Understanding stock market panics
When the Dock Street investment team met this weekend, we quickly agreed on one thing, “We’ve seen this movie before.” A rapid and unexpected policy change, predictions of a recession, and indiscriminate selling of stocks.Â
This time it’s Trump’s confusing tariff threats. Everyone remembers the sharp Covid decline in 2020, but the current market reminds us more of 2018, when the market struggled with the same issues–Trump’s tariffs and interest rate policy. Then there was a brief panic in 2011 triggered by the loss of our country’s Triple A credit rating. Policy driven panics are not uncommon.
We are not making light of what happened last week (and may continue), but it is important for clients to recognize that the stock market is subject to these types of violent sell-offs on a fairly regular basis.Â
But why does everything go down together? The following headline from Saturday’s Financial Times answers that question:
Hedge funds hit with steepest margin calls since 2020
When speculators/short-term traders, such as hedge funds, borrow money to buy stocks they take the risk that the bank will force them to sell stock to pay back the loan. Debt forces these stock holders to sell at the worst possible time and sell an entire basket of stocks—the great companies and the rest.
Our stock portfolios are stuffed with companies that share the following important advantages:
- High profit margins—they always show profits and those profits are likely to grow
- No or low debt—these businesses are so good they don’t need debt to boost profits
- Most provide services rather than products—less likely to be subject to tariffs
Yet these companies are also being sold. Once the panic phase passes, these are the companies that will be bought back first.
In the middle of a panic, it is hard to believe that not everyone is selling. Never forget that every share that is sold in a panic is bought by someone else. The seller is emotional and participating in the panic, while the buyer is looking beyond the panic phase, betting that the end of the world will be postponed once again.
One more point that clients need to know: everyone working at Dock Street owns the same companies that you own. We eat our own cooking.
Panics always end, but no one knows when that end will come. Policy errors, like this one, can be modified or reversed. We think we see a consensus evolving on a modification this time and will give it a couple of days before commenting further. Stay tuned.Â
Best regards,
Daniel A. Ogden
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