We used to live in an old house in Mount Lebanon, a suburb of Pittsburgh. The electrical system was up to date but I had a bad habit of hanging too many lights during the holidays. Most of the time the lights would shine bright and we wouldn’t have any problems. But Pittsburgh winters bring rain. Rain plus too many lights would cause the system to overload and trip the circuit. We were always thankful for that circuit breaker, no doubt it saved us time and money.
The stock market has circuit breakers too, so do individual securities. Panic selling has struck the markets twice this week. Circuit breakers were tripped Monday and Thursday. Both at the open, trading was halted for 15 minutes. A confluence of continuing coronavirus fears, including a travel ban to and from Europe, and a newly announced oil war as OPEC talks collapsed caused prices to plummet.
Stock market circuit breakers
The circuit breaker is meant to prevent panic selling and give investors a chance to breathe and collect their thoughts. There are three levels. First, a 7% drop halts trading for 15 minutes. Second, a 13% drop halts trading for another 15 minutes. Third, a 20% drop halts trading for the remainder of the day.
How would Monday have unfolded without a halt to trading? We’ll never know. For context, and for those who remember, the circuit breakers were put in place after Black Monday – October 19, 1987 – when stocks dropped over 20% in one day.
We’re in an official market correction
We officially hit a stock market correction this week… and then some. That is when stocks drop at least 20%. It only took three weeks making it a brutally fast drop. Compare that to the end of 2018 when the drop took three months. No market has been immune, everyone invested in stocks is feeling the pain. Us too.
Selling can be a pain reliever. As we watch our investments drop it is scary and fear causes pain. So, when we sell, it’s immediately gratifying and pain reducing. In other words, it feels good. The side effect to selling is the loss of future returns and those losses may not be felt for years.
Buying, though, which we believe is an appropriate, contrarian response, can make the pain worse especially if the market keeps dropping. We tell clients to buy low and sell high, but sometimes you have to buy lower and lower before you can sell high. It’s easier said than done.
The truth is market volatility hurts today but falling prices should mean higher future returns.
Being opportunistic when the market drops
There is an old saying that stocks return to their rightful owners in times of panic. The ones who will prevail over the long-term are the ones capable of keeping a level head when everyone else is losing theirs. Hartford Funds has run the numbers. The conclusion: be greedy when others are fearful. (Note: the stock market was down more than 8% in February 2020 and so far in March 2020)
Nevertheless, knowing that dropping prices means higher expected returns is no comfort when the market is in free fall. This is especially true when you take the right action and watch your investments drop further. Currently, that feeling is made even worse from the existential threat of sickness and seeing empty aisles where the disinfectants used to be in Target.
So, we encourage clients to stick to their long-term financial and investment plans. Unless selling is specifically part of the plan it’s best to stay the course or invest more money. That’s because staying the course can pay off and abandoning the course can be costly.
Stay the course in bad markets
Past performance is no indication of future results, yet we can look to history to prove the point to at least hold on. In a wonderful piece developed by Blackrock, they show that staying invested helps investors accumulate more wealth.
Why? It’s because the worst days are often accompanied by the best days. Missing the worst days may feel good today, but missing the best days destroys wealth tomorrow.
Stick to your financial plan
We advise sticking to plans and staying the course, but that doesn’t mean do nothing. It’s during periods of market turbulence that we are the most active. We’re trying to take advantage of the dislocation and reposition portfolios for future results. Today, that means shifting from mutual funds to exchange traded funds with the goal of lowering future tax bills. A wide range of returns allows us to offset winners and losers preventing taxable gains. It also means rebalancing asset allocations back to weight as bonds and cash contribute to portfolio stability. Rebalancing helps us to buy low and sell high.
Finally, the short-term is unpredictable. We can’t time the perfect entry or exit into the market. We’d argue no one can, so the best action we can take is to prepare portfolios and clients for future success.
If it’s all too much, turn off the news, put away your phones and go for a long walk. It’s what I do and it will help. I promise.
Adam K. Wright, CFA, CFP®