Guest Author - Guido Deboeck

On October 19th, 1987 I remember I was in the trading room of the World Bank. During that day I observed some unusual activity but did not get around to realize what was happening.

I had joined the Investment Department of the World Bank only a few months earlier --just before a major reorganization that reshuffled just about “all chairs on the Titanic”—and my responsibilities were not trading but manage technology, i.e. to make sure all technology was working. The technology of any trading floor is fairly complex: it includes a telephone system with hundreds of direct lines to other traders around the world, Bloomberg data terminals, Reuters workstations, plenty of PC’s and printers, TV screens, satellite data connections and the like.

The President of the World Bank had come down on that Monday in October to visit the trading floor, obviously not a coincidence.

The next morning at the daily 8 am “strategy meeting” of the traders, the exchanges made me realize what had happened: the stock market had collapsed by the biggest one day drop ever, the bond markets and the currency markets were hot. The Chief trader decided to flip strategy on the bond market and subsequently made millions (which less than a year later caused a major walk-out of traders because of a dispute about bonuses).

Later in October 1987 I realized the devastating impact of a 23% drop in the stock market on my own portfolio; I recall that for the rest of October I did not sleep much…Research later showed that the interconnectivity between markets in Tokyo, London, and New York contributed a great deal to a wave of declines surrounding the world.

Fast forward to May 2006. From May 5th till May 19th, the S&P500 dropped from 1325 to 1267, a 4.5% decline; the NASDAQ dropped from 2342 to 2193, a 6.7% decline. Using ETF as proxies for various regions/countries in the world, let’s see what the rest of the world did in the same two weeks in May:
- IEV (Europe) : minus 6.5%
- ITF (Japan) : minus 5.5%
- EEM (Emerging Markets) : minus 11.3%
- RNE (Eastern Europe) : minus 26.1%
- ILF (Latin America) : minus 13.6%
- FXI (China) : minus 5%
- IFN (India) : minus 20%

If you were holding a portfolio that is geographically diversified in equities you could still have been affected by a broad 5-10% decline in value. In short, all what you worked for in the first four months of the year could be wiped out in just two weeks. What does this tell you about all that good advice about being broadly diversified?

This is why it so crucial that you learn to read the changes in market direction and that you take action when the markets do change. The Big Picture in IBD can help, but as I wrote earlier, you need to make your own judgments as to when to bail out. The only way to prevent loosing the gains you made so far this year, was to move into cash in early May and wait until the market signals another change in direction.