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Why This Sign of Stock-Market Panic Is Good News For You

By Dan Caplinger - Feb 7, 2014 at 10:00AM

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Today's employment report could continue the exodus from stocks, but smart investors are getting their shopping lists ready.

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Earlier this morning, the Dow Jones Industrials (^DJI 0.39%) posted sharp gains, essentially ignoring worse than expected numbers on the U.S. employment situation and instead hoping that January's poor economic data were the product of one-time factors like extraordinarily cold weather. Yet by 11 a.m. EST, the Dow had trimmed its gains to just 48 points, and reports from Merrill Lynch and Citi Research point to a near-panic that many investors are falling prey to in light of the blue-chip index's poor performance so far in 2014.

How investors are panicking
The reports show that during the week that ended Wednesday, investors pulled out $28.3 billion from stock mutual funds and exchange-traded funds. Of those outflows, $24 billion came from U.S.-focused stock funds, reflecting the huge change in sentiment since 2014 began, and one source cited a $7.6 billion outflow from the SPDR S&P 500 ETF (SPY 0.25%) alone. Exchange-traded funds have made it far easier for investors to make panic-driven moves, with Citi saying that about 95% of the outflow amounts came from ETFs rather than traditional mutual funds.

At the same time, investors took much of that money and invested it in bond funds. Figures from the reports put net bond inflows at almost $15 billion, with investors putting nearly 90% of that money into Treasury bond funds while avoiding poorer performers like high-yield bond funds.

Why it's good news for you
For years, many stock investors have been waiting for downward-moving prices in order to get back into the stock market. Yet for years, the stock market has defied those wishes, moving inexorably higher with only brief breaks in the general uptrend. The experience of those investors has confirmed the futility of trying to time the market, as those who've made regular contributions even as prices have risen fared much better than those who hoped in vain for corrections.

Now that the market downturn has happened, though, many investors have forgotten their conviction that they would buy on weakness. Instead, they've naturally turned to the perceived safety of iShares TIPS Bond (TIP 0.01%), iShares 20+Year Treasury (TLT 0.23%), and other Treasury-focused ETFs that promise the full faith and credit of the U.S. backing their holdings.

The forgetfulness of most investors gives you and other smart investors an advantage. By sticking to your long-term strategy, you can exploit investor panic to pick up the stocks you want at lower prices. In fact, if you have more money to invest in the market, you should want stocks to fall more dramatically in order to take greater advantage of the panic before it inevitably turns back toward euphoria.

There's no guarantee that the Dow won't keep falling well into 2014, and those who buy now could end up with sizable losses before the tide turns. In the long run, though, panic-selling at the first sign of danger could well be far more costly than riding out a correction.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$33,892.31 (0.39%) $131.26
SPDR S&P 500 ETF Trust Stock Quote
SPDR S&P 500 ETF Trust
SPY
$428.17 (0.25%) $1.07
iShares Trust - iShares TIPS Bond ETF Stock Quote
iShares Trust - iShares TIPS Bond ETF
TIP
$115.50 (0.01%) $0.01
iShares Trust - iShares 20+ Year Treasury Bond ETF Stock Quote
iShares Trust - iShares 20+ Year Treasury Bond ETF
TLT
$115.82 (0.23%) $0.27

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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