Sometime in the future, another crisis will send stock market indexes plummeting. Maybe the US will be dragged into war…terrorists will attempt a 9/11-like incident…a major bank will fail…another serious virus will infect portions of the population. What should you be doing with your investments when crises hit? Wall Street offers the same advice to small investors, observes Christopher Manske, CFP—do nothing…wait it out…someday the market will bounce back.
But Manske says all crises are not created equal. The market shrugs off some…so should you. Others create reactions that are so dramatic and predictable that you can profit from them.
Bottom Line Personal asked Manske how to identify which crises will affect your portfolio and how…which ones he’s worried about now…and ways to use this information to protect—and possibly even grow—your wealth.
Despite the global crises in the past 15 years, the S&P 500 is up about 450% cumulatively. What’s wrong with doing nothing and waiting out a crisis?
It’s not a bad default approach since the US stock market has always bounced back sooner or later to reach new highs. But if you are a retired investor who depends on drawdowns from your portfolio, you may not have years to play the waiting game. More importantly, if you treat every crisis the same, they all feel scary and overwhelming. That makes it easy to deviate from your long-term plan and make irrational mistakes.
How can I tell if a crisis is going to set off a stock market disaster or not?
To see a major drop in value, the US auction-style stock market requires massive collective panic. Millions of investors need to react to a crisis at the same time in the same way. Terrible events happen every day—earthquakes, hurricanes, airplane crashes, hyperinflation—but they don’t cause enough investors to dump their investments at any price. To ignite that stampede-off-a-cliff response, a crisis needs to have two elements—it must feel very new and shocking…and it must feel like a direct threat to our finances, health and/or freedom. Examples: Overt acts of war that involve the US, such as the 2003 Iraq War or the Ukraine-Russian conflict…leader-driven threats, such as Russian president Putin warning the US that he is prepared for nuclear war…acts of terrorism like the 9/11 World Trade Center strike.
Interestingly, when the COVID-19 virus started spreading through China in late 2019, the stock market not only ignored it but continued to rise. Investors had seen epidemics such as SARS, swine flu, MERS and Ebola. It wasn’t until February 2020, when entire towns in Italy were forcibly quarantined, that stocks started to crash. The idea that Western governments could shut down society and keep people in their homes was so unique, it triggered widespread selling.
How long do threat crises affect the stock market?
You would think investors would have no interest in touching stocks for as long as the turmoil continues. But that has not been the historical pattern. Within a short period after a threat crisis—anywhere from a few days to two months—the selling in the stock market tends to abate. Reason: Investors acclimate quickly to the new normal, realizing that the world is not about to end and they may have overestimated the danger. In fact, they grow emboldened and hopeful, pouring back into the market.
And major indexes quickly return to pre-crisis levels. If you look at a chart of the S&P 500 index performance, this pattern, which has played out again and again over the past 200 years, looks like a cup or an elongated U. Example: While the COVID-19 pandemic lasted three years, the bear market in 2020 was over in 33 days. After the Japanese attacked Pearl Harbor and the US declared war, the stock market plunged but recovered in just 19 trading days. The market decline after the 9/11 terrorist attack lasted three weeks, as did the plunge after the Russian invasion of Ukraine.
What should investors do if this pattern during a threat crisis is so clear?
The U-shaped pattern offers an excellent buying opportunity. Steps to take…
Buy once the market descends 7% to 10%. Historically, the S&P 500 has suffered an average peak-to-trough decline of about that much during major geopolitical events. Don’t worry about picking the exact bottom. If you regularly dollar-cost average into the market (investing a set amount each month), consider adding the next several months’ worth of installments all at once.
Prepare a watchlist of companies you love but want to own only if their prices fall to attractive levels. See if the drop in the market triggers any buys from this list. Some stocks at the top of my list include AT&T and Exxon Mobil.
What crises concern you now?
I worry that a cybersecurity infrastructure attack could cause the stock market to tank. For example, hackers could disrupt the network of geopositioning satellites in space. Millions of people would no longer be able to rely on GPS on their phones or in their vehicles. I’m also worried about a terrorist organization setting off a dirty bomb or nuclear device in a US city…or a hostile incident in the South China Sea involving Chinese and American destroyers or submarines.
Are there crises that could cause the market to plunge and not rebound quickly?
Yes, investors should watch out for what I call systemic crises. This type of crisis doesn’t involve a direct threat but rather broad economic and financial systems failing. Examples: The financial crisis of 2008–2009, in which major US financial institutions failed…recessions caused by the Fed raising interest rates too high and choking off economic growth.
It’s hard to predict the length or intensity of the market’s reaction to a systemic crisis. It depends what stock valuations were at the time of the crisis and how badly the system stumbled. An average bear market after a systematic crisis lasts about 10 months. But after the 2008–2009 Great Recession, the stock market took four years to reach new highs.
During a systemic crisis, the typical Wall Street advice to do nothing is the correct action. Since there is no highly predictable pattern of recovery, don’t make any portfolio moves. Stay diversified. If you are saving for retirement, keep dollar-cost averaging because trying to game the ups and downs of this type of recovery is treacherous. Eventually, the system will heal and markets will recover.
Being able to execute any strategy in a crisis means maintaining emotional control. How do you stay grounded?
Three strategies are effective…
Envision your long-term goals and what you plan to do in a particular type of crisis to keep advancing toward those goals. Write it down so you can refer to it when the market is crashing.
Don’t expect to summon up discipline and courage all by yourself. Find a coach/partner/confidante, and share what you’ve written down with him/her. Make sure that individual is someone you will listen to when he needs to tell you something you don’t wish to hear.
Don’t think of the market as a casino and yourself as a gambler. Better: Approach investing like a supermarket shopper. If you notice the price of your favorite peanut butter is much higher and you’ve still got plenty at home, don’t buy it. If the price of peanut butter falls, it’s time to load up.
