Acting on scare headlines can lead to bad investment decisions

How to keep your head when stock markets start gyrating

If you got a bad case of market jitters over the latest stock market scare headlines, then the business media will have done their job – which is to get you to look at their websites, Twitter and other feeds, cable channels, and newspapers – and, of course, all those ads that track you and follow you around. Welcome to the brave new world of instant market panics! Trouble is, all that market and media noise can lead to bad investment decisions.

Sell in haste, repent at leisure

If you went ahead and acted on those jitters by selling stocks you might have held in a self-directed account or banged on the table until your advisor sold them for you, you’ve very probably made a mistake.

The market downturn that started in mid-August may indeed be the “correction” that had long been predicted but had yet to materialize. Both the S&P/TSX Composite Index and the S&P 500 Composite dropped into correction territory recently before rebounding as volatility rules the day. Stock markets had been rising steadily without a meaningful correction since mid-2012. Most analysts believed North American stocks had become overvalued, with price-earnings ratios of the major indexes higher than historic averages. While not a guarantee of a correction, the signs have been building for some time. All that was needed was a trigger.

What triggered the selling?

The late, great Greek debt crisis didn’t do the trick. But what got selling momentum underway last month was a combination of factors, led by the recent devaluation of the Chinese yuan in response to the strength of the U.S. dollar and China’s flagging economic growth, combined with the possibility of an interest rate hike by the U.S. Federal Reserve Board as early as its next meeting this month. Stir in typically lower-volume trading during the August summer doldrums on the major markets and the historical pattern of a major decline (followed by an equally large recovery) in the year before a presidential election, and you’ve got the recipe for a sudden, steep selloff.

Is it likely to turn into a prolonged, fully-fledged bear market? I’d be lying if I said “no.” But right now, the odds are against an old-fashioned bear taking shape. The reason is that the fundamental economic conditions are not in place for a global economic recession of the sort that accompanies bear markets.

Is a global recession likely?

While indicators certainly point to slower economic growth in China, which weighs commodity prices (China is one of the world’s largest consumers of most raw materials) and therefore on the natural resource sectors of commodity-producing countries like Australia and Canada, a reduction in Chinese demand won’t lead to a global recession. In fact, lower commodity prices, including, yes, energy prices, are actually a net long-term positive for economic growth. Yes, there are plenty of people in Alberta who say otherwise right now as the big retrenchment in the energy sector continues. But Alberta has always been subject to the boom-bust cycle of the energy industry, which dominates the economy of that province.

The Canadian dollar has taken a hit, too, owing mostly to the strength of the U.S. greenback. But don’t forget that the vast majority of Canada’s trade is with the U.S., and a lower loonie is bound to give Canada’s exports – and thus its manufacturing sector – a major booster shot of vitality. And indeed Statistics Canada reported on Thursday that Canada’s exports rose 2.3% in July, following a 5.5% advance in June. The export increase through June and July was the biggest two-month gain since January 2011, music to Bank of Canada Governor Stephen Poloz’s ears, who had been hoping for exactly this outcome, following marginal contraction in Canada’s GDP through the first half of the year. Adding to the positives, Canada’s trade deficit dropped to $593 million, the lowest since November 2014.

The U.S. economy is still growing, albeit at a very modest pace. Its housing and employment markets are the strongest they’ve been in years, and consumer sentiment is on the rise.

Volatility season

So if a recessionary bear market is not in the cards, how long will this current market volatility last? No one can tell. The late phase of a prolonged bull cycle typically gets pretty volatile. And we still have to get through September and October, which are typically marked by even more volatility as all traders get back to their desks after summer vacations and the end of the third quarter approaches.

The danger of succumbing to scare headlines and selling out of equities or drastically recasting your asset allocations is that you’re likely to do it at the wrong time – after the big moves have taken place – thus locking in your losses. It’s almost impossible to buy back in at “the bottom” in an attempt to catch the upswing when it occurs – and in this type of market it can happen very quickly. So you’ll really only end up making the classic panic-sellers’ mistake of “selling low and buying high” – and incurring sizable transaction costs to boot – instead of sticking with your plan and waiting out the storm.

© 2015 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

Acting on scare headlines can lead to bad investment decisions was last modified: September 20th, 2015 by robyn