Over the last century, the world has suffered through a number of financial crises and market crashes, ranging from the panic of 1929 to the 1987 crash.
With global markets stalling in the last week, investors might be forgiven for fearing that the bear market is back – or perhaps never left.
But one message should be shouted loud and clear above all the other mixed signals you’re probably hearing right now, and that is don’t panic.
In the midst of panic
Global markets have rallied strongly since March, most up around 50% from the lows.
However, the recovery remains shaky, and any sign of economic weakness is pounced upon by the bears.
In the last 24 hours, the UK, Australian and other global markets have dropped 3% or more.
The selling was precipitated by a re-emergence of credit fears, after a large state-sponsored company in Dubai requested an extension on paying back debt.
Why is there panic?
The panic settles in because people are confronted by a market situation that is far from normal. Panic in financial markets, just like panic in everyday life, is explained in psychological terms by the fight-or-flight instinct.
It looks like the flight instinct is the most prominent one when it comes to market psychology, however. The present market situation is seeing not only individual investors taking flight, but big financial institutions, too. Financial firms lose their confidence in the market, and, in a state of panic, lose their ability to transact business as usual.
But the very definition of panic is a state of irrational despair – a state whereby people or bodies act in ways that contradict reality. In its very essence, panic is therefore not a logical, or justified, state to wallow in.
That isn’t to say that the wide-spread selling occurring across global markets right now is totally irrational or panic-driven. The selling can be seen as somewhat logical, as it makes sense to move from a risky to a safe environment when the financial system looks broken, and a serious economic slowdown is on the cards.
But selling based on panic alone isn’t smart selling, and the fact is that investors who are sellers right now should be operating from a standpoint of cold, hard logic, not runaway emotion.
It’s smart to remember, too, that just because markets are behaving irrationality, this isn’t an open ticket for investors to work in the same way.
Some analysts believe that the current irrationality stems from one aspect of the market alone: from the financial sector. For instance, a large part of the nonfinancial part of the economy is strong, and statistics show that these sectors are much stronger than during the Great Depression – another time of global economic panic.
With strength still evident in some parts of the market, it is illogical to react to your entire portfolio with panic. Oh, and there’s that one significant point that panic blinds investors from seeing: that the current dismal state of affairs is not here to stay.
Wait out the storm
The good news is that financial panic doesn’t last forever. Though fight-or-flight instincts are now seemingly driving the market into the ground, the market must recover, or (brace yourself) crash first and then recover.
Either way, a recovery will come. Unfortunately, it is also a fact that recovery takes longer than a crash.
Benjamin Graham, the father of securities analysis, said all the way back in 1934 that a market crash stems from three forces: the manipulation of stocks, the lending of money to buy stocks, and excessive optimism.
When you remember the high-spirited bull market we enjoyed leading up to this crash, and the money that has changed hands in an attempt to stop this market drop, you might have to admit that Graham has a point.
Survival the key
It is true that the current situation is one of uncertainty, but behaving in an irrational manner won’t help the situation. Earnings growth has slowed and might continue to slow, but many companies still possess fantastic balance sheets, so when we come out of this crisis, we can expect pretty strong growth.
In other words: don’t follow the herd fight-or-flight mentality and jump out of the market because you’re feeling scared. Use sound advice to guide your actions. There are no easy solutions to the state of the markets right now. The issues guiding the markets at the moment have been building for decades, and won’t be solved in a day.
It’s rough at the moment, but the future will bring promise. Every generation has its own stockmarket crash, and this is ours.
And guess what? Each generation’s crash passed, and those that came out on top were those who used their heads – and didn’t panic!
