The Sky is Falling! Preparing for the Stock Market Crash of 2015

So Foxy Loxy led Chicken Little, Henny Penny, Ducky Lucky, Goosey Loosey, and Turkey Lurkey across a field and through the woods. He led them straight to his den, and they never saw the king to tell him that the sky is falling.

Panic is gripping the market, and frankly, I couldn’t be much happier.

In fact, it’s making me kind of hungry.

Like Foxy Loxy in the classic folk tale “Chicken Little,” I’m prepping the table to take advantage of the kind of mass hysteria that hits when people (or personified ducks and turkeys) start falsely proclaiming that the sky is falling down.

It’s not that my standing portfolio isn’t getting hammered along with everyone else’s (much of it is) but that the extra cash I’ve been patiently waiting to dump into the market following a major sell-off may finally be able to be put to good use.

I also find plenty of solace in the fact that the companies I own aren’t going anywhere anytime soon. I know quite well the sky isn’t actually falling and that, despite any level of panic, the sun will still be shining brightly five, 10, 20 years from today…

Storms Always Pass

Perhaps more than any aspect of the market, I find the psychological component of panic to be incredibly intriguing. Behavioral finance has always been an interest of mine, and while I’m certainly not a doctor, I’ve spent enough time studying the subject to offer the occasional insight.

Part of the reason I’ve chosen to allude to “Chicken Little” today is the fact that we often forget we humans are ultimately just animals, too. Yes, it’s certainly true our brain power is a step above the intellectual prowess of Ducky Lucky, but surprisingly not by much: We abide by irrational herd behavior just like virtually every other species out there.

John Maynard Keynes was one of the first behavioral economists to point out this idea that consumer decisions are animal-like and not always rational. In his 1936 publication, “The General Theory of Employment, Interest and Money,” he used the term “animal spirits” to describe the underlying human emotions that drive market confidence and direction.

Prior to Keynes, most economic theories simply ignored the effect of emotions on the market, but the subject has since received an increasing amount of investor attention and acceptance. For one, most people know good and well by now that greed and fear are ultimately what make bubbles form and burst.

Bernard Baruch was another early behavioral economist to draw a comparison between the market and animalistic human behavior, having argued:

All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking… our theories of economics leave much to be desired. It has always seemed to me that the periodic madnesses which afflict mankind must reflect some deeply rooted trait in human nature — a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea. It is a force wholly impalpable… yet, knowledge of it is necessary to right judgments on passing events.

Now, of particular interest here is the idea that these massive waves of human emotion are an inherent part of our being, ultimately resulting in economic patterns destined to repeat themselves. As Bob Prechter once keenly stated: “As I see it, markets are people, and people never change.”

The Fox’s Den

If there’s any truth to this idea that herd mentality doesn’t change, recent price action and media coverage doesn’t bode particularly well for the market in the coming months.

With #BlackMonday now the number one trend on Twitter and headlines reading “The Stock Market Crash Of 2015 Is Just Getting Started,” we’re beginning to see the emotional element of fear take over rational thought.

If we’re to take it seriously that boom and busts are an inevitable result of human nature, we should also take it seriously that yesterday was just the beginning of our classic folk tale: Chicken Little has scared the hell out of Henny Penny, and the two are about to lead everyone else to the fox’s den.

The trick, of course, is making sure you don’t react like a sheep — or bird, if we’re sticking with the analogy here — in times of crisis like this. You need to keep in mind that successful investment strategies are rarely popular ones: Just think, for instance, of how trendy Internet stocks were in 2000, or how unpopular equity was in 2009.

Judging by yesterday’s events, it’s likely panic will only continue to grow. Investors will start to see nothing but red on their screens, and selling stocks will become the popular trend.

But selling straight into market crash is very rarely a good idea, and I would warn you not to let your “animal spirits” cloud your decision making in times of panic.

Believe it or not, perhaps the most profitable action to take in response to a market crash is to buy equity methodically. Trust that the market will eventually go back up — as it always has — and continuously average down on companies you know will weather the storm.

More than anything, you want to scoop up companies in segments that have already crashed. Stocks that have already sold off tend to outperform the broader market during times of crisis due to the fact that they can’t go much lower than they already have.

As I write, the recently bearish chip sector is already shaping up to be a prime example of this kind of safe haven. Below is a map of the technology sector from yesterday’s trading session:

The reason that southeast corner there is mostly green is because it’s composed primarily of semiconductor stocks that have already taken a beating this year.

The average earnings multiple for Semiconductor Memory right now is just 4.76. With the broader market having much more room left to fall, semiconductors and similarly beaten-down industries will likely prove a place of relative safety in the months ahead.

Conversely, the industries you’ll want to avoid most are those with overly ambitious earnings multiples. Health Information Services, Software Application, and Scientific and Technical Instruments are all looking a bit too beefy for my liking right now.

If the market does continue to plummet, be prepared: You’re bound to hear a whole lot of doom and gloom over the course of the crash. You’ll be told to load up on silver, gold, and maybe even MREs, but believe me when I say you want to scoop up companies, not commodities, in the event of a major sell-off.

Until next time,

Jason Stutman

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