Zweig: We Can Control How We React to Market Panics

Market panics are “forces than can be hidden or delayed but never eliminated,” writes Wall Street Journal columnist Jason Zweig.

“The modern history of financial markets is a chronicle of attempts to control risk—if not eliminate it,” Zweig writes, adding, “One after another, they have all failed.”

Zweig cites a number of historical events that were intended to mitigate market risk, including the creation of the Federal Reserve “in the wake of the Panic of 1907,” the development of a “portfolio insurance” computerized hedging technique in the mid-1980s and the emergence of derivatives in the mid-2000s.

“But risk can’t be removed,”  Zweig argues, “it can only be moved,” asserting that derivatives “may have caused the financial crisis of 2008-09 by making bankers and investors so complacent that they never sufficiently tested whether their assumptions might be wrong.”

Zweig suggests that our forebears may have possessed a wiser view of the markets, embracing their vulnerability to emotion and volatility and assuming that “financial panics were a form of divine retribution for the sinful excesses of prosperity.” He argues that such panics, “through the ensuing upheaval, fertilize old ground for new competitors and transfer assets to those who can put them to their best use,” citing the tech bubble in 2000-02 that triggered a glut of fiber-optic networks that “make instant communication universal and cheap as dirt today.”

The article concludes with a list of questions investors might ask themselves:

  • Have I been taking more risk than I realize?
  • Conversely, how should I turn panic into opportunity?
  • How can I improve my portfolio and restore a sense of control?
  • Should I sell some stocks or funds to generate a tax loss I can use to offset gains or income?
  • Do I have long-held mediocre or risky stock positions I’ve been reluctant to jump until now because that would generate a taxable gain I’d no longer incur at today’s prices?

“Investors should never stop trying to manage their risks,” Zweig writes. “But they should never believe that they, or anyone else, can eliminate them.”