Off with their heads!
Investors and investment professionals were jolted out of their vacation reverie by wild swings in stock markets around the world in early August.
A combination of political gridlock in the U.S about raising the debt ceiling and a surprise downgrade of U.S. government bonds by credit rating agency S & P (Standard and Poors) triggered a flight out of stocks to cash and bonds.
Adding to the confusion, two other credit rating agencies; Moody and Fitch reaffirmed the U.S. government AAA (triple A) credit rating despite the S & P downgrade.
Concerns about Spain and Italy's government debt and rumours of France having their debt downgraded sparked major stock market corrections in Europe.
After just a few days of wild up and down trading, the S&P 500 stock index had erased the last 11 months of gains.
The August "flash crash" as I call it, does not seem to be based on any fundamental reason that we were aware of. U.S. corporate profits had indeed been growing strongly with the majority of companies exceeding profit expectations. Economic growth numbers for the U.S. came out weak but this was not unexpected. Federal Reserve Chief - Ben Bernake had previously held a public news conference announcing that U.S. growth would be weak temporarily. And it was.
Clearly, investors were in no mood for logic as many companies were indiscriminately sold.
Disney reported increased profits of 10% and as a reward, its stock price dropped more than 10%.
Off with their heads!
In the end, the U.S. stock market dipped 17.9% before recovering a few percent[1]. The August 2011 flash crash is eerily similar to last years "flash crash" inspired correction which saw the S&P 500 drop 15.99% last summer.
What is an investor to do when we find ourselves, like Alice in Alice in Wonderland where logic is turned on its head?
We could do what many investors did almost three years before during the U.S. financial crisis - sell at the bottom and get out at a steep loss or wait until the markets have recovered before resuming investing ( the buy high, sell low method rarely works except perhaps in Lewis Carroll's fantasy land.)
What to do? Rather than just watching the headlines, there is something we can do. We need to buy the market while it is cheap to do. Concerns markets may decline further? I have written an article about an ideal investment strategy that works in these types of markets.
You can read it here.
[1] at the time of writing, the market dip had shrunk to about 13% by Aug 12th.
