Market response
We have had several hundred years of market history to see the impact of “externalities” on trading. Externalities are what market watchers call those events outside of the usual business cycle.
We see throughout history that the impact of these externalities is to make the markets wobble for a brief period of time, then return to what they were doing previously. Pearl Harbor, the Kennedy assassination and the Sept. 11 attacks were all followed by a sell-off then a snapback rally, and finally a resumption of their prior trends.
Indeed, the snapback rally since the deep Japan-led sell-off is reminiscent of these prior events. Fear creates panic, and markets quickly become deeply oversold. That creates the environment for a strong bounce and a return to normal trading.
So much for the “black swans.”
The stock prenup
The last aspect to your emergency financial plan is having an exit strategy.
Your goals:
• Avoid owning the stock disasters that wreck portfolios.
• Steer clear of market sectors that are imploding.
• Avoid the worst of the market crashes that see stocks nearly cut in half or worse.
In terms of individual equities, stocks that go to zero are oh-so- dangerous to your portfolio. You cannot own the Enrons and Lehmans and GMs and AIGs as they go bust. So your plan will involve taking a small loss to avoid taking a giant 100 percent whack on those positions.
Market sectors can, at times, become terribly destructive as well. Consider the home builders, banks, telecoms and technology — all have had sectorwide losses of 80 percent or so during the past decade. When that happens, even the very best names in the groups get shellacked.
Last, you must be prepared to deal with the occasional market collapse. As we showed a few weeks ago, these occur more frequently than people realize. Your plan should incorporate the expectation that market crashes can and will occur.
Investors who have a plan to deal with these unexpected but unavoidable realities — and the discipline to see that plan through — will see drastically better results than those without one.
What is your plan?
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture.
Loading...
Comments