The past 12 months have been a once-in-a-generation stretch, and not just because of the pandemic. Civil unrest broke out in communities around the country, wildfires tore through the western U.S., and just last month thousands of Texans were left without heat, power and running water in the midst of a deep freeze.
It’s a good reminder to always have ready a “go-bag,” points out Nicholas Colas, co-founder of DataTrek, in a note out Friday. That means being prepared to leave your home with everything you need to stay safe for an extended period: batteries, water, first aid, and so on.
But reflecting back on the past year also means considering the panic at the start of the coronavirus pandemic — the one that manifested itself not just in the toilet paper aisle in supermarkets, but the financial markets.
“The real challenge in crisis planning is predicting what other, less prepared people will do,” Colas wrote, pointing to the run on toilet paper and canned goods.
That’s why it’s important to take some quiet time – perhaps now? – to consider, in Colas’ words, “1) ‘what will I do in a crisis?’ and 2) ‘what’s everyone else going to do?’ That’s because whether you’re assembling a go-bag or a portfolio the ultimate goal is to feel you’re prepared for outlier events and have a plan to deal with them. Yes, this is a bit of an illusion of control. But it is in service to a greater good – making rational decisions when under stress.”
Colas offers some guiding principles for thinking through that plan.
For one thing, he points out that market crises “express themselves in the same way: stocks suddenly tank and there’s no way of knowing when they’ll stabilize. You don’t need to worry too much about ‘why’ stocks are plummeting – that will just send you down a rabbit hole.”
Colas believes there are two paths forward in a market crisis. “One is to sell everything on the first down 5 percent S&P day and wait for the skies to start to clear. The second is to start buying/adding risk on every 5 percent fall after the first one.” Investors should keep an eye on 5% because it’s 5 standard deviations from the long run mean daily return on the S&P 500
That’s what DataTrek counseled throughout 2020, as MarketWatch has noted.
How’d it go? “The first down +5 percent day was on March 9th (S&P 2,745). There were 3 more: March 12th (2,481), March 16th (2,386), and March 18th (2,398). Average price: 2,422, and you were in the money on those buys every day past March 25th, just 3 days after the lows.”
It’s easy to dream up a plan when things are quiet. It can be agonizing, as a famous writer once said, to keep your head when all about you are losing theirs. In fact, that’s exactly what happened last March: the S&P 500 tumbled 34% over the course of about three weeks.
Still, just like with an actual “go-bag,” thinking through the next market crash may, paradoxically, offer peace of mind.