Commentaries

The Envestnet Edge, July 2015

Is this the Big One? What to do in a financial crisis

Download the full PDF

Events in Greece, China’s massive market sell-off, and the temporary shutdown of the NYSE remind us that change and crisis shift the narrative of what today holds and the future portends. Investors may at first want to run for the exit, but the wiser choice may be to stand calmly and let the storm pass.

If it seems as though we have focused on crises in Europe for years, that’s because we have. The seemingly endless impasses of Greece and its possible spillover effects on the rest of Europe and then, by extension, on the global financial system, have beset markets and investors for nearly six years.

The past month was yet another convoluted chapter, culminating in a referendum by Greek citizens who, by a margin of more than 60%, rejected their European creditors’ demands for further austerity. That vote was a significant development, but unfortunately for Greece especially, and the financial markets in general, it will not be the last word.

The slow-motion crisis is another opportunity to evaluate investments in the face of geopolitical instability. Greece is but one example of what happens continually in human affairs: change, both expected and unexpected, and crises small and large, which shift the narrative (or at least perspective) of what the present holds and the future portends. The world is always messier and less predictable than spreadsheets suggest, with their expected returns predicated on assumptions of bond yields and equity returns over the next five or ten years.

What to do with a crisis?

In every crisis, investors must answer one question first: Is this the Big One? Followed by: Is this the moment of the great unraveling? And further: Will this event trigger not only volatility but also a sharp deterioration, upending markets and prices so dramatically that no amount of prepositioning can inoculate against losses too severe to recoup in any reasonable amount of time?

If the answer to that first question is yes, then radical action is in order. In 2008—2009, we learned that there are few (if any) safe havens in a major crisis. And, that anything that can be bought and sold will be, at a steep discount. Even that dramatic financial sell-off, however, saw sharp reversals in the months after March 2009, and had you sold at the end of 2008 or during the first weeks of 2009, you would have suffered large losses and enjoyed none of the rebound. If you believe that a crisis of even greater order is on the horizon, however, then being invested in any financial instrument carries significant risks and heavy losses.

Voices in the financial world are always warning of the Big One. But the Big One rarely happens, and most of the time, it is a big mistake to heed those warnings. Opportunities are lost, and “inoculation” investments—i.e. gold bars—often turn out poorly, at best.

Of course, the Big One could be just around the corner. We only will know in retrospect. The next question to ask is whether it makes sense to prepare for it considering A) it may never come and B) the investment choices you make to protect yourself perform badly unless it does. How you answer these questions depends on your personal ability to manage the uncertainty and potential stress that come with a dislocating event. Remember, investment decisions born of the desire to protect against worst case scenarios will almost always do quite badly unless the events occur.

If the Big One isn’t on the immediate horizon, then the next series of questions has to do with the actual implications of the crisis du jour. Today it is Greece; a few months ago it was Ukraine. Prior to that, it was tension in the Middle East, from Iraq to Iran to ISIS, which may soon resurface. And before that it was the U.S. debt crisis of 2011. Unfortunately, each year there is always something, and there always will be.

Each of these junctures presented investors with a series of choices. The two most important are: Do you sell or trim exposure to financial markets and stay with “safe” investments such as U.S. Treasuries? Or do you increase exposure to investments that have been sold off in the stampede, since many of them are unlikely to be affected fundamentally?

To repeat, investments made at the heart of a crisis and designed to protect against further downside rarely perform well. Gold, bear-market funds, derivatives, (the simple act of buying puts)—none of these tend to outperform once the crisis passes. Most of the time, fear- and insurance-based investments need to be in place before the crisis hits to generate meaningful upside.

On the flip side, however, crises almost always cause a broad financial sell-off with implications for assets that have little fundamental exposure to the crisis. Many equities that experience volatility during a regional crisis become oversold either because of greater contagion concern or short-term traders and algorithms triggering selling pressure. Therein lies a genuine, albeit clichéd, buying opportunity.

The aftermaths of March 2009 and November 2011 (which was the last major global spasm triggered by the Greek crisis) demonstrate just how potent those buying opportunities are, and how significant the bounce-back can be for assets that sold off even though they had little direct connection. Today, countless American companies as well as global bond yields have experienced volatility despite no direct effect from Greece per se. Major American retailers, for instance, won’t see earnings affected by a Greek default, yet many saw price volatility. Investors who bought gold as insurance during the crises noted above, however, had considerable losses.

Never let a crisis go to waste

We all know the investing homilies: buy when others are selling; markets climb a wall of worry. But truth lies in such homespun wisdom. The caveat is that any one of these crises could trigger the Big One. And the further caveat is that Big Ones almost never happen, and when they do, most efforts to protect will fail.

But, market movements can be clumsy during moments of crisis and concern. The past weeks have seen not just Greece floundering, but also China’s rapid reversal of its equity markets, both of which have spooked investors worldwide. China is an admittedly larger issue and economy than Greece, but its equity markets are almost purely retail and do not involve foreign money. So even though tens of millions of Chinese investors are panicking, the implications for global markets should be minimal. Should be. But, indeed, many will take their cue from a purely local, retail, domestic Chinese event and apply it to a sell-off in equity and bond markets whose implications suggest little correlation.

Instead, there may be opportunities to build positions in areas that have been unduly hit. Or it may simply be a wave that passes, with one’s basic allocations remaining largely intact, and even adding new cash to them (unless those allocations were heavily focused on, say, Greece).

This basic wisdom has been repeated over and over: no crisis looks precisely like another, and we are all primed and alert about the ever-present potential for bad situations to spin out of control. Given the cost of attempting to prepare for the worst, however, and the opportunity cost of not calmly standing in the eye of the storm, that basic wisdom is unlikely to become common sense anytime soon, and bears repeating for some time to come.

Advisor Take-Away:
The Greek crisis, coupled with China’s massive stock market sell-off, triggered concerns that this could be the Big One. Some investors may be tempted to run for the exits, and seek to inoculate themselves from losses by purchasing investments that are purportedly “safe”—like gold or derivatives. Unfortunately, these fear-based investments seldom perform as hoped. Investors would do well to remember that the Big One rarely occurs—but if and when it does, almost all investments will be bought and sold at a steep discount. A crisis should never go to waste, as it often presents investors with a potent buying opportunity. Standing calmly until the storm passes usually makes the most sense.

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this commentary is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results. Indices are unmanaged and their returns assume reinvestment of dividends and do not reflect any fees or expenses. It is not possible to invest directly in an index.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet | PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Neither Envestnet, Envestnet | PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2015 Envestnet, Inc. All rights reserved.

Featuring

Articles By This Author

The Envestnet Edge, May/June 2018 Video: Five (Investing) Rules To Live By The Envestnet Edge, March/April 2018 Video: Buy The Dips Video: No Place Like Home? Market Bias Perceptions and Realities The Envestnet Edge, February 2018 The Envestnet Edge, January 2018 Video: Raging or Aging: How Much Longer Will the Bull Last? Webinar Replay: 2018 Market Outlook The Envestnet Edge, December 2017 Video: Bitcoin, Bubbles, and the Bigger Picture The Envestnet Edge, November 2017 Video: Taxes are certain, but don't obsess about tax reform The Envestnet Edge, October 2017 Video: Time to stock up on growth or value? The Envestnet Edge, September 2017 Video: Time To Take A (Measured) Risk? The Envestnet Edge, July/August 2017 Video: Bitcoin: Buy Or Buyer Beware? The Envestnet Edge, June 2017 Video: FANG, FAAMG: Too Big a Bite of the Market? The Envestnet Edge, May 2017 Video: Invest "As If" The Envestnet Edge, April 2017 Video: What To Do In Quiet Markets The Envestnet Edge, March 2017 Video: Bull Or Bear: Should Investors Still Care? PMC Weekly Review - March 10, 2017 The Envestnet Edge, February 2017 Video: Separating markets from politics, is it really a "Trump rally"? The Envestnet Edge, January 2017 Video: Investing in Trump’s Economy? Proceed With Caution The Envestnet Edge, December 2016 Video: Have We Only Just Begun? The Envestnet Edge, November 2016 Video: Rotations, Reversals, Rising Rates: A Time to Reposition Post-Election, Will Markets and Portfolios Emerge Winners or Losers? Webinar Replay: Post-Election Winners and Losers The Envestnet Edge, October 2016 Video: In a 2-2-2 world, look for modest economic growth and expansion PMC Weekly Review - September 16, 2016 The Envestnet Edge, September 2016 Video: Diversification is working in 2016 (so far) The Envestnet Edge, July/August 2016 Video: Valuations: it's all relative Brexit: Plunging into the Unknown? The Envestnet Edge, June 2016 Video: Equity valuations and bond yields: reach no further PMC Weekly Review - June 17, 2016 The Envestnet Edge, May 2016 Video: Hitting singles: a measured approach for this investing season The Envestnet Edge, April 2016 Video: Investing with impact: increasingly a matter-of-fact Video: In this election cycle, will investors be winners or losers? The Envestnet Edge, March 2016 PMC Weekly Review - March 11, 2016 Video: In a low-growth world, less could be more The Envestnet Edge, February 2016 The Envestnet Edge, January 2016 Video: Markets are a mess, but don't jump to conclusions yet A Most Challenging Year Video: Interest Rates and Energy: The Highs and Lows of Year-End The Envestnet Edge, December 2015 The Envestnet Edge, November 2015 Video: We'll always have Paris The Envestnet Edge, October 2015 Video: Politics and the markets: déjà vu all over again? Video: China, Commodities, and Crisis: What's Next for Emerging Markets? The Envestnet Edge, September 2015 PMC Weekly Review - September 11, 2015 Is This The Big One (Financially Speaking)? Probably Not. The Envestnet Edge, August 2015 Video: In a "meh" market, look again at U.S. stocks The Envestnet Edge, July 2015 Video: Is this the Big One? What to do in a financial crisis Don't Worry About China Don’t Believe the Hype About Greece The Greek Catastrophe Is Finally Here (Unless It Isn’t) The Envestnet Edge, May/June 2015 Video: When Following the Herd is Risky, Where is the Safety? The Envestnet Edge, April 2015 Video: The End of Short-Termism is Long Overdue PMC Weekly Review - April 24, 2015 The Envestnet Edge, March 2015 Video: Keep Your Friends Close and Your Robo-Advisor Closer The Envestnet Edge, February 2015 Video: The Return of the Comeback: Is 2015 the Year for International Stocks? PMC Weekly Review - February 13, 2015 Why the Jobs Report Means Diddly Don’t Turn America Into Europe PMC Weekly Review - January 23, 2015 Video: Active and Passive: The Yin and Yang of Investing The Envestnet Edge, January 2015 Will Politics in 2015 Catch Up with the Economy? Video: Our Perspective on 2015: Maintain Yours The Envestnet Edge, December 2014 PMC Market Commentary: December 12, 2014 No, This Is NOT the '90s Economy Again PMC Market Commentary: November 14, 2014 Video: 2014 U.S. Midterms: A Win for Stocks? The Envestnet Edge, November 2014 Whose Economy Will It Be in 2016? PMC Market Commentary: October 17, 2014 Video: Special Video Commentary: Market Volatility and Fundamentals The Envestnet Edge, October 2014 Video: You Know What’s Not Sustainable? Ignoring the Opportunity in Impact Investing Don’t Panic! PMC Market Commentary: October 10, 2014 Greenberg’s Folly Naomi Klein Is Wrong PMC Market Commentary: September 26, 2014 Subprime Loans Are Back! The Envestnet Edge, September 2014 Video: When it Comes to Interest Rates, Who Says What Comes Down Must Go Up? PMC Market Commentary: September 12, 2014 Why Indie Bookstores Are on the Rise Again The Fed Is Not As Powerful As We Think PMC Market Commentary: August 22, 2014 Americans' Sour Mood on the Economy Doesn't Square with the Fact The Envestnet Edge, August 2014 Video: The World is in Crisis... the Markets are not PMC Market Commentary: August 8, 2014 PMC Market Commentary: July 25, 2014 Punitive Damages Video: Market Valuations and The Theory of Relativity The Envestnet Edge, July 2014 Don’t Kill the Export-Import Bank. Clone It. How India’s Economic Rise Could Bolster America’s Economy Video: Separating Risk from Reality PMC Market Commentary: June 27, 2014 No Sex Please, We're French PMC Market Commentary: June 13, 2014 The Envestnet Edge, June 2014 PMC Weekly Market Review, May 23, 2014 The Envestnet Edge, May 2014 Don't Bet on Rising Wages PMC Market Commentary: May 9, 2014 The Sharing Economy: Why Are So Many So Afraid? PMC Market Commentary: April 25, 2014 The Obsession with CEO Pay Won't Help the Middle Class PMC Market Commentary: April 11, 2014 Time to Face Reality: Our Unemployment Problems Are Structural PMC Market Commentary: March 28, 2014 In Defense of Relentless Optimism The "Made in China" Fallacy Forget GDP - Use Big Data