"Panic" Is Not An Investment Strategy

The wild swings in the stock market over the past week - up 400 one moment, down 400 the next - are unsettling for all investors.

In stressful times such as these, it seems as if the stock market has come unhinged. But the reality is that extreme market swings are often clustered together, as volatility begets volatility. Panicky investors who are swayed by every piece of news in the market cycle see deep, rapid drops in the market and hit the "sell" button, fueling further declines. This is followed by what might be termed "panic buying," as large, institutional investors with substantial cash to invest try to catch the market at a low point and buy into the stock market on the cheap. And so the cycle continues for days, weeks and sometimes, as we saw in 2008-09, months.

What does this have to with long-term investors? Not much, actually. However unsettling the decline has been, it is not unusual for the stock market to experience such declines every few years. While we do not minimize the anxiety that such a rapid stock selloff induces in all investors, the fact remains that the decline in the Dow Jones Industrial Average has still not even met the technical definition of a bear market (i.e., a 20% peak-to-trough decline). For the Dow to be in official bear market territory it would have to hit a level of about 10,200.

Whether the Dow hits the bear-market threshold or not, the point is that the stock market's decline has actually been pretty typical on an historical basis. The media loves to obsess about "point declines" in the Dow, but such measures don't provide accurate historical context. Consider that on August 12, 1932 the Dow dropped a mere 6 points, yet this constituted an 8.40% decline - still the sixth-worst percentage decline on record! Meanwhile, the 635 point drop this past Monday failed to even crack the top 20 worst percentage declines in the Dow's history.

Whatever the story of this market downturn ultimately turns out to be, we are certain that "panic" is not a viable investment strategy for long-term investors. This is not merely our perspective. Lost amid the sea of negativity in the media have been some sage voices of reason and interesting tidbits that, we think, will help long-term investors keep the faith. We hope you find these reassuring in the face of the daily onslaught of media hysteria that will no doubt endure in the days and weeks ahead. 

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My advice for investors is to stay the course. No one has ever become rich by being a long-term bear on the fortunes of the United States, and I doubt that anyone will do so in the future. This is still the most flexible and innovative economy in the world. Indeed, it is in times like this that investors should consider rebalancing their portfolios. If increases in bond prices and declines in equities have produced an asset allocation that is heavier in fixed income than is appropriate, given your time horizon and tolerance for risk, then sell some bonds and buy stocks. Years from now you will be glad you did.

"Don't Panic About the Stock Market," Burton G. Malkiel, Wall Street Journal, August 8, 2011

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"My rule - and it's good only about 99% of the time, so I have to be careful here - when these crises come along, the best rule you can possibly follow is not "don't stand there, do something," but "don't do something, stand there!"

Vanguard founder John Bogle, as quoted in a CNBC interview, August 8, 2011

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Is the recent plunge in stocks a sign the economy is entering a recession? J.P. Morgan analysts looked at evidence from past declines, and concluded that it's not.

Since 1939, the market has seen 30 "waterfall" stock declines of 15% or more over four months, J.P. Morgan's chief equity strategist Thomas Lee said in a note to clients. Fifteen of those drops came entirely outside of a recession. Six of the declines came at the start of a recession, two preceded a recession within a year and the other seven occurred later in a recession.

That means a 15% decline in stocks over four months has resulted in a recession a third of the time - "not a great predictor," he writes.

"Stock Plunge Isn't a Great Recession Predictor," Sudeep Reddy, Wall Street Journal, August 9, 2011

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As traders everywhere seemed to be hitting the "sell" button lately, one important group was taking the other side: corporate insiders. Research firm InsiderScore reported Tuesday a "dramatic acceleration in insider buying" over the past few days. It noted the volume of insider buys hasn't been so high since the market's March 2009 bottom.

Some of the companies whose executives scooped up shares over the past week include manufacturer Mueller Industries, energy firm EXCO Resources and software company VMWare. The buying suggests that more than a few insiders aren't so worried about a double-dip recession clipping corporate profits.


"Overheard: Insiders Buy The Dip," Heard On The Street Column, Wall Street Journal, August 9, 2011

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"We're still in a place of extreme fear and emotional trading," said Ron Florance, managing director of investing strategy and asset allocation for Wells Fargo Private Bank. "We're not even close to where fundamentals and valuations are driving market performance."

"U.S. Stocks Gyrate In Post-Fed Chaos," Steve Russolillo, Wall Street Journal, August 9, 2011

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Billionaire investor Wilbur Ross said he's buying assets as the losses in global markets are being driven by fear rather than economic reality.

"Has the world really gotten 10, 12, 15 percent worse in the last 48 hours? I don't think so," Ross, who leads WL Ross & Co., said in an interview with Bloomberg Television. "Buying stocks at today's prices over a couple of years' time period will prove to be a uniquely rewarding experience."

"Stocks Soar Most in Two Years," Michael P. Reagan & Rita Nazareth, Bloomberg.com, August 9, 2011

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This isn't the 1970s, when P/E ratios were low but inflation and interest rates were high. Investors are worried about different problems: a weakening domestic economy, Europe's debt mess, political dysfunction in Washington and a massive and seemingly intractable federal budget deficit. Yet American corporations rarely have been in better shape, with generally robust profits and balance sheets flush with more than $1 trillion in cash.

"Attention Shoppers: It's Time To Buy," Andrew Bary, Barrons.com, August 6, 2011

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Stocks have tumbled 15% during the last month, and are down almost 20% from the year's highest level reached in April. The losses suffered during two of the last four trading sessions have been the worst since the 2008 financial crisis.

Following that slide, stocks are trading at a deep discount -- about 12 times forward earnings.

Not only is that compelling on a historical basis, but it's also at a time when companies are delivering strong earnings and have a record amount of cash on their balance sheets.

"Stocks at 'Fire Sale' Prices After Bloodbath," Hibah Yousuf, CNNmoney.com, August 9, 2011

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The U.S. "deserves a AAAA rating. Financial markets create their own dynamics, but I do not think that we are facing a new recession."

Warren Buffett in Bloomberg TV interview, August 8, 2011

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The very fear that the United States economy is heading into a double-dip recession may well serve to keep us out of it. As prospects for economic growth have dimmed, prices of a number of commodities have fallen. While ostensibly a sign of economic bearishness, these declines can also be interpreted as a good omen, for they lower the costs of production for business, as well as the cost of living for consumers.

For example, the price of oil has plunged from its recent high of nearly $115 a barrel in April to just over $80 at the close on Monday. This is a drop of more than 30% in less than four months. As a result, drivers can look forward to sharply lower gasoline prices over the next few weeks. This will put needed buying power in their pockets, just as the back-to-school shopping season shifts into high gear. This is clearly good news for the nation's merchants.

"Fear of a Recession May Help Avoid It," Irwin Kellner, CBSMarketwatch.com, August 9, 2011