It can often be a bit disconcerting that in times of great turmoil and upheaval, when we are subjected to a variety of feelings of distress and even sheer panic we are told by stern voices to “keep calm, don’t panic and “stay the course”. These words of courage and wisdom often prove to be true in the long run, but in the immediate moment, they offer little comfort.
Stock prices throughout the world have suffered heavy losses since the opening of trading in 2016, a rare straight down pattern reacting to the ongoing collapse in global crude oil prices. Market participants have committed, for whatever reason, to the idea that any decline in crude oil prices signals very serious global economic weakness. In truth, demand figures show steady consumption in an environment of huge oversupply, which does not necessarily suggest economic weakness, but this bit of truth is brushed aside by bearish traders fixated on every downward tick of the crude oil quote.. When markets overreact, especially on the downside, it is important not to be confused by facts, truth, reality or anything rational. When panic takes over, truth or facts don’t matter. “Stay calm” and “don’t panic” are words of cold comfort, no matter how correct they may prove to be further out in time.
One explanation sellers of stocks currently offer for the connection of US stocks to crashing crude oil prices is the prospect of multiple bankruptcies by smaller and medium sized energy companies, which have borrowed heavily in the “high yield” junk bond market, where many individual and institutional investors have (foolishly) invested their holdings. A wave of bankruptcies in the oil patch could cause an upheaval in the junk bond market, which may cause even further selling in other markets as junk investors attempt to shore up their balance sheets by selling unrelated assets such as blue chip stocks in order to raise cash; culminating in a classic domino effect.
So what should rational investors do in a situation like this? First, it pays to understand that equity markets were in fact setting up for a major decline last year, as stock prices levitated at valuations near 20% or more above historical averages. So the decline we’ve seen has been somewhat preordained; and now that it is here, investors that are incorrectly positioned are being crushed, while those correctly positioned and holding cash can look to set buy targets for what might be the best buying opportunity in stocks since 2009.
Getting back to “stay calm, don’t panic and stick with your plan” these words often prove to be correct, but require investors to endure excruciating pain in the interim. One method that alleviates some anxiety while awaiting opportunity is to take partial profits on winning positions, reduce or jettison entirely vulnerable and poorly performing assets and convert them into cash. This will give the rational investor a chance to do some portfolio house cleaning while in the meantime creating a shopping list of high quality securities that are being pummeled in the current down draft.
As markets descend to levels where buying opportunities are apparent, the calm investor can acquire high quality investments (lower quality and small capitalization assets are not permitted under my Investment Policy Statement) at prices that can set up considerable long term gains. This jumping into the pool of value when everyone else is freaking out is really very hard to do emotionally, but can often produce very good results.
Financial markets will often test the nerve of the rational investor, so recalling the easy to listen to but hard to follow words: “stay calm, don’t panic and stay the course” can be of great value to long term minded investors, especially in moments like these when markets go berserk and otherwise level headed people run for the hills.