As global stock markets continued to tumble Friday following the biggest one-day point decline on Wall Street since 2008, fears began spreading about the effect the worsening situation would have not just on the world of high finance but on ordinary investors.
We asked an investment expert to weigh in on the developments and suggest what small-time investors should be doing to protect themselves.
Eric Kirzner has written extensively about investment finance and published several books on the subject.
He holds the John H. Watson chair in value investing at the Rotman School of Management at the University of Toronto, where he teaches a number of courses, including Value Investing and Security Analysis.
CBC spoke with Kirzner on Aug. 5.
CBC: What's your take on the current economic situation?
Eric Kirzner: The problem is in Europe. I think that investors started refocusing their attention back in Europe after the U.S. debt crisis crash, at least in the short run. The sovereign debt problem in Europe is really severe, and I think this is really what it's all about.
Everybody's angry with the U.S. politicians, and so am I ... I thought they handled this really poorly, and it's really disappointing. There's a lack of leadership, and I'm not a fan of the Tea Party and all those things. But that's not really where the problem lies.
The problem lies with the so-called PIGS countries: Portugal, Italy, Greece and Spain. And now, [there are] even concerns about Belgium and maybe France.
There's the whole question of how the European community is going to handle all of this and what's going to happen with the euro and whether we're going to see a continuation and a spreading of this contagion in Europe.
How should investors ride out these turbulent times?
I've been commenting on times like this for 40 years. My advice is always aimed at retail investors because institutional investors do what they have to do.
It's always been my view that it's very dangerous to make decisions on the fly at times of extreme turmoil. You're just always going to make a mistake. So, if you panic and start selling, you may be selling into a very difficult market. Bargain hunting is also somewhat troublesome.
For most retail investors, decisions should be made when things are calm.
Investors have to constantly be making sure that the level of risk is acceptable to them. So, if they've found the last two weeks so disconcerting that they haven't been able to sleep and they're worried about paying their bills and so on, it does imply that they got too high of a risk component in their portfolio.
I want to stress that the best time to be making decisions is when things are quiet, markets are steady — when you can make unemotional decisions. You sure don't want to be trying to guess what's going to happen on a day like today or yesterday.
Should investors stay or should they go?
I would stay. That's assuming that you've got the right mix for you in the first place.
For me, the most important decision investors have to make — and they have to continuously make — is what mix of safety and income and growth bonds versus stocks, so-called macro asset allocation, their portfolio should have.
'Although it's painful, I sure wouldn't be making decisions at a time like this.' — Eric Kirzner, Rotman School of Management
Investors tend to get greedy after markets have rallied for a couple of years. We've had a pretty strong bull market in the wake of the 2008 sell-off. As a result, some investors start to have an over-allocation to equities.
So, getting the right mix is very important, and if you've got a sufficient percentage of defensive assets in your portfolio you should be able to ride out a storm like this.
The last two weeks have been horrible. But when you really look at it within the year and the last few years, what's happened in the last two weeks is we've pretty much given back all of the gains for the year, and we're still fairly nicely placed over the last couple of years.
It's a matter of perspective, and although it's painful, I sure wouldn't be making decisions at a time like this.
Are we in for another recession?
Markets are very smart. They tend to precede economic change roughly five to nine months ahead of it. This is certainly signaling that there's a slowdown ahead.
I'm not seeing that level of severity in the correction that would suggest that we're back into a significant recession.
We're already seeing slowdown numbers even though the unemployment numbers are a bit encouraging this morning. I think the markets are saying that we are looking at a slowing of economic growth, and markets may have already forecasted it.
So, you get this sort of paradoxical situation. People look at the news and say, 'Oh my God, look what's coming.' But the markets already said [that] — the markets already made the move.
It may very well be, and often is, the case that when slowdowns occur, the markets are always trying to rally back.
The positive signal out of all of this is that this probably means that interest rates are going to remain low for the foreseeable future, which will be helpful to markets. Corporate profits haven't been too bad. So, the outlook is not as gloomy as some people are suggesting.
At the same time, this European thing is very troubling. We went through the Asian crisis in 1997 and the long-term capital management meltdown in 1998. Those things were very short-lived.
This problem is not going away. Until it's solved, one way or the other, it is likely there will be pressure on markets.
What's your advice to investors for the coming months?
I don't usually like to get into market calls, but I am prepared to make one this time: I think we're actually going to see some pretty good bargain opportunities over the next few months.
'I think there already are some bargains starting to develop.' — Eric Kirzner, Rotman School of Management
I don't want to name specific stocks, but I'm certainly looking at some stocks … that have sold off significantly from their highs that are really great companies that are turning into what are called value propositions again, where it looks like you can buy a value for 75, 60 cents on the dollar.
For investors who like to pick individual stocks, I think there already are some bargains starting to develop.
For investors who tend to take a more indexed type approach, I think they're getting an opportunity to build up their portfolio over the next few months.
Those are the opportunities, but what are some of the risks of a volatile market?
Right now, there's too much risk out there to really be jumping in. There's a point again at which you start getting paid for risk.
Stocks have made such a nice move over the past couple of years that stocks have become fully priced by all of the metrics that you use for looking at pricing. They weren't grossly over priced, but they certainly were fully priced. So, you were not overly paid for taking on risk.
In light of this sell-off — and certainly if this sell-off continues — the reward for bearing risk ratio is starting to improve again.