That’s all well and good Matt, but what about the GFC then? Non-one saw that coming and look what happened! Well actually we essentially did see the real GFC coming. What we didn’t see, what you NEVER see, is the degree of the market’s reaction.
It’s important however to understand exactly what the “GFC” was – mostly because so few people actually seem to. The “GFC” was a collapse of credit markets due to the tightening of credit, essentially due to a lack of confidence between lending institutions. It was not an economic event in itself – it only amplified the economic downturn that was already underway. Ironically it will likely even ultimately be positive for many companies. In short, the “GFC” was the point where credit markets finally decided things had gone too far after years of virtually free money had drastically inflated asset prices. This “bubble” was principally in Housing Markets and the Credit markets themselves; hence we had minimal exposure in our portfolios to these sectors. It was clear to see this storm brewing and therefore we made sure we minimise our real exposure to investments which could ultimately destroy capital. What we didn’t see and why it doesn’t matter What we didn’t see is the degree to which the reversal in credit markets could translate to sell offs in all markets. As we’ve shown in previous articles, prices are driven by the volume of sells NOT the demand of Buys (as increases in sells generally prompts a decrease in buys).
Most importantly, you only lose when markets go up, NOT when markets go down.
Markets falling create opportunity, markets rising is often opportunity lost. Before we “guess” whether markets will crash, let’s first at least understand how they actually do and what really causes them. Only then can we have a half-way educated guess as to whether they will or not in response to any given “news”. How markets crash As more stock is offered for sale the price drops, however this is also often met be a decrease in buys as buyers react to an unexpected move. As a result more sales are rushed to market to “get out” and soon even those who were buyers are now beginning to sell, fearing that either a) they won’t be able to sell what they have for a profit any time soon with all this increased supply or b) they are forced to sell because they are leveraged and are in danger of defaulting.
But I’ve heard another crash is coming! Well just as someone picks the winning lotto numbers, this does happen. In fact a good friend of mine has picked at least 30 of the last 3 sharemarket crashes. If you think about it though, this can’t possibly be true. If we all know the market was going to crash next week, why would we wait until then to get out? Why not get out now?
The truth is, it’s the getting out now that actually causes the crash and whilst Traders are indeed trying to trade ahead of the market, they certainly don’t want a crash as that’s too easy to lose lots of money. What they love is volatility in a range. – Well that just doesn’t happen either and again is not even practically possible. The daily turnover in the Australian sharemarket is around $5.5Billion and sometimes exceeds $7Billion, but this only represents around 0.4% of the total market value.
In fact it’s rare for turnover to exceed 0.5% of total capitalisation on any given day. That’s hardly everyone heading for the exits; it’s simply those who supply most of this turnover (Traders) all switching to the same side of the order sheet, ie all buying or all selling. The simple fact is whatever our opinion on what the market might do, it’s just that, our opinion and doesn’t count for anything. Importantly, whatever is driving our opinion is known to everyone else so they know what we know! How is that an advantage we can profit from? It’s not and we can’t, so we don’t. The market will do what the market will do. You can’t control or influence it but the good news is, you don’t need to. In fact those don’t try on average do much better than those who do – See Dalbar study in “You lose on the way up, not the way down”.
 See “You lose on the way up, not the way down” for a more detailed analysis