Wealth Management & Financial Planning

Wealth Management & Financial Planning

Be Careful When Assuming How the Stock Market Will Act During a Crisis

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The speed at which the news cycle reports churns out unsettling headlines can make it feel as if the world is going in the wrong direction. Terrorist attacks, storms and economic surprises are commonplace. Even professional investors are often caught on the wrong side of market moves when they assume “this will cause that.” The recent U.S. Presidential election was perhaps the most recent example of the experts getting it wrong.

Wall Street clearly believed that Trump would not win. These “experts” also predicted that if he did win, stocks would turn downward. Trump won and the experts’ predictions proved correct for a few hours. The experts were not only wrong about the electoral outcome, but also in predicting what part of the equity world would celebrate with all-time high prices.

In his new book Socionomic Theory of Finance Robert Prechter examines the phenomenon of prediction versus outcome.  In the first chapter titled “The Myth of Stocks,” Prechter points out that if you believe in market shocks, you must also predict the consequences that could follow. And if you do predict negative occurrences, is there any evidence that terrorist attacks, political events, wars, natural disasters and other crises, are causal to the market’s downward movement? The facts may surprise you.

To illustrate his thoughts on events and market behavior, Prechter examined the Kennedy assassination. Using an anecdote where an investor traveled back in time with full knowledge of a pending event, Prechter shows that after President Kennedy was shot the market initially went down before moving higher the next day.

What about the costliest natural disaster in American history? In 2005, Hurricane Katrina hit New Orleans and wiped out a quarter of U.S. oil production! Simple reasoning would suggest that buying oil futures would be money in the hand; but it wasn’t.

Even September 11, 2001, would have created surprises for investors who bet on what would “reasonably” happen. Yes, the market did indeed go down following the attacks. But just six months later, investors’ portfolios were at a higher level than the day of the attacks.

Prechter argues that we make perverse conclusions based on data points that sound reasonable but really don’t move the market. He points out that if we look at an event – hurricane, terrorist attack, assignation, etc. – and the markets rally (which they did in every case he cited), then we must conclude the events are “bullish” which is clearly a perverse argument.

A good friend told me not to confuse him with the facts. Though I know the numbers and the research, I still find it surprising when the market proves it has a mind of its own. For our portfolios and the families who we serve, we will continue to rely on a disciplined approach focused on facts rather than emotions. We don’t know when the next surprise will occur and moreover common sense can’t accurately predict how the market will respond to such surprises.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

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