Good times and bad times come with the investing package. Periods during which financial markets experience turbulent times are quite frequent in fact. If you look at 121 years of history*, you will see for example, that one in every ten months on average, the US equity market experiences a drop of more than 5%. Sometimes it is a small and temporary decline, sometimes a market correction, sometimes what we call a market crash. One sure thing, when it happens it often leaves investors with an unpleasant feeling. And on the spot, the first reflex is to try to rationalize what is happening. We need a culprit. But is it the right thing to do?
Can one single headline explain the motive and behavior of millions of economic agents?
Why is it happening?
A possible answer (but probably not the one you want to hear) to the question “why is it happening?” is: Well, why not? It is very logical to want to find reasons behind events (open any financial newspapers and you will find plenty: growth concerns, inflation, crisis, disappointing results, rumors of wars, etc.). In my experience, it is a delicate exercise that does not always add value. First, the fact that assets go up or down is the result of thousands of financial transactions between millions of human and robot buyers and sellers. Can one single headline explain the motive and behavior of millions of economic agents? Second, when markets slide and a decision must be taken, assessing every potential reason behind their decline won’t necessarily help you. You will end up having to assess hundreds of variables and make a call on each one of them to see if the market downturn is likely to continue. Good luck!
In these situations, and in the absence of the clairvoyant abilities, I prefer to focus my efforts on trying to answer two questions instead:
Why did the assets rise in the first place?
And was price appreciation “healthy”? For example:
- A particular market has enjoyed an incredible rally for many years that even bad news could not halt.
- The price of a particular stock has gone up exponentially (for example 30,000%) despite the lack of revenue.
- A new asset class has attracted many new investors who pushed its valuation very high.
If I get the feeling that: “maybe the price of this asset went a little bit too high”…then I should not bit surprised that its price goes down. It does not mean that it will not go up again, but at least I have a reason for the “why” and I can try to assess how bigger the price decline can be. (hint: usually proportional to the excess).
Why did I get involved in the first place?
Most of the time, it is a story that got us to invest in the first place. Something like “This new company is disrupting its industry and will deliver double-digit double ”. Which is a good thing. Without a story no investment. But the step after should be a more careful analysis. Not only of the asset itself but also of my own financial situation. If I still believe in my investment thesis and if I can afford it, I should have no problem holding the asset even during turbulent times. But if I can’t remember why I invested in the first place or if I am finding myself “wishing” for the asset to go up…then I probably have a problem and putting money off the table should be an option worth considering. Markets will offer me plenty of other opportunities in my lifetime anyway.
Answering these two questions will already give you some valuable insights and help you devise an action plan. And after that, you are free to dig further and try to understand why markets are reacting this way.
*Source: V.Cianni, Bloomberg, based on the Dow Jones Index for the period 01/01/1900 – 31/12/2021
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