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May 23, 2017

What happens in the next crash?

Before talk of an impeachment of President Trump flared up last week, stock markets were rallying from one record high to the next. Volatility was also close to record lows. The last time the US stock market registered a peak-to-trough decline of 20% was more than 5 years ago (October 2011). However, we know that, on average, stocks fall by 20% or more roughly once every 3-5 years. Now is probably a good time to think what will happen into the teeth of the next 20% stock market decline. If you are well prepared, you can avoid the typical investor mistakes. We have put together a Top Ten list of what to expect when the next 5% “healthy” correction turns into a 20% “unhealthy” bear market:

  1. Some lucky doom-spouting charlatan who has been wrong during the last 10 year bull market will try to become the new guru. He will look clever for a brief period – similar to a broken clock, that is right twice a day. Many investors will still fall for it and subscribe this his expensive investor letter.
  2. There are more than 5,000 mutual funds in Germany. Statistically, a handful of funds will have outperformed or even have made money for their clients. Retail investors think they have found the next superstar fund manager not realizing that luck played a major role. He will still underperform in the next upcycle.
  3. Gold will rise by US$ 100 per ounce but the shiny metal will still have lagged a broadly diversified equity index over the last 10 years. However, gold will still not pay a dividend while European equities offer 4%-5% annual returns irrespective of capital gains/losses due to a hefty 3.5% dividend yield and 1% share buybacks.
  4. Individual investors will panic and sell at the trough. They will promise to themselves to never buy stocks again. Even if the crash only lasted 1 year and the equity investment was meant to be for their long-term retirement plan.
  5. ETF providers will lose a lot of clients. Mainly new clients that just recently jumped on the ETF bandwagon and who thought ETF investing was easier and somehow less painful.
  6. When stocks were still at their record high many investors said to themselves “if only I had bought at lower levels“. Now that stock prices are at lower levels they don’t want to buy.
  7. Warren Buffett suddenly looks very clever because he is sitting on US$ 95bn of cash and can now scoop up quality companies at a cheaper valuation. Individual investors who also have spare money are “waiting for markets to stabilize“.
  8. German government bonds are trading at negative yields again. Nobody understands why although people have no qualms paying a premium for their car insurance.
  9. Investors are starting to check their bank statements constantly without realizing that a tree doesn’t grow faster either if you dig up the roots on a daily basis.
  10. Investors realize too late that their previous definition of “long-term investing” somehow doesn’t apply anymore when markets drop more than 10%. Investors become hostage to their emotions instead of focusing on their long term goals.

Right now with nearly all asset prices up strongly over the last few years, investing seems easy. It won’t last forever. At some point, this bull market too is going to come to an end. We are not predicting here when and why – what we are trying to communicate is that this is a good time to have an honest appraisal of your appetite and tolerance for risk. BEFORE markets go through a correction. Everyone says they are patient on good days, but we have seen often enough that this is not always true on bad days. You need the right asset allocation in place that will allow you to stick with it and even rebalance.

If you would like to know how we can help you reach your financial goals, please get in touch.

 

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