Why you need a plan for when the market panics

A reliable stockmarket warning bell may be about to send investors running for cover, says John Stepek. That's when you will be glad you have your investment plan in place.


Is the US heading for a recession?

Pretty clearly, Donald Trump is getting a bit worried about what's going on in markets.

Yesterday, we heard that the White House plans to delay the introduction of new tariffs on Chinese imports until mid-December. The Chinese, meanwhile, said that there will be new talks in a couple of weeks.

The hope, presumably, is that he can prevent a stockmarket crash before the next election date rolls around in 2020.

But I am starting to think that he's running out of road...

The economic outlook is getting gloomier by the day

yield curve

The gap between the two-year US Treasury yield, and that of the ten-year, is the smallest since the financial crisis. If it turns negative (in other words, the two-year bond pays more interest than the ten-year), then that means the yield curve has "inverted".

That, in turn, has a very, very good track record of forecasting impending recession in the US.

The US, of course, isn't the only one. German GDP figures this morning show that the eurozone's most important economy saw its economic growth shrink in the second quarter. Another quarter of that, and it'll be in technical recession.

The problem is that global economies appear to be getting weaker, and this is all happening at a time when global central banks are in a position where they are struggling to plaster over problems that are geopolitical, rather than monetary, in nature.

The unrest in Hong Kong is a fresh worry to add to the mix. Hong Kong is China's financial window on the world. I don't know enough (I'll be reading up on it, I assure you) to be happy speculating as to what happens if that window closes. But I doubt it would be pretty for markets.

My concern is that central banks might be running out of rabbits to pull out of their hats. I have expressed this concern in the past and been wrong, so maybe it's the same this time. But Jerome Powell is clearly struggling with the job of Federal Reserve chair. Mario Draghi saviour of the eurozone is about to step down.

Can driving bond yields down even further via rate cuts and more quantitative easing really help anything? I'm struggling to see how.

If "buy the dip" stops working for investors, then the market psychology could switch wholeheartedly to "sell the rip" (in other words, get out when the market offers you the opportunity).

Like I said, I could be wrong. But the omens are currently not great.

How to build an investment plan that suits you

As I've been saying, if you've got a plan, stick to it. If you haven't recently reviewed it, then maybe you should check that the rationale behind your asset allocation is still valid, and that it hasn't moved too far out of line with your intended weightings. If it has, then rebalance.

If you don't have a plan, then get one. If you have no plan in the middle of a panic, then it is almost impossible for you to resist panicking too. When you panic, you make bad decisions. Bad decisions sometimes have good outcomes, but that doesn't stop them from being bad decisions. And in any case, they mostly have bad outcomes. So you want to avoid them.

What does a plan look like? Start with your goals. For lots of people, it's about saving for retirement. For those already retired, it's about ensuring their money lasts for their retirement (we're holding an event on this very topic by the way, on 9 October, in association with The Week and Netwealth you can book a ticket here).

Get an idea of how much you need. The further out you are from retirement, the looser your guesses will be, but it gives you a goal and also a way to measure progress. Yes, "save as much as I can" is a valid option, but it's more helpful and better for your mental state to be specific about these things.

You then figure out which "pots" to put your money in (this is known as "asset allocation"), based on your time horizon (the longer you have, the more ups and downs you can handle), and your risk appetite (which is really a function of your time horizon, and your existing wealth levels the closer to your goal you are, the more focused you should be on preservation rather than growth).

In terms of asset allocation, keep it simple. You have just five asset classes to worry about: equities, bonds, cash, gold and property (which is really just a subset of equities, but sufficiently different to pull out). These five asset classes behave differently enough to one another to be worth considering separately.

Cash gives you flexibility (also known as "optionality"), which is very useful in a panic. You can hold cash in different currencies if you want, but understand that you don't own cash as some sort of play on exchange rates you own it because it gives you room for manoeuvre and because, in certain macroeconomic circumstances, it outperforms everything else. So holding the majority in your home currency is probably sensible.

Gold is an oft-neglected, but I'd argue core, part of a portfolio, in that it gives you an element of financial disaster insurance, and it also benefits from certain macroeconomic conditions (mainly falling "real" interest rates, which we won't start on just now).

As far as shares, bonds and property go - it's mostly about finding value, and about making sure you aren't too reliant on one asset class. I won't go into where to find value today (not enough space), but we do have plenty of ideas in MoneyWeek every week (subscribe here if you don't already).

And if you're stuck, our investment trust portfolio covers most of these bases and has done pretty well over its lifetime (some of the managers of these trusts will be speaking at the MoneyWeek Wealth Summit, so if you own any of them, don't miss the opportunity book your ticket now).


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