How to Keep Your Cool During a Market Panic

And Profit! . . . while everyone else is losing their shirts

The “Toilet Paper Panic”—a fascinating “panic in a nutshell”—began in Hong Kong in early February 2020 with the fear that the effect of the coronavirus on China’s economy would disrupt the local supply of toilet paper. Within days, toilet paper had disappeared from the shelves of Hong Kong supermarkets, and panic buying began to spread around the world.

China is the world’s largest exporter of toilet paper, accounting for around 12% of the global export market. But a much lower percentage of total world production. Some shipments of toilet paper to the Hong Kong market were delayed thanks to the combination of China’s extended Lunar New Year holiday, roadblocks to prevent carriers travelling, and the shut down of many Chinese businesses thanks to the coronavirus.

In reality, there was no more than a possible temporary interruption in supply to the Hong Kong market—given no change in demand.

Nevertheless, pictures of Hong Kong’s empty supermarket shelves went viral and the fear that the shortage would spread led to panic buying all around the world. Even though a total interruption of Chinese exports would cause a mere 1.34%^[1] reduction in the whole world’s supply of toilet paper.

“No Supply Shortages”?

In an interview with Hong Kong’s South China Morning Post, Johann Christoph Michalski, CEO of Vinda International Holdings Limited, a major supplier of toilet paper to the Hong Kong market, said:

So the panic buying in Hong Kong and elsewhere was an overreaction to the reality of supply.

Or was it?

When rumors began people did not stop to investigate the real supply situation. Indeed, most people don’t have ready access to such information.

Simpler to do what most people did: just to go down to the supermarket and stock up. Worst case: if there was no toilet paper shortage after all, you’d just end up with a month or so’s supply in your cupboard.

So what might have been a temporary shortage became a prolonged one, as supply could no longer keep up with demand.

The same behavior spread around the world, even when domestic manufacturers supplied the overwhelming majority of the market. Which is logical when you realize that the transportation costs of a bulky, low-value product like toilet paper, give domestic manufacturers a financial edge over imports.

But China is such a large supplier of just about everything to the world that few people stopped to compare the economic difference between shipping $1,000 iPhones across the Pacific versus $5 packs of toilet paper.

So once the shortage appeared it was, once again, entirely rational for the average consumer to stock up.

Such panic buying is disruptive in more ways than one. For example, while sales of toilet paper zoomed up, you don’t use more toilet paper than usual just because you have a cupboard full. So future demand was moved to the present. Meaning that in the future sales will decline until the normal balance is restored.

Manufacturers reacted by ramping up production to meet the spike in sales. For example, in Australia Kleenex and Sorbent moved to round-the-clock production^[3], while the country’s third major brand, Quilton, tripled output. But they could only do that by paying overtime, and hiring additional workers at night-shift rates. In other words: by increasing their costs of production.

When the supply of wheat, rice, or soybeans drops from a drought or similar cause, the price rises. Had the price of toilet paper doubled or tripled that would have cut the panic short. But that so-called “price-gouging” didn’t happen with toilet paper, so manufacturers were not being rewarded for their actions in increasing supply (except in Canada, where there are no laws against “price-gouging”).

And when such a panic dies demand falls until people have used up their excess purchases. So the companies that make toilet paper will see an overall decline in profits: higher costs during the panic; lower profits afterwards until normalcy is restored.

Rational and Irrational Behaviors

While it may be rational for the average consumer to rush down the supermarket and stock up on toilet paper—so generating a shortage at the retail end of the supply chain—a panic also results in irrational behaviors.

For example, in the stock market, the panic resulted in a buying splurge in the shares of Vinda International Holdings Limited (3331.HK), which rose 51.9% in value from January to its year-to-date peak on March 5. Even though the panic would reduce the company’s profits from toilet paper sales. And, in any case, Vinda produces so many other products that toilet paper revenues are a small percentage of its total sales.

But there’s always a dark side to a panic: it generates fear.

In one Facebook post I saw a woman reported that as she was unloading her supermarket trolley in the parking lot, somebody ran past, grabbed her toilet rolls and ran off with them. While in Sydney two women fought violently over a shopping cart full of toilet paper and were both charged by the police.^[4]

And sometimes fear leads to absurdity: as in the case of an elderly woman I heard about who had filled one of her spare bedrooms with toilet paper. Enough to last way past her remaining life expectancy!

While coronavirus-inspired panic buying has expanded to many other products, from wet wipes, hand sanitizer, rubbing alcohol, face masks, to pasta, rice, frozen foods, and more, the latest ones being beer, wine, spirits, plus (according to my wife) hair coloring products and nail polish remover (go figure!)—and in the Netherlands, even marijuana!^[5]

How to Stop a Panic

There are two ways to stop such a panic.

The first is to let the free market handle it. Had that happened in Hong Kong, the supermarket price of toilet paper would have skyrocketed, panic buying would have been nipped in the bud, and within a couple of weeks, if not less, the shelves would have been fully stocked again as Chinese manufacturers rushed supplies across the border to profit from the higher prices—so restoring normal supply and sending prices back down.

And, quite likely, the panic would not have spread around the world.

But the free market solution of letting supply and demand iron out the temporary shortage was universally scorned as “price gouging.”

So the “solution” was rationing. A “solution” that merely extended the life of the panic by encouraging people to shop early before supermarkets ran out. As I discovered once when I went to Aldi just ten minutes past opening time, only to see a few packets of toilet paper in other shoppers’ trolleys at the checkout line—and none on the shelves.

Panic buying is not necessarily irrational. But its effect can be to multiply the consequences of a problem.

Currency Panics

For example, on Friday September 23rd, 1983, the latest round of Sino-British talks in Peking on the subject of Hong Kong’s future after 1997 concluded. The announcements that were were no announcements (meaning: no progress) sparked a run on the Hong Kong dollar. The currency, which had slipped from HK$7.56 to the US dollar at the beginning of the month, ended Friday’s trading at HK$8.83.

On Saturday morning the panic developed with the currency being quoted between HK$9.00 and HK$10.00 per US dollar, depending on where you went. By mid-morning however, most banks and currency dealers had run out of US dollars and there were enormous lines at the major gold dealers’ windows as the people of Hong Kong rushed to convert their Hong Kong money into real assets.

The panic continued over the weekend and by Sunday afternoon all stores had been cleaned out of rice and cooking oil, and in most supermarkets there were enormous gaps on the shelves as people stocked up on storable goods in anticipation of higher prices the following week.

The panic ended on Saturday, October 15th, when Hong Kong’s financial secretary announced a stabilization package which effectively pegged the exchange rate of the Hong Kong dollar to HK$7.80 per US dollar.Similar panic buying sprees are caused by rising inflation, especially when it develops into hyperinflation. After World War I, the German mark collapsed from 160 per US dollar in early 1922 to 4,200,000,000,000 marks per US dollar in November 1923. On a daily basis, Germans shopped with wheelbarrows full of almost worthless paper marks to turn them into real goods knowing that tomorrow they would be worth nothing at all instead of next to nothing. More recently, similar hyperinflations in Venezuela and Zimbabwe resulted in the same consequence of shoppers faced with almost empty shelves.^[6]

Although the result of such hyperinflations is a dramatic increase in demand for real goods, it’s more accurate to describe consumers’ behavior as the opposite: panic selling. Their aim being to get rid of the declining asset as fast as possible.

Either way, the result is what economists call an increase in “the velocity of money.” Which is an inverse way of describing a decline in demand for money, which by increasing the demand for real goods adds to the rate of hyperinflation, thus exacerbating the underlying problem: that the government printed too much money in the first place. Or these days, too much “Quantitative Easing.”

Fear is the Key

Fear is the most powerful human (and animal) emotion of all. In the wilds, it’s a powerful survival instinct. Running from perceived danger, like an approaching tiger, is almost automatic. A deer (or other animal) which takes a moment longer than its fellows is the one that does not pass its genes on to the next generation.

The fear, or fight-or-flight response, has been honed by millions of years of evolution.

Fear of snakes is a common phobia even though, for many of us, the only time we ever see a snake is in a zoo. And despite six thousand years of civilization, we are still wired to run like hell when we see a lion.

Running from a snake or a lion is an obvious thing to do.

But most of the fears we experience today don’t have that obvious fight-or-flight solution of escaping from the lion or lopping off a snake’s head with your stone axe.

In the absence of such experiences—which generate the knowledge of how to deal with them—such evolution-wired fear responses have no referents. Instead of “fight-or-flight,” our fear response has changed to “fight, flight, or freeze.”

What’s your reaction if you’re walking down a street and are way-laid by two guys with guns or knives?

If you’re a black belt in one of the martial arts you’ll know what to do: fight is your rational response. Especially when that’s the last thing the “highwaymen” expect.

Otherwise, what do you do? Run, perhaps, if you think you’re faster than them (but procrastinate, and you’ll be too late). Otherwise: freeze and fold.

The difference between fears that are hardwired and fears that are not (such as the fear of losing money when a market crashes) is that your reaction to the hardwired fear is automatic, while your reaction to other fears is not.

In the second case, you have to stop and think. So unless you’re a George Soros-style trader, or a Bill Ackeman or Warren Buffett-style investor, your first reaction to a market collapse is unlikely to be fight-or-flight, but: “What the hell’s going to happen next? And what the hell am I going to do?”

Consider your reaction to the toilet paper shortage, whatever it may have been.

Some people, no doubt, rushed down to stock up. Most, I imagine, didn’t—until they saw empty shelves in the supermarket.

My own reaction was at the opposite end of the spectrum. At first I dismissed it as crazy. Admittedly, we had a reasonable supply in our cupboard so there seemed to be no urgency. Eventually, we bought a few packets just in case.

This strikes me as a reasonable classification of three categories of reactions to a market collapse:

 

1. Act immediately
2. Fear ⇒ Freeze ⇒ Procrastinate
3. Fear ⇒ Freeze ⇒ Procrastinate longer

 

The first category is made up of experienced investors and traders who’ve “been around the block” several times.

The second and third categories consist primarily of average investors for whom investing is a sideline to their primary occupation.

While the third category is most likely filled with people who have come into the investment markets for the first time during the preceding bull market. Having never experienced a bust, they literally have absolutely no idea what to do.

The common reaction of most people in bull or bear markets is that the trend will continue. Keep rising in bull markets; keep falling in bear markets. Which is why when markets collapse, the level of fear usually rises in step with the markets’ decline.

Fear results in procrastination—which is often explained by saying, “I’m trying to figure out what I should oughta do.” Which is actually a lame excuse for freezing up. Which usually results in panic selling. More often nearer the bottom of the market than the top.

If this happens to you, the problem is you don’t know the rules. It’s like walking out onto a football, baseball, or hockey field and trying to figure out on the fly what the rules of the game are and what you should do with the ball when it comes your way: you’ll be a liability rather than an asset to the team.

The investors who avoid procrastination and panic selling are those in Category #1, who know what they’re doing. The key to protecting your investment wealth is to join them.

Which is easier than you think.

What do those who act immediately have that you don’t?

A well-developed investment or trading system that suits their investment personality and investment goals. When you have one too, you’ll know what will cause you to sell before you buy.

Having an exit strategy is the key component of every investment and trading system. When you have such a system you’ll know what to do—come rain or shine, boom or bust. When a panic hits, you’ll be able to act coolly and quickly, avoiding the fear that’s causing everyone else to lose their shirts.

Building such a system can be easier than you think.

Here are four books that will help you create an investment or trading system that will work for you:

• In my The Winning Investment Habits of Warren Buffett & George Soros you’ll learn from the world’s richest investors why having an investment system is essential to success in the markets, and the necessary “building blocks” to creating the system that best works for you.

• If trading rather than investing is your preference, Trade Your Way to Financial Freedom by Van Tharpe is essential reading.

If you are not yet sure whether you’re most suited to investing or trading, check out my Investor Personality Profile to discover the investment approach that suits you best.

If your primary investment goal is to preserve and increase the purchasing power of your savings and wealth over time, far simpler systems than those used by active investors are available.

Here are two different approaches for your consideration that will enable you to sleep easily at night, regardless of what’s happening in the markets. With the added benefit that you’ll only need to rebalance your portfolio once or twice per year:

• Fail-Safe Investing: Lifelong Financial Security in 30 Minutes. Harry Browne’s “Permanent Portfolio” approach is designed to maintain and increase your purchasing power in all economic conditions. A brief introduction to the concept is available on Investopedia.

• Think you could become a millionaire on a teacher’s salary? Andrew Hallam did, and he relates how he did it (and how you can too) in Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School. With a system even simpler than Harry Browne’s Permanent Portfolio.

Whichever approach works best for you, with even an uncomplicated system you’ll know exactly what to do whether the markets are sky-rocketing, collapsing, or merely fluctuating.