Investors are starting to panic – resist joining in

Markets are falling hard as investors take fright. But whatever you do, says John Stepek, don’t panic. Keep your head and prepare for the opportunities that will eventually arise.

Gosh, where to begin this morning? 

Yesterday was a shocker for markets everywhere. 

Cryptocurrencies melted down (of course) and that grabbed a lot of attention. 

But the most worrying developments were grinding away in far more important markets.

Why crypto isn’t that important even if it’s eye-catching 

The world of cryptocurrencies saw yet another big panic yesterday. 

The platform in question this time was Celsius. As someone who only pays a little bit of attention to cryptocurrencies, this was not one I’d heard of. But it’s big enough that Canada’s second-biggest pension fund had invested in the platform behind it (not the currency directly). 

Celsius appears to have been yet another of these too-good-to-be-true magic boxes that promised to enable users double-digit annual yields. 

As I understand it, you deposited your cryptocurrency with Celsius. Celsius loaned it out and you got a hefty interest rate in return. But yesterday, it stopped people from pulling their money out. 

There are plenty of in-depth explainers out there for those who really want the grim details on this, but the truth is, all you really need to understand about this is that someone tried to do an experiment in banking which has already been tried many times, and which always fails when liquidity tightens and people suddenly want their money back. 

The reality is that this individual example of a speculative venture collapsing in the face of tighter monetary policy doesn’t matter much beyond it being yet another dead canary. 

The cryptocurrency world is fascinating, but in financial market and economic terms, it’s small. I’m open to alternative views, but I haven’t seen anything to persuade me that cryptocurrencies pose any sort of systemic risk. So even if the sector has a Lehman Brothers moment, these aren’t mortgage-backed securities – they aren’t going to poison the entire financial system. 

There are, however, other areas that look a lot more worrying. 

Markets that actually matter are looking wobbly 

The S&P 500 is now in a bear market, for example. That is, the US stockmarket index has fallen by more than 20% since it peaked at the start of this year. People like to quibble about definitions of a bear market, but no one’s quibbling that we’re in one now. 

By the way, the Nasdaq, which was the leading major index during the bull market, is now down nearly a third from its November high. 

That’s all worrying for investors. But at the end of the day, this is what markets are for – equity markets go up or down; you own the stock or you don’t. You might get margin called if you’re a leveraged investor, but usually the amount of debt involved isn’t going to be systemic.

The scarier stuff is happening in bond markets. The yield on the ten-year US Treasury bond hit its highest level since 2018 (which is when interest rates were last being raised by the Federal Reserve, America’s central bank). Rising interest rates mean tighter money across the globe, and raise some intriguing questions about the cost of borrowing for governments.

The US is probably not the biggest problem on that front. But one concerning phenomenon elsewhere is that yield spreads in the eurozone are widening again. In other words, it’s starting to cost Italy a lot more to borrow than it’s costing Germany, which implies that markets are differentiating between the creditworthiness of countries in the eurozone again.

Why does that matter? Well that’s basically why we had the sovereign debt crisis back in the early 2010s.

To be clear, I’m not convinced that’ll happen again this time around, but I can see it becoming an issue that the markets force the European Central Bank to address. And the politics around that could be sticky depending on what happens with inflation

Anyway – long story short, yesterday felt like the first genuine glimmers of panic that we’ve seen in this particular downturn, and I can see why. 

What should you do about it? 

Don’t panic – just prepare for the opportunities that will eventually arise 

For what it’s worth, despite epic levels of bearishness among both consumers and in the latest Bank of America fund manager survey, I don’t think we’re near the bottom. You’ll certainly get bounces – history shows that the biggest bounces come alongside the biggest drops – but it also shows that bear markets tend to end once the central banks start cutting. And that’s not close yet. 

In any case, as a private investor, you shouldn’t spend time worrying about “are we there yet?” I suspect that more money has been lost trying to call the bottom of markets than through any other investment error. 

It’s only too easy for investors (particularly inexperienced ones) to damage their retirement prospects by giving into their urge to catch falling knives. That is, assets which have fallen so far, that our reptilian hindbrains assume that they have to bounce some time. 

This is not the case. Remember that a stock which has fallen 90% can still fall another 100% from where you bought it. And they don’t bounce from zero, unfortunately. 

Instead, the main thing to remember in markets like these is the golden rule: “don’t panic”. Don’t feel that you have to act, whether that impulse is “sell out now!” or “buy the dip while the bargains are still here!” 

You need only look at the aftermath of past bear markets to realise that you don’t have to get in at the bottom, or anywhere near it, to do fine when the bull market starts again. You didn’t have to buy in March 2003 or March 2009 to do perfectly nicely out of the subsequent bull markets. 

So while the market is riven with chaos, focus on other things. Make sure you have more cash than usual – this is useful for emergencies (chaotic markets and nasty economic times go hand in hand) and it will also serve as a battle chest for when it really is time to buy aggressively. 

The other thing to do is research. We’ve gone from a market driven by momentum and technical analysis to one where fundamentals are very much going to matter again. So all those sickeningly old-fashioned things like balance sheet health and (for wider markets) Cape ratios are likely to matter again. 

In short, don’t be distracted by the noise. Don’t get panicked by the sight of your portfolio taking hits. Instead, focus on getting yourself into a good financial position to take advantage when longer-term opportunities finally arise as a result of this bear market.

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