Chapter 20
When You Should Not Sell
Directly after the tragedy on September 11, 2001, the market went down 20 percent.
Given everything we've talked about, if the market suddenly dropped 20 percent, your first impulse would be to sell and protect yourself, right? But there are times when you need to ignore your sell strategy.
Take a look at Figure 20.1, which shows what happened in the month after the 9/11 terrorist attacks.
Figure 20.1 September 11 (September 10, 2001–October 31, 2001)
The market rebounded very quickly. A month later, on October 11, 2001, the market was higher than it was on September 10. In just 30 days, the market had completely recovered from the initial shock caused by the tragedy on 9/11.
After September 11, everyone thought another terrorist attack was imminent. We had many meetings at our firm to discuss how to protect our clients if another attack did occur. In order to create the most effective plan, we had to consider a worst-case financial scenario: an event that would drive the United States' economy into recession.
We brainstormed: Could this happen? Could terrorists bring down the U.S. economy? What would it take? The destruction of an important harbor city might do it, we thought. It would be especially damaging if it were a harbor that handled most of the oil that came into the United States. That type of a shutdown could cause the economy to suffer so greatly that we could go into a recession and experience a bear market.
Little did we know that our worst-case scenario would happen, and that it wouldn't be caused by terrorists, but by nature. Hurricane Katrina destroyed oil rigs, devastated New Orleans, and basically shut down all the oil shipping headed into that harbor. But even our worst-case scenario didn't dampen the U.S. economy for long. The market bounced back within a month of the storm, recovering all of the losses it had experienced due to Katrina (see Figure 20.2).
Figure 20.2 Hurricane Katrina (August 2005–September 2005)
The market's behavior after 9/11 and Hurricane Katrina reconfirmed that event-driven market drops tend to rebound.
More Event-Driven Market Drops
This event-driven market-drop phenomenon repeats itself over and over. The attack on Pearl Harbor precipitated the same kind of fall followed by a relatively quick rebound, as shown in Figure 20.3.
Figure 20.3 Pearl Harbor (December 1941–August 1942)
So did Kennedy's assassination (shown in Figure 20.4).
Figure 20.4 Assassination of John F. Kennedy (November 1963–December 1963)
Even the recent debt ceiling debate in 2011 caused the same type of drop (see Figure 20.5). After all, everyone was scared that America was going to default on its loans and/or shut down the government. The market tanked during the debate that summer and went down until October, when it began to rise again. By January 2012, the market had come back.
Figure 20.5 Debt Ceiling Debate (July 2011–February 2012)
Even though the market went down 19 percent while the debt ceiling debate was raging, it recovered quickly because the fall's trigger was a singular event. It wasn't a bunch of incidents or conditions that pointed to a weakening economy; it was the vote before Congress and the way that the situation had eroded Americans' confidence. It was a single event, and the market followed its historical pattern of rebounding after an event-driven drop.
If You Can Point to a Specific Event…
You probably should ignore any drop, because it's likely that the market will rebound pretty quickly. In other words, if you can point to the event that caused the market to go down—if a bomb went off or a natural tragedy hit—you may not want to sell.
It's not easy to stay in the market during tumultuous times. The types of events that drive the market down are by nature unsettling. The period of time following such an incident can be very scary, and when you're surrounded by panicked people, all of your emotions and instincts will probably tell you to get out of the market now. Buy, hold, and sell will sound like a great idea—but for the wrong reasons.
It's not a good idea to sell in these kinds of circumstances because the market will probably rebound quickly. And, chances are, by the time you realize the market is reacting to an event, it's already gone down significantly. If you were to sell, you would have already lost a lot. To add insult to injury, you would be out of the market when it rebounded. You would have sold low.
If There's More Than One Reason for a Drop…
But…
- If you can't pinpoint a specific event…
- If a conglomeration of economic data tells you that the future looks grim…
- If it's looking like inflation, unemployment, and recession are coalescing to create a really ugly economic picture…
Pay attention.
In these circumstances, don't ignore the sell strategy you have designed to protect yourself. A market drop caused by an accumulation of many negative economic conditions is a big, red warning sign.
The 2008 Bear
Look at the lead-up to our last big bear. Though some people blamed the collapse of Lehman Brothers for the drop, this bear was not event-driven. You could see trouble coming from miles away.
The Dow Jones peaked at 14.093 on October 8, 2007. Over the next year:
- The unemployment rate went up dramatically.
- The real estate market began to collapse.
- The bond market tanked.
- The banking system was at risk.
- The United States looked like it was headed for a recession.
By the time Lehman Brothers filed for bankruptcy on September 15, 2008, the market had already gone down 22 percent.
As you can see in Figure 20.6, though Lehman's collapse may have been the nail in the proverbial coffin, it wasn't the event that precipitated the fall of the market.
Figure 20.6 Pre-Lehman Collapse (October 8, 2007–September 15, 2008)
Since this was not an event-driven drop, the market did not rebound. In fact, Lehman's collapse poured fuel on the fire—not just a little gasoline, but an oil-tanker's worth. The market plummeted another 35 percent before it bottomed on March 2, 2009, for a total drop of 57 percent from peak to trough (see Figure 20.7).
Figure 20.7 Post-Lehman Collapse (September 15, 2008–March 9, 2009)
Use Your Sell Strategy, Unless…
You designed a sell strategy to protect your investments, and you should use it. But as with any strategy, there are exceptions. Event-driven drops are those exceptions. If we have an incident that causes a sudden exogenous shock to the system, take a step back. Look at the recent economic data. Ask yourself if the event could push the economy into recession. And while doing so, remember that Katrina wasn't enough to derail our economy—an event that we considered a worst-case scenario did not drag the country down into a recession. Our economy is remarkably resilient. It takes a lot to change its direction. As scary as they can be, event-driven market drops do not typically lead to recessions or bear markets. In the vast majority of cases you should ignore them, override your sell triggers, and let things play out.