Golden rules for a market crash
Having just seen the market plunge and recover, investors now know what to do next time
It is just over a year since the pandemic hit the stockmarket, kicking off one of the sharpest corrections and recoveries in living history. It was, in hindsight, a tremendous opportunity for those who remained objective, for those who had the stomach to watch the herd and not join the herd. In 23 trading days, the S&P/ASX 200 fell 38.8% from the high in February to the extreme low in March, and from there it has rebounded 58% as I write. It has been one of the most volatile years in history and, armed with the experience and wisdom of hindsight, I have collected the following golden rules for you.
1 Some of the best bits of the market are the exponential bits ahead of a correction. You have to participate in those exuberant moments or you’ll never get the averages. Enjoy the exuberant bits. Play the game when it’s “on”. Laugh all the way to the top. Let the finger-waggers wag; they always do when people make a fortune with little effort.
GOLDEN RULE: Don’t be too cautious or you’ll miss all the best bits.
2 Corrections are inevitable and regular. Expect a big one every 10 years (50%), and a tradeable one every three years (10%-20%).
GOLDEN RULE: Corrections are to be expected, not feared; they are normal.
3 Corrections come quickly. You don’t have much time to react. You have to be decisive.
GOLDEN RULE: Corrections happen fast, so react fast.
4 Recoveries come slowly. What we lost in 23 trading days we still haven’t recovered. At the time of writing, the S&P/ ASX 200 was still 3% below the 2020 high. You have plenty of time in a recovery, plenty of time to decide when and what to buy. There’s no rush. You never have to catch the knife. The market never crashes up. You do not have to catch the bottom.
GOLDEN RULE: Sell fast, buy slow.
5 Don’t bother to buy defensive stocks when the correction starts. Do you remember A2 Milk, Fisher & Paykel Healthcare, Telstra and Woolworths performing better than the rest when the market fell over. They had a “moment” of outperformance. But in the recovery they have been some of the worst performers. Defensive stocks will not serve you well at all times. Leave them to the fund managers that concern themselves with their own relative, not actual, performance. For an individual investor there is almost no point at which you would want to buy a “defensive” stock. They make less money in the recovery and there is no point holding the stock that loses you less money in a correction.
GOLDEN RULE: Defensive stocks are for fund managers, not investors.
6 If you ever say “I can’t buy it, it’s gone up 10% in a week”, you will fail at investing. If you are the sort of investor who says “it’s up 20%, I’ve missed it”, you doom yourself to conservatism. Chickens don’t make money. You will never buy a ten-bagger if you don’t buy one-baggers. Forget APT up 780% in a year. Eleven stocks in the All Ordinaries have been ten-baggers (up over 1000%) in the past year; 180 stocks (36% of the All Ordinaries) have doubled; 290 (58%) are up more than 50%. Percentages are big in a correction and in a recovery. Do not be scared of big percentages. In a recovery you have to buy stocks that have gone up.
GOLDEN RULE: All the percentages are big in a correction and a recovery; do not let them put you off.
7 No one knows when corrections are coming and those who did didn’t know for sure, they just made a fuss when they discovered (in hindsight) that they made the right noises at the right time.
GOLDEN RULE: When timing the top or bottom, your guess is as good as anyone’s.
8 Do not think you will be so clever as to predict the end before it happens. You can’t predict the big sell-offs; just be aware when some of the ingredients are in place but don’t do anything about the signs of a market correction until the correction begins. We are in the reaction game, not the prediction game. Yes, become more sensitive to the signs the more stupid it gets, but wait. And when the precipitous signals turn into a precipitous market, you’ll be ready to be decisive.
GOLDEN RULE: Wait for the top or the bottom and react, but don’t predict.
9 Corrections are great! They are to be welcomed as a rare stockmarket opportunity. Do not fear them, welcome them. Corrections present some of the most exploitable extremes of the market, but not if you pull out, stay out, or deny it’s happening.
GOLDEN RULE: Exploit corrections, don’t avoid them.
10 No one will ever tell you to sell. No one in the industry wants you in cash. They want you in their fund, in their product; trading, speculating, active. To go to cash through a professional will require you to be assertive. GOLDEN RULE: You are on your own when corrections happen.
11 Cash is always king. There is nothing wrong with cash, ever. Even if you get the timing terribly wrong, all you miss is “not making money”. You can wear that while you think. Being in cash is riskless. You have all the power. You can buy tomorrow. Going to cash is very cathartic, especially when things get wild.
GOLDEN RULE: Cash is king in a correction.
12 Fundamentals are useless when it comes to timing the market. It’s why value investors always emphasise the long term, because they are useless at the short term. The classic saying that “the market is a weighing machine, not a voting machine” is just an excuse designed to avoid any responsibility for timing the market.
GOLDEN RULE: You can’t time the market using fundamentals.
13 At extreme moments the market drives all; it sinks all boats and lifts all boats. Focus all your attention on identifying the “pivot point”. In corrections the woods are on the move, so forget the trees until the forest is going up again.
GOLDEN RULE: Market first, stocks second.
14 Stock selection comes second to the market. After the market pivot point, stock selection is about where you will make the most money, but you have to get the market right first. If you get that right you’ll make money in everything.
GOLDEN RULE: Market first, stocks second.
15 You must remain objective. This whole game is about watching and exploiting the herd, observing its sentiment swings, identifying the moments when it loses its sanity and when it regains its sanity. You can’t do that if you join the herd. You need to see yourself as the general on the hill, not the fodder on the field.
GOLDEN RULE: Watch the herd, don’t join the herd.
At the end of the day, the pandemic year has been great for investors. It has been a year of fabulous opportunities for them. Hopefully you played the game and are looking forward to the next great correction. Hopefully we’ll all have the vigilance, experience and courage to exploit it, not run from it.