(Editor’s note: This is an article we first published in October of 2014. I’ve dusted it off and updated it to fit today’s environment. While the situation today is completely different than things were in 2014, the advice remains the same.)
If you’ve got money in the market, you’ve got to be feeling a little nervous about now. As I write this, the Dow Jones Industrial Average has plummeted more than 8 percent in 2016: That’s the worst performance the stock market has ever turned in during the first trading days of the year. Just last Friday, it dropped 391 points. That’s almost 2.5 percent.
Is it time to panic? Let’s take a step back and look at where we are, why we got here and what’s likely to happen next.
What’s happening to the stock market?
Much of what’s happening to the stock market is panic. Like hearing “Fire!” in a crowded theater, investors are stampeding for the nearest exit. What’s being shouted in the Wall Street theater, however, isn’t “fire,” but words like “China,” “oil collapse” and “recession.”
As for China, there are signs its economy has been slowing down, which is being reflected in the 20 percent plunge its stock market has suffered over the past month. The Chinese stock market doesn’t directly impact ours. And its economy isn’t all that critical to ours, since we buy a lot more stuff from China than we sell to that nation. But as the world’s second-largest economy, big trouble in not-so-little China could be a symptom of a worldwide recession that will eventually wash up on our shores.
Things are also not great in Europe. The growth rate for the European Union has slowed to 0.3 percent: barely above recession levels. So from Berlin to Beijing, consumers are consuming less and manufacturers are manufacturing less.
As for the U.S. economy, things aren’t too bad — at least not yet. Our unemployment rate remains at 5 percent — half what it was during the Great Recession. Oil prices are in free fall, resulting in gas prices as low as they’ve been in this century. That’s putting more spending money in the pockets of consumers.
Those low oil prices, however, while helping consumers, aren’t as rosy as you might think. Not only can sustained low prices cost the jobs of those working directly or indirectly in the oil business, they also can result in banks losing billions from bad loans to bankrupt drillers. Low prices on oil and other commodities also are a sign of excess supply, which in turn is a harbinger of a faltering economy.
And for a little salt in the wound, last month the Federal Reserve began raising interest rates. While the first increase was small –just a quarter of a percent — the move shows that the easy money gravy train is leaving the station. Stocks like low rates, not rising rates.
In short, the world has become a scarier place than it was just a few weeks ago. There are reasons behind a falling stock market. The speed of the sell-off and the monster volatility we’ve seen over the last two weeks, however, are tied to more than mere numbers. The selling has taken on a life of its own as people do what they often do when Wall Street stumbles: Sell first, ask questions later.
What should you do?
The only way to trade during a market panic is not to. Panics are by definition irrational, so rational thinking doesn’t work. The thing to do at this point is to wait for the smoke to clear.
If American stocks were radically overvalued, the situation would certainly be worse. While our market is overvalued by historic measures, it’s been a lot more so. (The average price-to-earnings ratio for the S&P 500 is around 20, compared with 70 in January 2009 and 46 in January 2002.)
Also supporting stocks are interest rates. Yes, they went up last month, but they’re still low. Ten-year Treasuries are still paying around 2 percent, and banks are paying basically nothing. There aren’t a lot of options other than stocks.
That being said, since at least part of the current sell-off is the result of irrational selling, now is not the time to step up and be a hero. As an old Wall Street expression goes, “Don’t try to catch a falling knife.” Let the correction run its course, and keep an eye on the news.
I haven’t sold a share of stock in my online portfolio. In fact, I’m carefully monitoring the price of oil and may buy some oil stocks for a long-term gain. I’ll let you know if and when I pull the trigger.
As for you, unless you’re over-invested, have too many risky stocks or are short-term oriented, I’d suggest hanging tough, at least for now. Rather than reducing my portfolio, when times get tough, I reduce my expectations instead. I suggest the same for you.
The silver lining
There are no sure-fire investment systems guaranteed to create stock market profits. But there’s one that comes close. It’s called dollar cost averaging.
Dollar cost averaging refers to investing a fixed sum of money at regular intervals. It works because you buy more shares when they’re cheap and fewer when they’re not. As long as shares don’t permanently decline, this system will always result in profits over time. To learn more about this and other investor basics, see “Beginning Stock Investor? Here’s All You Need to Know.” But the point is, if you’re investing monthly in a 401(k) or other investing account, when markets drop, you’re buying things on sale. That’s not a bad thing.
Bottom line? If your nest egg is exposed to the stock market, there’s little you can do at this point. But here’s something not to do: Freak out and sell at what may turn out to be an inopportune time.
What do you think is ahead for stocks? Are you getting out? Buying more? Share your thoughts below or on our Facebook page.
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I founded Money Talks News in 1991. I’ve earned a CPA (currently inactive), and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate. Got some time to kill? You can learn more about me here.