Hold tight when volatility strikes
Ouch! At the end of March the FTSE 100 had its worst day since the end of 2016. The rally since then, however, demonstrates that you should fight the urge to sell during these short pullbacks. Bull markets die with a whimper, not a bang. Big bounces usually follow sudden selloffs.
This was classic correction-type movement—painful, but normal in bull markets. Corrections are short, sentiment-led drops of -10 per cent to -20 per cent. They come and go without warning, for any or no reason. A bear market is characterised by a longer, deeper decline of -20 per cent or worse with a fundamental cause like a looming recession. Bear markets are avoidable if you catch them in time. Corrections aren’t—they’re unpredictable, impossible to time.
Volatility is normal. Pullbacks are a toll we pay for long-term returns. Big daily moves aren’t extraordinary or signs of impending doom.
Bear markets usually don’t announce themselves with huge startling drops. They typically begin slowly, with gentle rolling tops, fooling folks into throwing more money at them before their violent final stages. Those selling during corrections wrongly think they’re avoiding bear markets. To avoid getting fooled and whipsawed, follow the three-month rule and 2 per cent rule.
Don’t cut your equity exposure until three months after a peak. Take advantage of bears’ slow starts. Look for fundamental reasons driving the downturn. In a real bear market, the media probably won’t do this. They’ll instead seek reasons the party will soon resume. Their search today for causes justifying the drop is correction-like, and so is their overhyping its size.
During the three-month window, remember bear markets decline about 2-3 per cent monthly from peak to trough – a slow grind that takes time. If monthly declines average far worse than 2-3 per cent during the next three months, it’s probably a correction.
The steep magnitude and frantic search for cause are classic correction signs. People forget Ben Graham’s simple truth: Markets are voting machines in the short term and weighing machines in the long term. Near-term returns, good or bad, are popularity contests. Only long-term moves, when markets weigh fundamentals, have identifiable causes. Nothing headlines fear now will impact corporate earnings in one, three or five years.
Whether or not the pullback lasts a bit longer, we think this bull market has plenty of fuel. If you own stocks, you’ll make more money today simply sitting on your hands. If you have cash, it’s a good time to buy.