Last week we had the referendum heard round the world. Voters in the United Kingdom turned their backs on the Continent after 43 years.
Investors worldwide were fearful and fled equities in droves. In two days the Dow Jones Industrial Average fell 871 points.
And then a strange thing happened. Investors decided that perhaps the sky was not falling after all. Counting a one day run up before the vote, in just four trading days, the Dow had nearly returned to its level of the week before. By the fifth day, it was actually 100 points higher.
This is yet another lesson that investors should not react rashly to emotional events. In the short run, markets are highly unpredictable. Study after study going back a century has shown that investors are likely to hurt themselves by quickly reacting to events and trading emotionally.
The research firm Dalbar has shown that current investors receive about one-third of the return of the mutual funds they invest in because they make ill-timed moves in and out.
It feels uncomfortable to sit there and do nothing while the world is falling apart. But do it anyway. Your wallet will thank you.
The Three Dangerous Times
The three particularly dangerous times for investors: when markets go up, when they go down and when they are flat.
For the last two years, U.S. markets have been in a narrow trading range. Some days the market is up a lot, some days it’s down big. But overall, for two years the broad market is close to flat — up 3 percent a year — a third of the long-term average.
During a long flat period, investors get bored and are often up to mischief, searching for alternatives that promise much and mask danger.
In bear markets — the market often plunges quickly –and investors are prone to panic and do things that imperil their finances for many years.
When the market is doing well — bull markets — people get exuberant and overconfident and may take on greater risks and obligations than they intend. This sets them up for failure in the next cycle.
Given this bleak picture, what should investors do to improve their odds of success? Investors need to be patient, avoid emotional decisions and think long-term.
None of this is easy but it’s important for a successful investment experience.
The U.S. stock market is off to its worst start ever — down nearly 12 percent in just three weeks. Standard & Poors searched records back to 1897 and couldn’t find anything worse.
While the market has been drifting lower since summer — including a brief but scary decline in late August — this drop has seemingly come out of nowhere and is unremitting in its furor.
Yesterday, the Dow dropped 550 points by midday before rallying sharply. While there are always things to worry about, this seems to be the bear market about nothing.
The Chinese economy, the second largest in the world, may be getting unhinged. And the oil market has gone from boom to busted in 18 months but hey, nobody’s perfect.
If it weren’t for these minor issues, the outlook might seem bright. Job growth has been strong in the U.S. and corporate balance sheets are in the best shape in years.
Worldwide, corporations and investors are awash in cash and looking desperately for places to stash it (no place more frantic than Colorado where legal marijuana growers can’t access the banking system).
So what’s an investor to do? It’s usually best to hunker down and not panic. And if you feel like panicking, turn off the TV and the Internet and take a walk. You’ll feel better and in the long run, your portfolio will thank you.
Apple Goes Into Dow
This week Apple Computer becomes part of the prestigious Dow Jones Industrial Average. The Dow is made up of 30 stocks and since its creation in 1896 has become the single most widely cited indicator of stock market performance. And yet its quirky structure shows the dangers of relying on any one indicator to mark investment performance. The Dow Jones average is based on just price, not the total value of the companies. Once a stock splits, its weight in the Dow goes down even though the value stays the same. After some moves in the Dow this week Goldman Sachs will have the heaviest weight in the average because it has the highest price. Moves in the price of Goldman stock will have a disproportionate affect on the average. Often the Dow moves in sync with other major averages such as the S&P 500 but many times they have widely divergent moves. While the Dow is a good shorthand way of following the stock market, keep in mind that its only a snapshot of a small number of stocks and there are thousands of other great companies.