When a rare event occurs, it’s often labeled as a once-in-a-lifetime happening or an occurrence so infrequent that we may never witness it again.
When it comes to investing in the stock market, it’s almost as if this rare event is so unpredictable and impossible to foresee that it somehow excuses the fact that many market strategists and money managers don’t have a plan to deal with or respond to it. Some will argue that the historically reliable yardsticks of the past are no longer valid in these instances, while others will proffer that the market is in unchartered waters. What good is that? The fact is that the event is occurring! So while this all may be true, the bottom line is that the reasons why your portfolio is worth what it’s worth, after all is said and done, really don’t matter. The results are the results, whether good or bad. The market doesn’t care. This is the cold reality of the investment business, like it or not.
Still, I can’t help but think about all those folks who worked so hard for their money and watched the value of their portfolios sink substantially during a nasty bear market span, not to mention other instances that I have painfully witnessed over the decades. That’s the reason I wrote this book.
I heard former Federal Reserve chairman Alan Greenspan on the radio on September 14, 2008, commenting to the effect that the (then) current financial crises was a once-in-fifty-year occurrence and the worst he had ever seen. Look, no matter how rare a market event is—whether it’s a once in fifty year, once in a hundred year, or once dating back to the Paleozoic period—you always need to be prepared for it. You don’t get a pass. There are no exceptions, despite whatever highly unusual circumstances may exist.
That’s what capital preservation is all about. That’s why we’re willing to sell on the way down to prevent financial cuts from becoming financial hemorrhages in our risk management approach. It’s why we listen to the language of the market and respect its verdict, and realize that capital preservation considerations should precede capital appreciation ones. This is done in case good turns into bad or bad turns into worse or worse turns into who knows what. The excuse that an event is a once- or twice-in-a-lifetime occurrence means nothing if that occurrence happens in your investment lifetime. In fact, you need to assume that it will! Already in my lifetime I’ve witnessed:
- The big bear market of 1973–1974, among the worst since the Great Depression at the time, with a Dow Jones Industrial Average loss of approximately 45 percent.
- The 1987 stock market crash, which claimed approximately 41 percent from the Dow Jones Industrial Average in less than two months.
- The technology stock bubble of 2000, and the NASDAQ’s 78 percent plunge from March 2000 to October 2002.
- The subprime mortgage crisis starting in 2007. The market punishment inflicted during this period was particularly brutal, with the Standard & Poor’s 500 Index plummeting approximately 57 percent and many big-name companies becoming little-name stocks.
- The flash crashes in 2010 and 2015.
I also remember some notable events that captured Wall Street’s attention at the time, including:
- The jitters preceding the pre–Gulf War major market low in October 1990, when the Standard & Poor’s 500 Index sank below the 300 mark.
- The Long-Term Capital Management crisis of 1998. LTCM was a highly leveraged hedge fund whose bailout had to be coordinated by the Federal Reserve.
- The late 1994 Orange County, California, bond crisis. The county was the largest municipality in American history ever to file for bankruptcy at the time.
You can see how these rare events are occurring with more frequency. And that’s just a start. One of the things I like about using technical analysis is that you don’t necessarily have to gauge the extent of a market move. Once you’re out of a stock, you’re removed from whatever downside (or upside, to be fair) movement that remains—whether that downside is in the context of a common market correction or a once-in-a-lifetime bear market collapse. Divorce detaches a couple from further downside in their relationship, just as liquidating a home or a business extricates the seller from future difficulties in those areas. The key market challenge is to try to discern when a change in the supply-demand dynamic has occurred. My attention is always primarily focused on the downside part of the investment equation. I don’t worry about the upside part; that’s not what’s going to hurt me. Your stock market objective is always the same: trying to be invested in winners during bull moves and be out of the market during sustained bear moves. I realize that “selling short” is also an option in the latter case, but my first consideration when my technical gauges and charts suggest that a bearish market climate may have started is to be increasingly out of weakened positions and maintaining a risk management discipline. The fact that there may be a “perfect storm” of forces at work or an extremely rare event occurring is that much more reason to always have some sort of well-thought-out exit plan.
I want to take you back to early 2007, ahead of the subprime mortgage crisis. As with major market moves in general, rarely do the experts see it coming. If you took a look at the action of the Standard & Poor’s 500 Index and Dow Jones Industrial Average, you’d be noting fresh all-time highs as late as October of that year. But underneath this surface strength the popular banking indices were telling a different story with their refusal to follow suit during that upswing. Most peaked in the first quarter of that year, and by the time the aforementioned duo were achieving their fresh fourth-quarter peaks, many popular banking indices had been trending lower for months. Their charts were telling a story. In technical jargon we refer to that as a divergence. We all know how the market performed following the October 2007 peak, as the “500” plummeted from a high of 1576 that month to its trough of 666 in March 2009, and the Dow Jones Industrial Average sank from approximately 14,198 to 6470.
Who knew the extent of that devastating financial period? Certainly not I. But something seemed technically amiss in the banking indices, and when that happens you need to wait on the sidelines for as long as it takes the stock or market to rectify the supply-demand situation. That wait can be a long one, but when the tide is against you, don’t swim.
Moral: You need to plan for the unexpected in both investing and life. Regarding the former, when all is said and done, your portfolio is worth what it’s worth, whether a rare and totally unexpected event occurs or not. Remember that markets go to extremes. And while scarce events may occur once over many years, a risk management strategy should always be front and center on an ongoing basis.
(To be continued...)
This excerpt is taken from “Relationship Investing: Stock Market Therapy for Your Money” by Jeffrey S. Weiss. To read other articles of this book, click here. To buy this book, click here.
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