How to behave in the markets during a crisis

by Lim Say Boon
04:46 AM Apr 04, 2011

The recent triple disaster in Japan - as tragic as it has been in human lives and suffering - provides a useful example to investors on how not to behave in the markets during a crisis.

One can easily sympathise with the horror of the moment for Japanese investors as they watched the north-east of the country's main island devastated by earthquake, tsunami and, subsequently, a nuclear power station malfunction. You can understand why they would dump their stock holdings. You can understand the powerful emotions driving their selling.

But thousands of kilometres away in Singapore, investors were also joining the herd, dumping not only Japanese equities but also Asia ex-Japan stocks.

Warren Buffet famously urged investors to - and I paraphrase -be fearful when others are greedy and be greedy when others are fearful.

And there was real fear in the markets in the days following March 11. But what I urged our clients to do by late Wednesday, March 16, was to start to buy on the fear - yes, even Japanese equities.

There had been massive "gap down" plunges on volumes that even exceeded that recorded at the peak of market fear in March 2009.

The market had oversold Japanese equities. You do not need complex "quant models" to work this one out. Here are the back-of-the-envelope calculations.

By March 16, the Nikkei had lost nearly a quarter of its value from its year high in February. Most of that - 22.8 per cent - was lost as a reaction to the March 11 disaster and its aftermath. How did that measure against other disasters?

Let's start with the Chernobyl disaster of April 26, 1986. The German market index, the DAX, lost 17 per cent over the next three months. That was the big one. The Three Mile Island nuclear accident in Pennsylvania, United States, in 1979 knocked only 5 per cent off the S&P500.

Then there was the Great Hanshin earthquake of Jan 17, 1995, which saw some 26 per cent wiped off the Nikkei. But that was over a period of nearly half a year.

And it was set against the backdrop of massive overvaluation of equities, with price to earnings multiples of over 50 times compared to the low teens today. There was also the collapse of Barings at the time, which could have compounded the pressures on the Nikkei.

And as we pointed out on March 14, it was important to keep an international perspective on this.

As terrible as the Hanshin earthquake was, it barely registered on international markets. Asia ex-Japan markets dipped slightly and then continued upwards until the Asian Financial Crisis of 1997.

What typically happens during a crisis is that investors usually take a day or so to absorb the horror of the situation before they panic. In this instance, it would have taken them to Tuesday, March 15. That was indeed when the selling was at its most intense - with huge losses and extraordinarily high volumes.

The market bounced back the very next day and has been gradually recovering since. There was a very similar pattern of investor behaviour on the Asia ex-Japan markets.

Fearful investors, encouraged by the talking heads on TV, were understandably concerned: "But what if the Fukushima nuclear reactors go into full meltdown as in Chernobyl? What if this damages international supply chains? What if ... what if ... "

Truth be known, nobody had the answers. And even now, nobody really has all the answers.

But history tells us again and again that points of maximum pain are often opportunities for maximum gain.

In 2001, when I was actively trading my own stock account, I found myself in a similar predicament, after Sept 11. Stocks gapped down everywhere. I gave in to fear and threw whatever I could out the proverbial window.

If I had held on another eight weeks, I would have broken even on the Dow Jones index. If I had waited four months, I would have made a profit. If I had just ignored all the noise and just held on - through the war in Iraq, through the collapse of Lehman Brothers, through the recent disasters - I would still be 22 per cent up on my Dow Jones index position. That is the power of time.

And never forget that markets are anticipatory.

Clients are usually startled when I point out to them the lowest point for the Dow Jones Industrial Average during the Second World War. That was late April 1942 - less than five months after the bombing of Pearl Harbour and two months after the fall of Singapore.



The writer is chief investment officer for DBS Bank's wealth management business.