Paul Andreassen of Harvard did a study on two groups of people. He gave each group a portfolio of stocks to manage. One group was told to watch certain financial programs, read stock market articles, and stay on top of information regarding their portfolios. The other group was told explicitly to avoid all information regarding their holdings — a news blackout of sorts.
When the gains and losses of the portfolios were later compared, the people who read articles and watched financial news programs did significantly worse compared to those who avoided the media. In fact, in more volatile times the gains of the “non-watchers” were twice as good.
2020 found investors experiencing anxiety over market volatility, economic recession, and political unrest. These events were dramatized in the media. In response to these events many investors decided to sell, resulting in losses, and missed opportunities to increase their allocation to cheap stocks.
The following are examples of events which caused investors to panic:
- Price of oil went negative
- March 11, 2020 Dow closed at 23,553.22. It was down 20.3% from the record level on February 12, 2020 of 29,551.42. That decline signaled the start of a bear market. It also ended the 11-year bull run that began in March 2009
- March 16, 2020 Dow set a one-day loss record falling 2,997.10 (12.93% drop)
- Ending April, the unemployment rate was up to 14.8%
- Second quarter GDP was down -31.40%
Even though these previous events drove prices lower, the S&P 500 was up over 16% for the year. Many investors sold following a type of herd mentality and missed out on the recovery.
Why investors panic:
Psychological studies, done by Amos Tversky and Daniel Kahneman, have confirmed that for the majority of investors losses are twice as painful as the pleasure of a gain. Additionally, they determined that small amounts of pain over long periods of time are worse than large amounts of pain delivered in a single moment. For example, when investors see their account values going negative day after day they adversely react to their emotions and decide to sell. Investors sell to stop the pain, regardless of the rational logic and evidence which tells them markets will recover, this is why markets tend to fall significantly below their rational value. Another example of irrational selling comes by the way of Peter Lynch manager of the Magellan Fund from 1977–1990. According to Lynch in the book, “Heads I win, Tails I win”, the average investor in the fund made approximately 7%, when the fund returned over 29% annually. Other reasons for poor performance include performance chasing, casino investing, herd-based decision processes, and news-based influence.
Emotionally based decisions also drive investors to buy stocks which are overvalued. Examples included tulip mania in 1630’s, the South Sea Bubble in early 1700’s, the speculative margining of stocks in the 1920’s, the tech driven mania in late 1990’s, and the real estate bubble in 2006–2007. During these times irrational investors refused to sell stocks which were overvalued based on long term predictive valuations. They believed they were playing with house money and took risks a rational investor would not take.
This type of behavior is the reason for the hyperbolic moves at the extremes of market cycles.
Why markets recover:
Since I began my career, I have seen the following market downturns:
- 1987 October stock market crash
- 1989 Japanese financial crisis
- 1994 Bond market losses
- 1997 Asian financial crisis
- 1998 Collapse of Long-Term Capital Management
- 2000 The collapse of the technology stocks
- 2008 The Great Financial Crisis
Despite each of these major events, stock prices continued to new highs. The one common reaction to each of these events was intervention and stimulus from the Federal Reserve and U.S. Government, then referred to as the “Greenspan Put”. This term was coined when the former chairman of the Federal Reserve, Alan Greenspan, used monetary policy to support the markets after the market crash in 1987. Since then, the Fed has intervened to support the markets during every major downturn. This accommodative Fed Policy along with U.S. Government deficit spending have not only supported the market but has increased its’ value. The following is the 2020 stimulus:
- Congress passed multiple bills resulting in $2.5 trillion in stimulus.
- According to the Federal Reserve H.4.1 release, assets on the U.S. balance sheet grew from just over $4 trillion in December 2019 to $7.4 trillion in February 2021
The results of the different stimulus packages have been predictable, each and every time the markets face a major downturn the Federal Reserve and U.S. Government have been there to aid in recovery and use their influence to create new highs. These actions have created the term “Helicopter Money”.
What would cause this policy of cheap money to change?
We would need for the “Helicopter Money” to create forces which would harm the economy to the point of political risk. The last force which caused changes to cheap money was the inflation of the 1970’s. Until we see the cheap money create inflation strong enough to cause downturns in the market and the economy, I would expect each and every downturn to be met with more new cheap money.
Now this does not suggest I believe every investor should blindly invest all their money in the stock market. Investors, like passengers on an airplane, react differently to turbulence. Some can sleep continually through the storm, while others have a death grip on their armrest.
Each investor must determine how much and for how long they can handle the turbulence of the stock market. Having an investment strategy which is based on long-term historical evidence of predictive factors will help to alleviate the stress of market turbulence. Most of all, if you feel your emotions are controlling your financial decisions, drop the remote and step away.
Louis Pelz is the CIO for Core Capital Management and Research. For over 30 years Louis has been providing peace of mind for private client and institutional investors by tailoring individual strategies based on predictive factors from over 50 years of data. If you would care to learn more about our award-winning process, or would simply like to ask a question, I can be reached at l[email protected].