This week’s market storm was the one everybody saw coming but nobody expected.
On Monday, the S&P 500 slipped 1.7%, its biggest drop in two months. It was a rough day, yet it could’ve been much worse. At the end of the day, the index closed just 4% from a record high, a tame outcome given the palpable anxiety in the market. And after two days of big gains, the S&P 500 has found itself back within striking distance of a record high.
What was supposed to be a bang was more of a whimper. Over the past few weeks, investors have quickly switched from offense to defense, so many portfolios were prepared for a sell-off. After all, it’s hard to disappoint a market that’s bracing for a meltdown.
Investors are watching a lot of headlines these days, but the biggest market driver could be fear.
And that’s not necessarily a bad thing.
A Note on Fear
We’ve talked before about how too much optimism can be dangerous for the market. Now, we’re dealing with the opposite scenario. Caution is back in style with political issues looming on the horizon and the Federal Reserve preparing to pull back on its historic support.
Defensive stocks have slowly caught up to cyclical stocks. The VIX “fear index” has crept up since the middle of August. Last week, the number of investors pessimistic on the market’s prospects rose to the highest level in 11 months, according to the American Association of Individual Investors.
While fear can feel ominous, a healthy dose of skepticism can be constructive. Cautious investors tend to pay more attention to risks and hedge their portfolios, which makes them less likely to sell in times of crisis. Fear can also lead to more cash on the sidelines that could flow back into the market if prices fall. Typically, the worst sell-offs occur when the market is underestimating risks, not overestimating them.
That doesn’t mean stocks are out of the woods yet, though. The market’s mood changes quickly these days, and pullbacks can happen even in healthy markets and strong economies. Plus, swings can naturally lead to more swings up or down. Since 1950, the S&P 500 has dropped 1% or more in a day an average of 25 times per year. In about 75% of those cases, the S&P 500 has dropped 1% or more another time in the following two weeks. For reference, the average daily move in the S&P 500 this year has been about 0.1%.
Battle-proofing Your Portfolio
The crowd was prepared for Monday’s sell-off. But were you?
If you weren’t, that’s OK! It’s never too late to battle-proof your portfolio, and we’ve got a few ideas for you.
When you buy a stock or security, have an exit plan in mind. It’ll keep you from selling pre-maturely just because the market is dropping. Also, consider setting limit orders or using options to ensure you hit these targets without having to follow the market too closely.
The strongest portfolios have a good balance between aggressive and conservative assets. Stocks have done well this year, so it might be worth re-balancing, or double-checking to make sure your portfolio isn’t too heavily weighted to one asset class.
Sometimes, the best protection for stocks may not be other stocks. Several asset classes tend to move in the opposite direction of stocks, such as bonds, gold and alternative assets.
Cash gets a bad rap these days. Inflation is high, so it’s understandable. But a small stash of cash could be one of your most stable holdings during a market breakdown. Cash is also one of the quickest ways to pick up stocks on sale during a pullback.
If you’re going on defense, why not pick a stock that’s known to act defensively? Sectors like utilities, health care and consumer staples tend to hold up better in sell-offs because of their stability. In Monday’s sell-off, utilities only fell 0.2%. Defensive stocks are more likely to offer dividends as well, and dividends can be a good source of income when stocks are falling.
The Bottom Line
Fear is back in style, and in a roundabout way, that can help keep the market afloat. Still, we wouldn’t be surprised to see more bumps this fall, even if a bigger sell-off proves to be elusive.
As you navigate the ups and downs, remember to keep your feelings in check. Too much fear can hold you back from your goals, but a little bit of skepticism could keep your risk-taking at bay.
Anxious about the future? Don’t worry – Lindsey will be releasing her Q4 2021 market outlook on September 28. Because of that, we won’t be publishing a Weekly Viewpoint on October 1.
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Callie Cox, senior investment strategist, contributed to this article.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.