August Market Dip - Dress Rehearsal?

(NOTE: A version of this was published on August 9, 2024.)  

 

On Monday, August 4, 2024, as the market dropped precipitously into deep 3-figure territory (-800 or so), I decided to stick to my Monday morning routine: yoga. My teacher started class by telling us about her recent trip to Portugal where she co-led a retreat.  While frolicking in the ocean one day, she noticed a fast, fierce wave heading right at her.  Realizing that she couldn’t outrun it, she decided to go with plan B: become more flexible by crouching over and going limp.  When the massive wave hit her, sure enough, she got knocked over.  But, by rolling with the tides, she was able to avoid serious injuries and live to tell the tale.         

 

What happened?!?!?! 

Monday ended with the stock market (Dow) down -1,034 points.  If you’re like me, part of processing is acknowledging hard emotions: Holy crap, that was scary!  If you’re like most people, you’re probably wondering: what caused this sudden and dramatic downturn?  Here are key theories circulating in the news: 

 

One, contagion or trigger, depending your perspective.  Bank of Japan (BOJ), their version of the Fed, decided to increase interest rate by 0.25% after holding it negative since 2016.  This decreased (arbitrage) opportunities wherein traders borrow cheap yen to invest globally for profit.  In response to BOJ raising interest, the Japanese stock market (Nikkei) plunged by -4,451 or 12.4%.  This, in turn, triggered a sudden sell-off in other countries, including the US.   

 

Two, as of late, the US stock market has been “priced for perfection” due to optimistic outlooks, despite the Fed aggressively raising of interest rates (from 0% to 5%+):

·       Unemployment will continue to hover at historical lows (4% – ish).

·       Corporate earnings will continue to beat forecast.

·       Magnificent 7 (e.g., Meta, Apple, Google) will continue to dominate and deliver outsized returns.  

·       AI will power the next wave of growth and prosperity. 

 

But, recently, things began to unfold less perfectly:

·       Intel dropped 38% over the course of a few days as it was viewed a laggard in the AI race.

·       Google lost a big antitrust case brought on by the US government.

·       Unemployment inched up slightly from 4.1% in June to 4.3% in July.  

As a result, investors (over)reacted by dumping stocks, especially in the expensive tech sector (Nasdaq).    

Three, inversely, the less than perfect unfolding of events helped bring into view the great uncertainties that have been looming on the side of the stage, foremost being the upcoming Presidential election and the Fed potentially too slow in cutting interest rates and, thus, inadvertently triggering a recession (hard landing).      

 

Dress rehearsal – Potential ways to prep for turbulent/volatile market

I’m fiscally conservative. I care about the downside (risks) far more than the upside (returns).  Reason being, if we can survive the downside, the upside will take care of itself.  Historically, the stock market has trended upward, but only if we can buy and hold through thick and (especially) thin. The best time to prep for any potential storm(s) is when the weather is still sunny.  Again, below are the cardinal rules of successful investing and some steps to take to help ensure survival should markets turn turbulent.      

 

Stay liquid.  (In other words, have enough cash.)  

·       For those still in the work force, consider building up or setting aside at least 12 months’ worth of living expenses (emergency fund 1.0).  Should a recession hit resulting in job loss, you can use emergency fund to meet living expenses while you look for another position.  Additionally, a healthy emergency fund can help you psychologically buy and hold as your investment portfolio declines (temporarily).       

·       For those who are financially independent (FI), close to retirement (3-5 years out) or in retirement, consider setting aside 2-5 years’ worth of living expenses (emergency fund 1.0) to help ride out a potential market downturn.  The extra cash will allow you avoid force-selling investments to meet short-term expenses.  Doing so, will likely impair your portfolio forever.  

·       FYI, for those of you with a brokerage account, I recommend holding some short- and intermediate (tax-exempt) bond fund, which can be considered emergency 2.0, in case you use up cash-like reserve.      

 

Stay diversified.

·       Regarding your investment portfolio, it’s important to stay diversified, especially since the US stock market has had a massive run (14+ yrs) and now looks expensive compared to international markets:

o   Asset class: stocks, bonds, cash

o   Geography: US vs international

o   Market capitalization: large cap, mid cap, small cap

o   Style: growth vs value  

o   Concentration: company stock (options) vs broad market 

·       Diversification is boring in a bull market, but a lifesaver in a bear market.  Holding different assets help ensure that when one asset zig the other zag.

·       For those with highly concentrated portfolio in any of the areas (above), consider diversifying to lower your overall risk, especially since the market still hovers close to all-time high. 

 

Stay invested.

·       When the market gets choppy, it may seem smart to park a portion or all of our portfolio in cash and wait it out.  (Don’t.)  Markets can move up and down quickly.  Foregoing bad days may also mean foregoing good days.  (See bar graph below for impact of market timing to portfolio return.) Also, ironically, during a downturn, it’s not uncommon that a steep down day will be followed quickly by a meteoric up day…So, stay invested.   

·       For those working, saving and investing for retirement, continue to dollar cost average into the market… automatically (ideally).  Volatility is your friend!  It gives you the opportunity to buy stocks on sale.      

  

Source: “3 reasons to stay invested right now,” Fidelity, August 2024. 

 

Stay calm.

·       Terrified by the thought of what a downturn may do to your future goals, consider taking a break from looking at your investment portfolio, the stock market, financial news, etc.  

·       Find ways to relax: hangout with friends, walk, read (books), do yoga, binge watch popular Netflix serie(s), etc.    

 

Final thoughts…

Though scary, in my opinion, early August’s dramatic downturn (-1,034) served as an important and useful “dress rehearsal” for us investors.  It allows us to gauge our own reactions and, if necessary, take steps now to help ensure we can buy and hold should the downturn become more extended.  Just as waves roll in and out, so markets move up and down.  If we learn to bend, we can avoid breaking, because surviving is the cornerstone of thriving.    

 

 

Sources: Blackrock and Morningstar; US stocks represented by S&P 500 and the IA SBBI US Large Cap Index