Mark Hulbert has compiled an interesting list of recent market panics:
- August 2015: Concerns about the Chinese economy and stock market led to panic selling, with the Shanghai index plunging 8.5% in one day. Soon after in the U.S., on August 24, 2015, the DJIA plunged over 1,000 points in just a few minutes, its most precipitous drop ever, ending the day down 588 points, its worst one-day loss in five years.
- January 2016: Concerns about the direction of the U.S. economy, and fears that the U.S. stock market was overheated led to a 5.5% drop during January, with the Nasdaq composite down 8%, its worst month in six years.
- February 2016: U.S. stocks took another dive, as investors freaked out over (rather than celebrated!) oil’s drop below USD$27 per barrel. As of February 11, the DJIA had lost 1765 points since the start of the year. The Nasdaq was close to bear market (20% decline) territory.
- June 2016: Worldwide markets panicking over the U.K.’s Brexit vote wiped out USD$3 trillion.
Prophets of doom
Along the way, there have been numerous solemn prophecies of doom, some of them very dire (and certain) in their predictions:
- Can Anything Prevent a U.S. Stock Market Crash in 2016?.
- 80% Stock Market Crash To Strike in 2016, Economist Warns.
- Analyst: Here Comes the Biggest Stock Market Crash in a Generation.
- The man who accurately predicted 4 market crashes told us 3 more dates to worry about this year.
- RBS cries ‘sell everything’ as deflationary crisis nears.
Now it must be kept in mind that it is entirely possible that some or all of these predictions might materialize. Indeed, a major market correction might already be underway when one reads this piece. But volatility is the nature of markets in general and stock markets in particular — investors who do not have the stomach for roller-coaster rides should place their savings and investment elsewhere.
Statistical consequences of panic selling
But one does have to ask what is the point of panicking during a market decline. If one sells, it is statistically more than likely that one will ultimately take a loss, compared with a buy-and-hold approach (because it is statistically more likely that one is selling out near the market bottom). And the deeper the market decline, the more statistically certain it is that selling will ultimately result in a major loss.
For example, millions of panicking investors sold billions of dollars (and euros, pounds, yen and yuan) of stocks on 9 March 2009, which was the bottom of the 2007-2009 bear market. Many of them later bought back into the market, but in most if not all cases their investments took a major permanent hit in the process, because they bought back at a significantly higher price. One financial colleague of ours reports that at least one client of his never bought back into the market.
A recent DALBAR study found that over a 30-year period, the average self-directed equity mutual fund investor earned only 3.7 percent, compared with 10.3 percent that could be obtained by simply investing in a S&P500 index fund. Much of this huge shortfall is due to panic selling during market downturns, or attempts to “time the market.” Indeed, the American system of relying on 401K accounts for retirement savings has been a decidedly mixed experiment, with typical returns very much less than a simple buy-and-hold, low-cost index fund strategy.
How do other market prophets fare?
At least individual investors have plenty of company as they lament their inability to predict or time the vagaries of the stock market. Hedge funds, those boutique financial operations that cater to very wealthy investors (and charge similarly exalted fees) have not done very well either. The HFRI index of U.S. hedge funds posted an average loss of 0.85% during 2015, compared with a 1.36% gain in the S&P500 index. And over the past five years, the Barclay hedge fund index has posted an average 3.36% gain, substantially less than the average 12.58% gain for the S&P500 index.
Along this line, in 2008 Warren Buffett entered a bet with a hedge fund manager that a portfolio of hedge funds would not out-perform the S&P500 index over the next ten years. Eight years into the bet, it appears that Buffett will win hands down, as the hedge fund portfolio is up only 20%, whereas the S&P500 index is up 63%.
The failure of emotion-based trading
Paul Merriman, citing the DALBAR report, assesses the situation in these terms:
The numbers change from year to year, but every DALBAR report comes to the same conclusion: Investors’ emotion-based trading is counterproductive.
Along with many others, I have tried over the years to educate investors about the effects of what DALBAR describes as “knee-jerk reactions to crises and mistakes.”
Has that helped? Here’s what DALBAR says: Despite “enormous efforts by thousands of industry experts to educate millions of investors, imprudent action continues to be widespread. … The belief that investors will make prudent decisions after education and disclosure has been totally discredited.”