Swedroe: Don’t Join The China Panic

August 26, 2015

It’s not as if investors didn’t already have enough to worry about with the Greek crisis, Puerto Rico’s default, the Iranian nuclear agreement, ISIS, the Fed ending its zero-interest-rate policy in the near future, and gurus such as GMO’s Jeremy Grantham proclaiming that the market is vastly overvalued based on the Shiller CAPE 10 ratio. But we now have alarm bells going off from the world’s second-largest economy, China, where slower economic growth is expected.

Concern over slower growth in China has led to sharp sell-offs in many emerging market countries. Those concerns spilled over to the markets of developed economies last week. After closing at 2,012 on Monday, Aug. 17, the S&P 500 fell 0.5 percent on Tuesday, another 0.8 percent on Wednesday, 2.1 percent on Thursday, and 3.2 percent on Friday.

That’s a total loss of roughly 5.3 percent in those last two days, and a total loss of 6.3 percent in four days. That made it the worst weekly loss since 2011. Further, the drop of almost 4 percent for the S&P 500 on Monday, Aug. 24 increased the total loss over five days to 9.4 percent. That’s certainly enough to scare many investors.

While there surely is risk that the markets will fall much further, the prudent strategy is to stick with your well-thought-out plan, one that has already anticipated events like those of the past few days because they have happened many times before.

Consider the evidence from a study by Benoit Mandelbrot and Richard Hudson, which found that the stock market exhibits far more extreme events than would be expected if returns are normally distributed like we see in the famous bell curve.

We can also see evidence of this in how investment returns are not earned smoothly. While the S&P 500’s average annual return has been 12 percent, you can see from the charts below that there are very few years with returns close to the average.

The lesson here is that it would have been virtually impossible to earn those long-term returns of just over 10 percent per annum without having the discipline to be present all the time.

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