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Stock markets are tumbling and so are your investments. What should you do? Buy (if you have some cash).
At least that is what the fear gauges are saying. Readings show pessimism has not been this deep since compilation of the gauges began. And as one of the investing greats, John Templeton, said: “Buy at the point of maximum pessimism.”
A leading gauge of investors’ fear level is the CBOE Volatility Index (VIX). It measures the implied volatilities in U.S. stock options. The idea behind it goes something like this: nervous investors buy put options to hedge/bet on falling prices, so the more they bid for put options, the more they signal bearish sentiment.
In the past, whenever the VIX jumped into the 30 to 40 range, the tumble in stocks usually reversed. This week, the VIX shot up to 59, an all-time high. The previous record was just above 45, back in 1998. The VIX is not saying, buy stocks; it’s screaming: “BUY STOCKS!”
Or take mutual-fund redemptions. In Canada, approximately $4.5 billion flowed out of Canadian mutual funds in September, which, even adjusting for outflows from money-market funds, was far above the previous monthly peak. That was $1.7 billion in April, 2003, roughly the bottom of the last bear market.
A lot of mutual-fund investors pushed the panic button in the U.S. too. In September, $75 billion (U.S.) fled U.S. mutual funds, three times the previous monthly record, set during the bear market earlier this decade.
Of course, buying into the teeth of a roaring bear market can be painful. It is unlikely that your stocks will turn around just after you buy them. The downward momentum will inevitably push them into a loss position, and potentially a substantial one in the short run.
That’s why the long-term investor should only be investing with a focus three to five years out, as a minimum. Like the golfer who must keep their eye on the ball in order to hit it straight on, the long-term investor needs to keep their gaze on the horizon three or more years away.
Detach from the here and now. In time, this crisis too shall pass and financial markets will return to normal. Visualize what the markets will be like down the road. Also, it sometimes helps to average in your positions over time (but during periods when pessimism is rife).
The example of legendary investor Warren Buffett conveys the same message to buy. As everyone rushes to dump their investments, he is on a buying spree. His company, Berkshire Hathaway, and its subsidiaries, has made large purchases within the past five weeks or so in: Constellation Energy, Goldman Sachs, BYD Company Ltd., General Electric, and Wachovia Bank.
Another seasoned investor laments the opportunities missed in the past. “For the 20 or so years your editor has been writing and investing for his personal account there's a recurring theme that gnaws,” writes James Picerno in The Capital Spectator. “We didn't take advantage of the calamity.”
When the crash comes, it’s hard to go against the crowd and throw one’s money into what looks like a meat grinder. But history shows that’s what successful investors have done.
There is always a possibility “this time might be different” and the stock market fails to resume its tendency to appreciate at an average 7% to 9% a year as quickly as before. But if one waits long enough, the upward trend should resurface. Time is the ally of the long-term investor in stocks.
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