Lesson taught by Brexit: Stay calm, buy the shock
“Buy the shock” is emerging as a new buzzword — and investment strategy — on Wall Street.
The market reaction to the Brexit bombshell was pretty much textbook. The knee-jerk response after the United Kingdom’s vote to leave the European Union was panic and a sell-first mentality. Then cooler heads prevailed, worst-case scenarios were analyzed and debunked, and stocks rebounded sharply in a matter of days.
The mini-crash and rapid-rebound reaction is becoming commonplace in the wake of the financial crisis of 2008. Recent market history shows the market doesn’t stay down for long after scares. The Brexit caused a 5.3% drop for the Standard & Poor’s 500-stock index in just two trading sessions spread over four calendar days. That’s in line with the single-day, one-and-done 6.7% plunge in August 2011 — when the USA was stripped of its AAAcredit rating — and a two-day drop of 4.7% after the “Flash Crash” in 2010.
The Brexit recovery was just as swift, which is becoming the norm as well. The S&P 500 on Friday, eight calendar days after the sell-off hit, climbed within 10 points, or 0.5%, of its level before the Brexit drop. That compares with the seven days it took stocks to recover after the Flash Crash and the 11 days it took to erase losses after the U.S. credit downgrade.
The lesson? Don’t let your emotions drive your investment decisions because most market shocks don’t end up causing big bear markets like the Lehman Brothers bankruptcy did in 2008.
“This is yet another example of why investors should not panic and should remain calm,” says Alan Skrainka, chief investment officer at Cornerstone Wealth Management, adding that he was shocked at the initial extreme reaction and conclusions to the Brexit vote. “Investors should remember that, in the short run, markets are unpredictable. In our view, jumping in and out of a quality, well-diversified portfolio is the single biggest mistake investors can make. In time, people will forget about the Brexit vote much like they have forgotten about other short-term events that upset the markets.”
The quick market bounce-back was driven by a few key events, says Quincy Krosby, market strategist at Prudential Financial. First, sophisticated trading soft- ware — the so-called machines — did not detect the kind of distress in the markets that would signal “systemic risk,” like they did after the fall of Lehman. That helped reverse earlier bearish bets. Wall Street was also buoyed by central bankers that were “prepared for financial triage if need be.” Also boosting the rebound was the realization that the Brexit drama would drag on for years and not pose an immediate risk to the U.S. economy.
The initial Brexit sell-off created opportunities, says Bob Centrella, president of Forza Investment Advisory.
“Let’s face it,” he says, “we’ve been through bear markets and major declines — yet we are near all-time highs for U.S. equities. So the bias is that the market will come back. And I still think that the U.S. market is the best house on the world’s block.”