I remember days like this when I was a hedge fund analyst.
They started like most other ones: leaving way too little time to reach the train and then arriving at my desk with a cup of slightly acrid street coffee, black. Then there were news releases and analyst notes to review, followed by a conversation with a portfolio manager and a trader about what was going on. All of this before getting into the meat of the day's meetings or calls.
At some point, someone would point out the market was down over 2%. That seemed to be the trigger to start paying closer attention. That is when you just start to watch. Then you check your PnL-Wall Street speak for profit & loss-and try to absorb the magnitude of the losses (or gains, if you started the day particularly pessimistic).
Then you check your benchmark. If you can't win an absolute profit game, then maybe you can win a relative one. At this point, the clichés kick in: "don't catch a falling knife"; "buy when there is blood in the streets"; "obey the rule of three" (wait for a few days and let the situation start to settle); "stocks are now on sale"; and perhaps the most hated comment of all, some form of "I told you so."
Reacting appropriately to these events, in my experience, is more art than science. Aggression is rewarded sometimes; caution is rewarded at others. One thing that I believe is universally important is you must know your client.
That means if you are at a market-neutral hedge fund, you better not pile up big losses. That is when a bad day becomes an existential risk. The worst thing you can do in that scenario is double down on a mistaken bet.
That goes for the individual investor, too. If you are your own client, investing your own money, you better know yourself. If you needed that money within a few years, then you may be guilty of the same crime the market-neutral hedge fund made-trying to get rich quick outside of your mandate.
The Dow Jones Industrial Average finished down 3.1%, in the top 1% of bad days, but not even close to the worst days ever. The Dow lost 22.6% in a single day in October 1987 thanks to portfolio insurance; it lost 20.5% in December 1914, in what was probably World War I-related; it lost 13.5% in October 1929 on the eve of the Great Depression; it lost 10.7% in March 1907 when the collapse of the Knickerbocker Trust triggered a bank run in a pre-Federal Reserve world; and it lost 7.7% in December 2008 during the Great Recession.
This year has already seen Dow declines of 1175, 1032, and now 832 points. At some point in the distant future, we might blame today's spiral on the end of the 30-year bull market in bonds.
Al Root was previously a manager at London-based Altima Partners, among other hedge funds.
Write to Al Root at firstname.lastname@example.org