Panic has hit Wall Street, or so the headlines would make it appear.
Yesterday, May 17, the iconic Dow Jones Industrial Average (^DJI +0.01%) "plunged" 373 points and wiped out more than three weeks' worth of progress in the index. It was the biggest move lower that Wall Street had seen in the Dow in quite some time.
Image source: Getty Images.
The reason for the move lower appears to be worries over President Trump and his ability to lead the nation. In particular, The New York Times reports that former FBI Director James Comey put together a memo outlining President Trump's request to drop his investigation into former national security advisor Michael Flynn. Since the stock market very much dislikes uncertainty, rumors of possible wrongdoing from the President has investors unnerved.
Here's just a sampling of what investors saw in yesterday's news headlines:
- Dow Plunges 350 as Trump Worries Rattle Wall Street -- NBC Boston
- Look Out! Dow Drops 250 Points; VIX Spikes 28% -- Barron's
- Banks Battered As Dow Crashes Through Key Technical Support -- ZeroHedge
- Wall Street Tumbles As Investors Flee Latest Trump Crisis -- Reuters
You'd think it was utter chaos and an absolute bloodbath on Wall Street based on these sensationalist headlines. Yet, in spite of what turned out to be the Dow's biggest move in eight months, the 373-point "plunge" in the Dow worked out to a decline of (*drumroll*)... a pedestrian 1.77%.
Cue the laughter.
Everything is relative
Throughout its storied history, I'd be willing to bet that the Dow has seen hundreds, if not thousands, of days where it moved up or down around 2%. What's changed over time is that the Dow's intrinsic value has increased. In other words, the Dow has gone from less than 2,000 points to more than 21,000 points in just 30 years. Unfortunately, investors haven't adjusted how they view the Dow's daily moves in percentage terms despite the underlying growth in the valuation of its 30 components over the years. What we're left with is sensationalist headlines and fear seemingly every time the Dow moves 200 or 300 points lower when, in reality, it's nothing more than a pedestrian and forgettable move, based on its history.
Data source: Wikipedia, The Wall Street Journal, Dow Jones. Table by author.
For example, just to register among the Dow's 20 largest daily point losses of all-time, the Dow would need to drop about 470 points. Today, that works out to a drop of about 2.2%. Again, that would be a very pedestrian single-day move in percentage terms, but the news outlets would lead you to believe the Dow "plunged."
In order for the Dow to really "plunge" (and to be fair, there is no concrete definition of what qualifies as a plunge, meaning I'm being arbitrary) it would have to register a 7% move lower to break into the 20 largest daily percentage losses of all-time. In other words, we'd need to see a drop of almost 1,470 points in a single day based on the closing value of the Dow on May 16 just to rank 20th all-time in terms of percentage drops. Yesterday's move lower on Trump worries wasn't even in the ballpark of cracking the top 20 largest percentage declines in the Dow.
History suggests you're smart to buy high-quality companies when they drop
So, what should you do, if anything, given that the Dow "plunged" 373 points yesterday? History suggests that buying high-quality stocks that dropped in value probably isn't a bad idea.
Last year, J.P. Morgan Asset Management put out a report, "Staying Invested During Volatile Markets," which looked at the performance of long-term investments in the broad-based S&P 500 (^GSPC +0.60%) between Jan. 3, 1995 and Dec. 31, 2014. What the analysis showed was that investors who held throughout the full 20-year period earned 555%, or 9.9% per year. Mind you, this includes investors having held throughout the dot-com bubble and the Great Recession. Both events led to a peak decline in the S&P 500 of 50% and 57%, respectively.
Image source: Getty Images.
Conversely, missing just the 10 best days the S&P 500 had over a more than 5,000-day period would have more than halved investors' returns. Since no one can effectively "time the market" over the long-run, the lesson is that investors should stay the course in high-quality stocks since they tend to increase in value over time.
It's also never a bad idea to consider revisiting the investment thesis for every stock you own, albeit you don't have to wait for a perceived "plunge" to do so. Your investment thesis describes your reasoning for buying into a company in the first place. If that reasoning hasn't changed (and chances are a sizable point drop in the Dow isn't going to change your investment thesis), then there's no reason to panic and sell your stock(s).
If you approach investing with a long-term mindset (which history shows is your best path to generate healthy returns), you'll not only sleep better and earn more, but you'll get a good chuckle at sensationalist headlines in the process.
