TheStreet.com- How to Protect Yourself From a Market Crash: Invest With Your Brain Not Heart


The downward spiral of stock markets globally on Oct. 19, 1987 sent traders into a panic as valuations plummeted, but three decades later with the potential for another sudden downturn, Black Monday can remind investors of an important lesson: panic selling during a flash crash could prevent them from reaping the upside rewards when the market inevitably rebounds.

With the current markets reaching new all-time highs frequently and the Dow Jones Industrial Average (DJIA) nearing 23,000, TheStreet looks at the attitude of some investment professionals in this environment as part of its Crash of ’87 — TheStreet Special Report. The findings were mixed but some investors seem to be jittery. Many worry that an inevitable correction is on its way worrying how high can this market go: 23,000? 24,000? We seem to be flying at Icarian heights.

Invest With Your Brain, Not Your Heart

The carnage of Black Monday can still cause investors tremors of panic, as they see the Dow reach record highs on the daily. On that dark day 30 years ago, the Dow had fallen 508 points or 22.61% to 1,738.74. This sharp plunge was the result of fears of a recession and an immense surge of selling in the market.

But logical, calm investors took a breath and realized the sky wasn’t falling. There were perfectly reasonable explanations for the drop.

The extreme volatility that day was attributed, in part, to the fact that stocks didn’t open in a timely fashion, which resulted in a major disconnect between futures and the index quotes, severe data dissemination issues, along with a lack of liquidity and issues with electronic trading, said Fariba Ronnasi, CEO of Elite Wealth Management in Kirkland, Wash.

One of the biggest and more “ubiquitous” mistakes happening on Oct. 19 was panicked trade decisions occurring without having all the data and ignoring the irrationality of the price moves, she said.

The execution confirmations had over an hour delay, the quotes weren’t being disseminated accurately and participants were throwing sell orders out into a dense fog with very limited pricing information and not knowing exactly what was going on in the markets.

Other crashes like the 2010 flash crash caused panic among some investors who need to ask themselves whether any “new tangible data has been introduced to justify the market moves or challenge their own market valuations and then make rational trading decisions based on the full picture,” Ronnasi said.

Any knee jerk reactions can be especially damning for investors. For people who tend to be emotional investors, it’s best to curb those apocalyptic feelings and instead be proactive in your asset allocation.

How to Flash Crash-Proof Your Portfolio

Investors need to examine their portfolio and make sure they are comfortable with what they own, said Ron McCoy, CEO of Freedom Capital Advisors in Winter Garden, Fla.

“One good question to ask is if a certain stock were to drop 50%, would I sell it or buy more,” he said. “If the answer is sell, then one might consider taking a little bit off the table here. It pays to know what you own and why you own it.”

One good rule of thumb to follow for investors who did not sell their assets before a crash is that history indicates you are better off riding it out, said Patrick Morris, CEO of New York-based HAGIN Investment Management.

By selling during the panic, investors must realize they are only locking in the loss and timing when to reenter the market is nearly impossible.

“If you didn’t have almost perfect timing in February 2009, you missed a huge rally,” he said. “With confidence rattled, you will probably also get caught flat footed and assume that every rally, no matter how robust, is just a ‘dead cat bounce.’ Timing the market just plain doesn’t work. Traders can’t even get it right.”

Even in bull markets, 5% to 10% corrections are very common, said Sreeni Meka, a managing member of Lakeland Wealth Management, a registered investment advisor in Memphis, Tenn.

“You will never see the market going straight up continuously in the bull markets or nose diving every day in the worst bear markets,” he said.

While historically the markets always rise, equity markets are not meant for short-term investors.

“It is always good to have a long-term perspective if you have a long-time horizon,” said Meka. “Otherwise, it’s good to diversify by placing some of your assets in short-term bonds and the rest in equities.”

Since interest rates remain at such low levels, the Federal Reserve’s policy is to normalize interest rates and may increase the short-term rate again in December and in 2018.

If you have a short time horizon, build a portfolio with a mix of short-term bonds with lower duration or cash and rest with the equities. Younger investors should enjoy the last leg of the bull market which may end up 20% or more before it is hitting all-time highs, he said.

Instead of selling or panicking, a correction is a good opportunity to buy more quality stocks.

“This bull market may stretch until the middle or end of the next year, since all leading economic indicators are pointing high,” Meka said.

Remaining fully invested in the stock market is a good strategy for investors who are 55 years old or younger, said Edison Byzyka, chief investment officer of Hefty Wealth Partners in Auburn, Ind.

“The long-term ability of your portfolio to survive whatever may happen is highly in your favor,” he said. “I know that this is hard, but it’s by far the most rational move to a potentially more successful retirement.”

Investors who want to reallocate their portfolios should limit themselves to a minimal exit such as limiting their cash position to no more than 20%.

“Build a plan of when you’re going to buy back-in — is it every 5% pullback or 7%?” Byzyka said. “Do this before the correction happens and stick with it. You must also keep in mind that a correction may not actually happen.”

Embrace These Highs

While it is true that the stock market is selling at a very high price to earnings ratio based on historical norms, the certainty that it is overvalued is debatable, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa. The potential bubble is in the bond market and not the stock market.

The S&P 500 currently has a PE multiple of 25.5 and historically, the multiple has averaged around 15. When investors take into account the current yields in the bond market, the stock market actually looks much more attractive than the bond market.

The 10-year bond is yielding 2.34% and it is essentially at a PE multiple of 42.7 times.

“Investors need to ask themselves would they rather buy the S&P at 25.5 times earnings or the 10-year bond at over 42 times earnings,” he said. “When evaluated on that basis, the bond market is the market that looks relatively overvalued.”

Market pullbacks give investors an opportunity to buy pieces of businesses at lower prices, said Yale Bock, a portfolio manager on Interactive Brokers Asset Management.

“Really knowing the companies or assets you own and why you have invested in them provides an investor with facts and a plan for coping with the market and its fluctuations, versus say charting techniques like the handle and spoon, cup and saucer, horse and buggy, double bottom, triple bottom, etc.,” he said.

The “Crash of ’87 — TheStreet Special Report” is a series of stories, videos, graphics and other multimedia elements that look at the stock market crash of 1987, also known as Black Monday. TheStreet examines the cause of the crash, reveals some of the hottest stories of the day, and discovers what could cause a similar crash in the future. How can we prevent another Black Monday? Read more about the Crash of ’87.


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