Those of you interested in international financial markets probably noticed there have been some rather dramatic changes in the the major stock indices over the past week. The US benchmark Dow Jones Industrial Average stood at 17, 345 last Thursday and subsequently plummeted to 15,666 at the close of business Tuesday. Following a turbulent Friday and some bad news from China on Monday, the Dow went into a free-fall on Monday, losing over 1,000 points before closing 588 points lower.
On Tuesday, the Dow seemed to regain some of its mojo, soaring 442 points in early trading. That mojo was a no-go, however, and by the end of the day the Dow had shed another 205 points. Ouch.
On Wednesday things really did turn around, with the Dow closing 619 points higher, the third-largest gain ever in absolute terms. As of this writing on Thursday, the Dow is up another 200 points, continuing to scratch back some of the losses from last week. (Wait, now it’s only up 150 points, better post this picture before it changes again):
The causes of these wild gyrations are quite varied, and would be difficult to explicate before the market moves a hundred points in either direction (that is, even if we knew what all of those causes were, which I’m not convinced that we do). The question for the decision maker is what do these market fluctuations mean to you?
Well, many flesh-and-bone economists will tell you with a straight face that you are either in the market or you’re not, so if you want to get out now, you shouldn’t have been in the first place. If you are in, you should just sit tight.
Although that might seem preposterous to you, what economists will tell you is that the idea that you can either predict or time the market is even more preposterous. More on this after the bump:
I saw several articles this week that had this flavor, but none were any better than when Henry Blodgett laid out our talking points for us back in 2007:
No one but Nostradamus knows what the market is going to do. Last week’s sell-off does not make it any more or less likely that the market is going to go up or down this week (or, for that matter, this year).
No one but Nostradamus can time the market consistently. If you knew the market was going to crash, the answer to “What should you do now?” would be obvious: Short the world. Alas, numerous academic studies have shown that successful market-timers are, at best, an extremely rare breed.
If it really matters to you what the market does in the next several months or years, you shouldn’t own stocks. Sorry to alarm you, but stocks are a very risky investment over periods of less than five to 10 years, no matter what the market is doing. If you need your money before then, you shouldn’t have it in stocks.
The last thing you should base your investment strategy on is what the market has done. One of the most common and most devastating mistakes investors make is “driving with the rearview mirror,” as Warren Buffett puts it. Specifically, they buy investments that have done well and sell those that have done badly. Although this strategy feels comfortable, it is idiotic.
This past week, Jordan Weismann at Slate effectively writes the same column, summing up point two thusly:
[T]he S&P 500 has fallen 5 percent or more in a week on 28 other occasions since 1980 (Click here for the summary data of these 28 occasions). In the three months following those falls, stocks have risen about 70 percent of the time. So, one could maybe argue that bargain hunting right after a big weekly drop has typically paid off.
But, it doesn’t always. In big downturns like 1987 and 2008, stocks kept falling after large weekly drops, sometimes as much as about 20 percent further.
And here’s point three:
If you think you’re going to need your money in the near future, don’t keep it in stocks. Simple as that
Ben Casselman over at the FiveThirtyEight site sums things up even more dramatically in his headline: Worried About The Stock Market? Whatever You Do, Don’t Sell.
And here is (literally) the money point:
Since 1950, the S&P 500 has had one-day declines of 3 percent or more nearly 100 times. It’s had two dozen days where it fell by 5 percent or more. Slow-motion crashes, where big declines are spread out over several trading days, are even more common.
But every one of those declines has been followed by a rebound. Sometimes it comes right away. Sometimes it takes weeks or months. But when it comes, it comes quickly. If you wait until the rebound is clearly visible, you’ve already missed the biggest gains.
For those of you who were here last year, Grinnell’s Mark Montgomery laid out the basic argument (“Always bet on the monkey”). We do have an investments course running this fall, where I am *certain* these ideas will be explored in depth.