A good friend, Sherman Doll, related the following story. Sherman has been a two line sport kite flier for years. While not a pro, he has learned a few tricks from observing the flying behavior of these kites. He told me that one of the most difficult skills for beginners to master is what to do when their kite starts to plunge earthward.
The natural, panicky impulse is to yank backward on the lines. However, this only accelerates the kite’s death spiral. The effective, kite saving technique is to calmly step forward and thrust out your arms. This causes the kite’s downward acceleration to stop, allowing you to regain control and end its plunge.
What does this have to do with investing?
As you likely know, the S&P 500 Index dropped 579 points from its closing high of 2,930 on September 20 to finish at 2,351 on December 24, a price drop (not including the return from dividends) of 19.8 percent — just short of the technical definition of a bear market, a loss of 20 percent. Combined with the weak performance of global equities over the same period, the geopolitical turmoil in the world (including the risk of a trade war with China), President Trump’s attack on Federal Reserve Chairman Powell, and the shutdown of the government, many investors started to feel queasy.
Over the almost 25 years that I’ve been providing investment advice, I’ve learned that when we have situations like the one we’re in now, many investors begin to “catastrophize.” They tend to focus solely on the negative news — such as ignoring all the good economic news. For example:
- Economic growth is strong. The Federal Reserve Bank of Philadelphia’s Fourth Quarter 2018 Survey of Professional Forecasters projects real GDP growth of 2.7 percent for 2019, down just slightly from the forecast of 2.9 percent for 2018
- Unemployment is at 3.7 percent, the lowest rate in 50 years
- Inflation is moderate. The Philadelphia Fed’s latest 2019 forecast is for an increase of 2.3 percent in the Consumer Price Index (CPI), down slightly from its forecast of 2.4 percent for 2018
- Consumer sentiment (a leading indicator) is strong. The final December University of Michigan Consumer Sentiment Survey came in at 98.3, remaining near the highest levels we have seen over the past 18 years (despite the recent weakness in stocks). The last time the Consumer Sentiment Index was consistently above 90.0 for at least as long was 1997 through 2000, when it recorded a four year average of 105.3
- New claims for unemployment continue to be at very low levels. In the week ending December 22, the advance figure for seasonally adjusted initial claims was just 216,000
Ignoring the good news, and focusing only on the market’s drop causes many investors to begin anticipating everything that could possibly go wrong, and end up in a loop of worry and anxiety that leads, at best, to indecisiveness and, at worst, to panicked selling.
Returning to my friend’s story about flying kites. Just as when a kite starts to plunge earthward and the natural, panicky reaction is to yank backward on the lines, the natural, panicky reaction to a dive in your portfolio’s value is to pull back (sell). In both cases, pulling back is the wrong strategy. The right strategy is the less intuitive one. It involves the choice to remain calm and step forward (actually buying stocks to rebalance your portfolio back to your desired asset allocation).
By Larry Swedroe