The Panic is Back

Today the stock market experienced its worst day since the 2008 financial crisis: the Dow Jones Industrial Average closed with a loss of 513 points, or 4.3 percent, while the broader S&P 500 Index was down 4.8 percent. Since July 22, the S&P 500 has closed lower in eight of the nine trading days, accumulating a decline in value of 10.8 percent.

Over the last week, debt-ceiling concerns have been overtaken by worries that the U.S. economy is entering another recession as the recovery has slowed markedly and job growth remains anemic. Additionally, Europe’s debt problems are not close to being solved: Greece is very likely to default (it is largely a matter of whether the default will be orderly or disorderly), while Portugal and Ireland are financially vulnerable as well.

In the face of these fears, prices on U.S. Treasury bonds have again rallied (resulting in further decreasing yields). Some may find this surprising given the historically high government debt levels and the recent political turmoil over possible default—while these concerns are valid, U.S. Treasuries continue to offer the financial world’s best combination of stability and liquidity.

So what should investors do in the midst of this financial market turbulence? First and foremost, tune out the panic—it is nearly impossible to make prudent investment decisions in the absence of calmness and patience. Second, evaluate market fundamentals from a rational perspective. This market sell-off comes at a time when corporate profits are rising. For the S&P 500, the forward price-to-earnings ratio has fallen to about 12, well below its long-term average of 16. As a result, investors who rebalance into stocks now are paying approximately 25% less than the historical norm for each dollar in profits.

While it has only been 29 months since reaching bottom in the most dramatic market decline since the Great Depression, it is instructive to revisit that experience. Through the downturn, individual investors were, on net, fleeing stocks. As a result, many portfolios will never fully recover. Did disciplined investors know something the average investor did not? No. In fact, those who remained invested were likely just as uncertain and heartsick as those who fled. The difference was simply a refusal to act out of fear.

Prominent economist and author Jeremy Siegel of the Wharton School has written, “Fear has a greater grasp on human action than does the impressive weight of historical evidence.” History proves time and again the benefits of staying the course. Those who benefit most are the investors who actually capitalize on the opportunity through disciplined rebalancing.

While the swiftness of this market correction is unusual, the 10% decline is not—just last summer stocks fell 16% on concerns not unlike those we face today.  To be sure, new and developing crises will continue to confront investors going forward. Unfortunately, the closer investors follow current events and the financial markets, the less investment perspective they are likely to have.