Where Does the Money Go When the Stock Market Crashes

Where Does the Money Go When the Stock Market Crashes: Safehaven Assets

April 22, 2024

Introduction

The stock market has been a subject of fascination for centuries, with its complex mix of numbers, speculation, and human psychology. As the ancient Greek philosopher Heraclitus once said, “The only constant in life is change,” a statement that seems particularly apt for the stock market, which is constantly fluctuating. Every rise and fall, every economic tremor, has a ripple effect affecting millions of people worldwide.

But what if we told you that when the market crashes, not everything goes down? What if something goes up? According to Google Finance data, during the stock market crash in 2008, while the S&P 500 plummeted by 38.5%, gold prices rose by 5.5%. The Stoic philosopher Seneca said, ” Luck happens when preparation meets opportunity.” Savvy investors who prepared by diversifying into safe-haven assets were better positioned to weather the financial storm.

This article will explore the intriguing assets that tend to rise when the stock market falls. From the “Fear Index” VIX to the glitter of gold and precious metals, the stability of government bonds, and the essentials of consumer staples stocks – these are the life rafts that can keep your portfolio afloat during a market maelstrom. As Socrates wisely stated, “The secret of change is to focus all of your energy, not on fighting the old, but on building the new.” Understanding and investing in these safe havens is a crucial strategy for building a resilient portfolio that can withstand the disruptions of the financial markets.

Fear Index or the VIX

Strap in as we delve deeper into the world of the ‘Fear Index’ or the VIX. Born out of the need to quantify market risk and investor sentiment, the VIX is a real-time market index that gives us a 30-day forecast of expected market volatility. When we say volatility, we’re talking about the rate at which the price of an underlying security, index, or exchange-traded fund moves for a set amount of returns. It’s a bit like predicting the choppiness of the sea for an upcoming voyage.

The VIX comes to life when the market crashes. Why? Because it feeds on fear and uncertainty. Investors become nervous as the market turns turbulent, and these emotions play out, causing wild price swings. This increased volatility causes the VIX to spike.

Remember the 2008 financial crisis? The one that saw banks collapsing like a house of cards? During that period, the VIX, usually averaging around 20, skyrocketed to an all-time high of 80.86! This was a clear reflection of the extreme fear and panic among investors.

So, watch the VIX the next time the market goes into a tailspin. It’s the pulse of the market, the measure of fear, the barometer of investor sentiment. And in the chaos of a market crash, it’s one of the things that goes up.

Gold and Precious Metals

Let’s embark on an exploration of the glittering world of gold and precious metals. These shiny commodities have held sway over human civilization for millennia, not just for their beauty but for their enduring value. In times of economic turmoil, when the frantic dance of stocks becomes a disordered stumble, investors often seek solace in these timeless assets. But why?

Gold is often called a ‘haven’ in the financial world. It’s like the eye of a hurricane, calm and stable, while everything else whirls around it. When the stock market crashes, the price of gold usually soars. It’s a reflex action from investors seeking to protect their wealth from the market’s wild gyrations.

To illustrate, let’s step back in time to the 2008 financial crisis. As the financial world crumbled, gold prices climbed by approximately 24%. It was as though investors had found a lifeboat in the sinking ship of the economy.

And it’s not just gold. Other precious metals like silver and platinum often follow similar trends. They become the glimmer of light in the dark abyss of a crashing market.

So, the next time the market faces a downturn, remember this golden rule: When stocks fall, precious metals often rise. They can provide a much-needed anchor in the stormy seas of financial turbulence.

Government Bonds

Welcome to the world of government bonds, the quiet stalwarts of the financial market. In essence, a government bond is a loan you give to the government. In return, they promise to repay you with interest over a certain period. These bonds, particularly those issued by economically strong nations, are seen as dependable pillars in an investor’s portfolio. But why do these bonds gain prominence during a market crash? Let’s delve deeper.

In times of economic uncertainty, when the stock market is in a free fall, investors look for safer places to park their money. This is where government bonds come into play. They are considered safe because they are backed by the full faith and credit of the government that issues them. It’s like lending money to a trustworthy friend who always pays back; in this case, the friend is the government.

Investors often flock to these ‘haven’ investments during a market crash. This increased demand pushes up the prices of these bonds. A clear example of this was during the 2008 financial crisis. The 10-year US Treasury notes yield, a bellwether for other interest rates, fell from 4.02% to 2.08%. Bond prices and yields move in opposite directions, so a declining yield indicates rising prices.

But it’s not just about safety. Investing in government bonds is also about strategy. Bonds might seem like an unexciting cousin when the stock market is booming, but when the market crashes, they can be the lifeboat that keeps your portfolio from sinking.

Moreover, government bonds provide regular income through their interest payments. This consistent cash flow can be a boon during market downturns when other investments might be underperforming.

Bonds from the United States do not surge during market crashes alone. Bonds from other economically strong countries, such as Germany, Japan, and Canada, also tend to perform well. These countries have robust economies, and their governments have a solid track record of honouring their debt obligations.

Government bonds are like the tortoise in the age-old fable of ‘The Tortoise and the Hare’. They might not give you quick returns like stocks (the hare) in a booming market, but they provide steady, reliable returns over the long term. And during a market crash, they can even outpace their hare-like counterparts. So, when the stock market tumbles, these bonds often rise, providing a silver lining in an otherwise gloomy market.

Consumer Staples Stocks

Let us now step into the everyday world of Consumer Staples Stocks. These companies produce the goods we rely on daily—the milk in our morning coffee, the soap we wash our hands with, and the toothpaste that freshens our breath. We can’t do these items without them, no matter how the economy is doing. And it’s this indispensability that makes consumer staples stocks a beacon of stability during a stock market crash.

When economic turbulence hits, discretionary spending – on non-essentials like luxury goods, eating out, and travel – usually takes a hit as people tighten their belts. However, the demand for consumer staples remains relatively unchanged. After all, we still need to eat, clean, and care for our health.

This consistent demand translates into stable revenues for companies in the consumer staples sector, like Procter & Gamble or Coca-Cola. These companies often see their stock prices remain steady or even increase during turbulent times. They become the rock in the stormy sea of a bear market.

But it’s not just about stability. Consumer staples stocks are also often dividend-paying stocks. This means they distribute a portion of their earnings back to their shareholders. These regular payouts can provide a steady income stream for investors, handsome when other investments are faltering.

Furthermore, companies in this sector are often large, well-established firms with strong market presence and robust supply chains. They are better equipped to weather economic downturns than smaller, less diversified companies.

Take Procter & Gamble, for instance. This multinational giant has a diverse portfolio of brands across various categories, from healthcare to home care. This diversification can help cushion the impact of a market downturn.

Or consider Coca-Cola, a company whose products are sold in over 200 countries. Despite economic downturns, the demand for its beverages remains relatively stable, helping to shield its stock from market volatility.

Cryptocurrencies

Let’s explore the world of cryptocurrencies, the digital disruptors of the financial world. These digital assets, secured by cryptography, have been making waves in the economic landscape since the introduction of Bitcoin in 2009. They promise to streamline financial transactions, making them faster, cheaper, and independent of traditional banking institutions.

Cryptocurrencies have shown remarkable resilience during market downturns. A prime example was during the stock market crash in March 2020, triggered by the Covid-19 pandemic. The most popular and valuable cryptocurrency, Bitcoin, rebounded faster than the stock market. This resilience has led some investors to view cryptocurrencies as a potential hedge against market volatility.

However, it’s important to note that cryptocurrencies are still highly volatile and speculative assets. Their value can fluctuate wildly, often within short periods. This volatility can be attributed to various factors, including regulatory news, market sentiment, technological advancements, and macroeconomic trends.

Despite this volatility, cryptocurrencies have gained a significant following. Bitcoin remains the dominant player, but thousands of other cryptocurrencies, often referred to as ‘altcoins’, each with unique features and uses. For instance, Ethereum, the second most popular cryptocurrency, introduced the concept of ‘smart contracts’, allowing decentralized applications to run on its blockchain.

Investing in cryptocurrencies can be a high-risk, high-reward game. While they have the potential for substantial returns, the risk of loss is equally significant. Therefore, it’s crucial to understand the risks involved and invest responsibly.

Moreover, the regulatory landscape for cryptocurrencies is still evolving. Countries have different regulations, which can significantly impact cryptocurrencies’ value and acceptance.

Cryptocurrencies have emerged as a new asset class that can offer significant returns during market downturns. However, their high volatility and speculative nature mean they should be cautiously approached. As with any investment, it’s crucial to research and understand what you’re investing in before jumping in.

Conclusion

From a contrarian perspective, these trends make sense. As the masses panic and sell their stocks, the savvy investor looks for opportunities in the chaos. They understand that fear and uncertainty drive market crashes, but they also drive up the value of certain assets.

Understanding these trends and their psychology can help you navigate the stormy seas of market crashes. It’s not about profiting from others’ fear but understanding the market’s rhythms and making informed decisions. It’s about understanding that not everything goes down, even in the throes of a crash. Some go up.

However, it’s crucial to remember that all investments carry risk, and past performance does not indicate future results. What goes up can also come down. Always consult with a financial advisor before making investment decisions.

A stock market crash isn’t the end of the world. It’s a shift in the market’s psychology, a change in the wind. And for the informed investor, it could be an opportunity to sail against the wind and find safe harbours in the storm.