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Panic is not the right response to this

Some sold everything. Some gritted their teeth and said to themselves this is what markets do.

I sat there, figuring another 3% to 5% decline — today’s futures are negative — and the markets should turn positive.

I’ve been through this before. Panic is the worst response.

The crash has attracted world-wide headlines.

The Economist last night published the best piece:

Crash course
How to interpret a market plunge
Whether a sudden sharp decline in asset prices amounts to a meaningless blip or something more depends on mass psychology

FOR much of the past two years, market watchers have had little to write about, apart from the passing of one stock-index milestone after another. The events of the past week, however, have shaken the financial world awake. A recent, upward zag in bond yields seemed to signal the arrival of a new theme in market movements. Stock prices confirmed it, and then some. Over the past week, American stocks have dropped about 7%, punctuated by a breathtaking, record-setting plunge on Monday. The Dow Jones stock index recorded its largest ever one-day drop, of more than 1,000 points. In percentage terms the decline, of more than 4%, was the biggest since 2011.

The swoon set tongues to wagging, about its cause and likely effect. There can be no knowing about the former. Markets may have worried that rising wages would crimp profits or trigger a faster pace of growth-squelching interest-rate increases, but a butterfly flapping its wings in Indonesia might just as well be to blame. There is little more certainty regarding the latter. Commentators have been quick to pull out the cliches: that “the stock market is not the economy”, and that “stocks have predicted nine out of the past five recessions”. These points have merit. A big move in stock prices can signify some change in economic fundamentals, but it can just as easily signify nothing at all. For those not invested in the market, or whose investments consist mostly of retirement savings plunked into index funds, Monday’s crash matters about as much as Sunday’s Super Bowl result.

A drop like this is not entirely without economic risk, however. And that is because the ebb and flow of the business cycle is to a large degree about mood management. And mood management is hard.

Recessions occur when a little slowdown in spending in an economy feeds on itself. Businesses get a little more cautious in their hiring, so vulnerable workers do a little more precautionary saving, so businesses become more cautious still, and so on. There is nothing structurally broken about the economy when this happens; factories work like they did before and workers have the same skillsets. But because everyone worries and saves a little more, and invests and spends a little less, the economy gets stuck in a downturn. Recessions are an outbreak of collective madness.

Governments and economists have discovered that these outbreaks can be fought. They can be fought by replacing the lost spending directly (that is, by having the government pick up the slack) but also by persuading everyone that their worry is misplaced, that things are actually fine, and that they should go back to being cheerful and optimistic. Central banks do this by having public policy targets that they promise to hit and by announcing the policy steps they take to hit them (like changes in interest rates). Keeping an economy out of recession, in other words, is in large part a matter of psychology. It is about coordinating everyone’s expectations, so that everyone believes the economy will continue to chug along-and that any stumble will quickly and adeptly be managed by governments and central banks.

What could change the mood? An unexpected bank failure might. Or a spike in the price of oil. Or butterly wings. Lots of things conceivably could, and a dramatic drop in stock prices is certainly among them. For a drop to have that effect, however, would require some extenuating circumstances. A folk-wisdom sense that the economy was “due” for a downturn might contribute. Or another random piece of bad news. But critical to a broader shift in mood would be the notion, lingering across markets and the public as a whole, that the government or the central bank might not quite be prepared to swing into mood-elevating activity. It’s like a trust exercise: you might lean a bit just to see if a friend is prepared to catch you, but not so much that you cannot recover, then a bit more, then maybe you start to worry that actually the friend seems frankly lackadaisical in his reaction, and then oof, over you go.

Why might a central bank underreact? It might not detect a shift in mood until it is too late, particularly if hard data across the economy look strong. It might not wish to be seen to be beholden to markets: willing to slash rates or take other action the moment stock indexes slip (particularly if the personnel making monetary-policy decisions are relatively new to their roles and keen to establish their independence). It might even welcome a bit of a droop in mood if it is concerned that growth has been too fast, unemployment too low, and inflation about to spike as a consequence.

It is hard to imagine that a tumble in stock prices-even one as dramatic as Monday’s-could shake economic sentiment enough that policy-makers would need to try to lift anyone’s spirits, given how robust economic figures have been of late. To say the fundamentals are strong tempts fate, but the fundamentals are as strong as they have been in over a decade. Of course, it is when things seem rosiest that policy-makers are most prone to underreact to a bump in the road. This crash is probably nothing. But they always are, except for the times when they aren’t.

In short, don’t do stupid and panic.

You can’t time markets.

But the long-term trend — in good stocks — is up. My portfolio is in the right column on this web site. 

Here’s the last ten years of the S&P500. The stockmarket does not go straight up — like it did in the last year. That was an aberration. But the trend, long-term, is up.

10yrsSPX

HarryNewton
Harry Newton.

  • Dman

    Harry, Trump is going to convict both Hillary and Obama of Treason. Do you know the penalty for Treason in the U.S.?

    Harry, your evil satanic demonic democrat party is FUCKING OVER!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

    UP YOUR ASS!!!!!!!!!!

  • Dman

    Looks as though the SCHIFF is about to hit the fan.

    Harry, your sick evil democrat party is DONE !!!!!!!!!!!!!!!!!

    Thank God

  • Nico Robertson

    HAryy likes the auction rate preferreds when they froze up in 2008.

    i talked to him and he said they are duddy

    I like most ipo prices in May…then take a shit

  • Hugh

    The bursting of the bond bubble and stock bubble (all time high Price/Sales) is overdue. Go look at your stock chart again. The market dropped over 50% in 2008. Could be worse this time. Fed is out of ammo (unlike in 2008) having fueled the bond and stock markets to record bubbles. Government spending and tax cuts are fueling record bond sales at a time when China and Japan no longer want to buy our bonds. Interest rates are headed up. Stock market headed down. No time for complacency. In the months ahead you may wish you’d panicked!

    • Jerry

      I agree. I’m looking for a 90 percent drop in the Dow.

    • Omer Acikel

      I think there is a sentiment of “overpriced” stock market in the US and some correction may be due. But saying Fed having no ammo, especially compared to 2008, is not correct: back then the rate was less than 0.5%. Now it is at 1.5%. Not much margin but better than 2008s. I personally thought, and still wonder, if there is a student loan bubble, causing many millennials to go bankrupt. It can have trickling effect on whole economy. Baby boomers can spend so much.

  • Jerry

    I’ve never said this to anyone but I encourage everybody in the stock market to sell everything. THe Nikkei is down 8 percent – I predict it’s going to drop another 70 percent. THe U.S. stock market is worse.

    • Chezy

      Can you repeat that please?

  • Joe B.

    Thank you Harry for your words of sanity. As a long term investor I’m not worried(yet). This was normal and to be expected.
    Are there any good buys that you can recommend so that I can get in at this dip?