I’ve always liked air travel, ever since I was a little kid and we’d fly across the country to see my grandparents. Not everything was perfect back then. Luggage would get misplaced (still does today, but now you get to pay extra for that experience) and then (as now) you could almost always count on running into air pockets on a pretty consistent basis. You’d be flying along smoothly with everything outside looking fine and then … thwop … your stomach would be up in your throat (or worse).
“Air pockets” have happened consistently through stock market history but have been rare in the past five years. Folks have forgotten that losing periods are normal – almost as common as times when the market goes up. Instead, everybody believes in the tooth fairy – the stock market can’t lose money because the Fed will always come and save the day.
At least, that was the case … until the end of August.
This Is What an Air Pocket Feels Like
In a matter of a few trading days, a year’s worth of gains were wiped out … and here we are several weeks later with little to no recovery of those losses. Maybe the Fed will save the day tomorrow and the market will rally all the way back up the cliff.
Then again, maybe it won’t.
One of the truths of investment management is that the stock market goes up on an escalator and down on an elevator. Sometimes it doesn’t even wait for the elevator to arrive, it just jumps down the shaft (word chosen carefully) and eventually hits the bottom.
What Choices Will You Make?
So … air pockets DO happen. Maybe this one was a surprise for you, maybe it wasn’t. I wasn’t surprised.
The more important question is, how are you going to behave when we run into the next air pocket? Are you going to freak out and sell away (like millions of investors did that Monday morning) or are you going to buy stocks “on sale” instead? How do you know when the sale price is the best price and not the teaser discount before it goes on the clearance rack at 50% off?
I’m amazed by how few investors even think about such things. Even investment management professionals miss this.
What’s Your Policy?
Investing done right (the Wealth Health Way and the way the best investors in history have approached it) means leaving your emotions at the door and having rules about how the portfolio will be managed through all possible scenarios. If the market goes up, the manager will do one thing. If it goes down a little, something different may be done. If we hit an air pocket, there is a pre-defined process for managing that, too.
Investing done the retail way (and promoted by the financial pornography outlets) means buying a stock or index because it looks good and some researcher somewhere (who may or may not have been incentivised to come up with his/her opinion) said it was a good idea. The purchase is made with the hope that the price will go up like it’s supposed to. If things don’t work out … well … that won’t happen. The Fed has our back, right?
Check Your Bags (and Assumptions)
When it comes to good investor habits, there is never a bad time to check your assumptions and work through what might possibly happen.
Can the Fed really keep the stock market going up forever? Or is it more like John Hussman suggests that Quantitative Easing and Fed Policy the past 20 years may prove to be the most reckless in the heavily tarnished 100+ year history of our central bank? Does the fact that the Fed was actually easing rates (not tightening) into each of the two previous major market corrections change your opinion?
I manage millions of dollars of other people’s money. I have my own rules-based approach and I’m ready for most everything but I still spend countless hours each week trying to figure out how my system can “break.” What am I missing? What assumptions am I making? Are they still valid?
Fasten Your Seatbelts
If you choose to manage your own investments, you should be thinking about these things, too. If you pay a professional (me or someone else), it would be in your best interests if they were constantly going through their assumptions, what could go wrong and how they would manage that.
At the beginning of every flight, the first thing the pilot does is check over all the equipment. Then she settles in and fastens the seatbelt and tells everyone else on board to buckle up.
It might happen this week … or next … or next month … or maybe not again until next year, but understand there’s no reason to believe that this time is really different. There will be more air pockets.
It wouldn’t be such a bad idea to think through how you’ll navigate the next one.