Is there ever a time when it is okay to sell stocks during a sell-off or bear market?
If you listen to 99.9% of the financial professionals, talking heads or academicians, there is never a good time to sell, especially when there is panic in the air.
But I ask again, does ever make sense to sell when stocks are in a downdraft?
Clearly we are in a bear market. Stocks are weak across the board, and there is panic in the air. Do we hold our ground here and stay long and strong?
In most cases the answer is yes. Staying invested in the market despite selling pressure has historically resulted in maximum gains in a portfolio. There is a good reason why nearly every person involved in this business suggests that investors stay calm. (See also: "Users Guide for a Bear Market.")
Historically, drops in the market are followed by snap-back rallies. The pendulum effect is as reliable as Old Faithful. Watch stocks drop in value only to be followed by a rally of biblical proportions.
Wringing out the weak hands sets the stage for a rally. Examples of reliable recoveries include the crash of 1987, bear market of 1991, Asian and Russian crisis of 1997, September 11 and the recession of 2002.
There has been only one occasion of late where sticking to your guns cost investors money and that would be the dot com crash of 2000. In that circumstance, shares of Nasdaq companies dropped significantly after reaching bear market territory.
So here we are today, and everywhere I turn I see recommendations for investors to stay calm. Hold your stocks, don’t panic. It is a familiar tune that has been sounded before.
This time around will we see the snap back rally or are we now looking at something more similar to the dot com debacle? (See also: “5 Rules for Bear Market Investing” and “You Still Need Stocks, Just Not The Headaches.”)
Unfortunately the odds of a longer contraction are improving by the day and that is after factoring in the government bailout fund that is being created to buy bad assets providing much needed grease to the banking system.
I wish I could be more positive about what is transpiring, but doing so would require me to stretch the facts in a way that would not be credible. The facts are the facts, and these facts simply do not support higher stock prices.
Here’s the big problem…
The world’s economies are undergoing a massive de-leveraging and contraction process. That process results in slower growth, or worse, recession.
To be fair, the market in its current form has been anticipating an economic slowdown, but that slowdown was expected to be shallow and short lived. The bulls on the market have long ago assumed that this recession would end by the end of the year with smooth sailing thereafter.
That was before Wall Street collapsed leading to the $700 billion bailout from the government. And as I have said before, the market is reacting to this seismic shift in the potential for the future as if it was a mere squall that will come and go with little impact.
To state that there will be little impact from the events of the last two weeks is almost laughable, and that’s why I say that in this situation the typical snapback rally may not arrive for some time, if at all. (See also: "How to Play the Wall Street Bailout.")
It is not too late to sell.
In order to gauge the impact of this event on the economy, one need only turn to the experience of Japan in the 1990s. They call it the lost decade for a reason. Japan’s economy was stagnant for 10 years in the aftermath of a real estate induced bank crisis.
Sweden on the other had experienced a deep recession for two years when in the early 1990s its banking system nearly collapsed. Its solution was a much more aggressive version of what we are now seeing in the United States.
The deal agreed to over the weekend may or may not stem the tide in the credit markets. There they are already behaving as if we have reached the abyss. How else would you describe investors buying Treasury bonds in return for zero yield?
Washington Mutual (WM) was taken over by the government and sold to JPMorgan so as to avoid a crunch on the FDIC insurance fund. The same happened with Wachovia (WB) on Monday when it was announced that it would merge with either Citigroup (C).
The dominoes are falling.
Go ahead and stay calm and patient as long as the wisdom of sage advice is now directing you to do so. Keep believing that this mess will have little impact on the economy.
Or, liquidate your longs in order to preserve your capital from another 10-20% deterioration in value with little hope for recovery. Such action would not be panic.
It would be Rational.