of valuations, fundamentals, or rationality. Any amount of buying is likely to be overwhelmed with a flood of selling. Generally, the best thing that investors can do is not panic.
There will be some assets that are clearly overpriced, impossible to value, or just too illiquid or volatile to touch. But there will also be other assets that have been unfairly sold off. Investors should work to identify these assets and consider if and how to add them to their portfolio.
It is unlikely that investors will be able to catch the very bottom or even within a percentage point or two. Know and expect to be a little early or a little late. If you’re a little early, you’ll have some immediate losses, but catch all of the ensuing gains. If you’re a bit late, you’ll miss the immediate losses as well as the early gains. Our bias is towards being a little late, because fear often subsides more slowly than it strikes and opportunities often linger for longer than one might expect.
There is a lot more detail to how we measure and implement the above, but that is the general framework. To summarize:
- Be prudently allocated.
- If panic ensues, do not get drawn in. Do not panic.
- Identify assets that have been unfairly punished and represent compelling opportunities.
- Prioritize opportunities and purchase assets. This will differ from person to person, depending on risk tolerance, allocation, tax situation, etc.