Countering a looming market crash is easier said than done
We fail to get out because we are uncertain it is the right thing and because we don't know how
Despite the corrections of late there remains a great deal of concern among investors that the stock market is in for a bigger fall, something they’re helpless to do anything about.
“This baffles me,” says Ranjeet Singh at London Stone Securities, “because if you know something is about to happen to you which is going to be painful then surely it would make sense to do something to counter it.
“It’s the equivalent of a deer being caught in the headlights of an oncoming truck and not moving out of the way. The only difference is that the deer has far more reason not to take preventative action. Firstly, the poor thing has no real idea about what is about to happen to her and secondly even if she did, and depending on the speed of the truck, she probably doesn’t have a huge opportunity to get away.
“The same can’t be said for investors. Most of us have lived through stock market crashes before and so we all know exactly what is coming. Furthermore, and unlike our friend Bambi, we don’t have a split second to make a life-changing decision. We should be embarrassed with ourselves how much time we actually have. We don’t have seconds, minutes, hours or days. We have months to plan ahead, even years ....
“And that’s the crazy thing. A stock market that turns from bullish to bearish is like a great big oil tanker trying to slowly make a 180° turn in the middle of a tiny bay while honking its horn warning everybody. The thing takes ages to turn around and will crash several times as it tries to manoeuvre its way out. We all have time to move out of the way. And yet most people don’t. Why is that?”
To answer Singh’s question, there are probably two main reasons why we don’t get out of the market despite seeing a crash coming: the uncertainty MICHEL PIREU that it’s the right thing to do and, if we get past that, just not knowing how to go about it.
Singh blames the big institutions, which have “conditioned, even brain-washed, us not to panic and to instead play ‘the long game’”, for the first of these reasons. “Their motivation to act in this misleading way is clear,” he says, “they don’t want you to panic and cash in your shares, because if you do the value of their funds fall and they don’t make their fees.”
That seems unlikely. For a start, many of the big hedge funds, looking to exploit a crash, would no doubt be delighted if investors panicked and sold their shares as it would first play to their short positions and then provide them with the opportunity to buy at lower prices. Institutions, having the benefit of playing with other people’s money, are always far quicker to take on the risk of getting back in after a crash. It also overlooks the fact that there are those who do advise getting out of the way.
“While it may be a fool’s errand to try to catch the market’s twists and turns, that doesn’t mean you have to suspend judgment about overall valuations,” says Howard Marks. “If you invest in shares when they’re ‘cheap’ compared to cash flows and assets typically when everyone else is gloomy you’re likely to do far better than if you invest in them when they’re expensive, typically when everyone else is unreasonably bullish.” Which is pretty much what Warren Buffett is advocating when he advises being “fearful when others are greedy and greedy when others are fearful”.
Part of the problem is that Buffett also says he doesn’t hold an opinion about what the market will do next, because it wouldn’t be any good and it might interfere with the opinions that are good. Which may explain why, as Peter Lynch has pointed out, far more money has been lost by investors preparing for corrections or trying to anticipate them than has been lost in the corrections themselves.
To add to the confusion, there are those who say you can’t time the markets but will then happily tell you corrections provide great buying opportunities, apparently unaware of the contradiction. If you can’t tell when prices are too high, how do you tell when they’re too low?
In the end it’s hard to argue with Ben Stein and Phil DeMuth that in the aggregate what is happening every day is that the mass of investors are making decisions about what to buy and sell and when to buy and sell, so it really makes no sense to argue that market timing is not a helpful strategy or that no smart person does it. The more likely reason the majority of retail investors don’t get out of the way of an imminent crash is that they simply don’t know how.
“Here again the hedge funds are to blame,” says Singh. “Think about it like this if as an investor you are told there is nothing that you can do about a stock market crash, that it is part and parcel of investing, you are most likely not even going to try to do anything about it. But the truth is that there are three simple strategies that will put you ahead of 95% of other investors, and it’s incorporated in one simple acronym, CAP. Cash: just sell your shares and go into cash. Asset Allocation: reallocate your assets by moving out of equities to the lower-risk class of fixed income investments. Protection: choose not to sell your equities at all but to simply protect them.
“This last option is the most popular strategy used by hedge funds and investment banks,” says Singh. “They just don’t want you to know it.”
Which once again seems unlikely, as you have to ask: why would a hedge fund with the wherewithal to protect investors against a market crash choose to keep it a secret rather than profit by sharing it with us?
In all probability because nothing’s quite as simple as Singh makes out. Getting into cash creates another problem getting back into the market, which, when done wrong (as so many investors who sat on the sidelines after the last crash learnt) can be more damaging than staying in. There’s no guarantee fixed investments will turn out to be the lower risk. Or that alternate strategies will succeed in providing the protection they’re supposed to.
So while Singh may be right in claiming that unlike the poor deer we should know what is about to happen, he’s wrong in saying we can easily avoid it.
SOME SAY YOU CAN’T TIME THE MARKETS BUT WILL THEN HAPPILY TELL YOU CORRECTIONS ARE GREAT BUYING OPPORTUNITIES