Continuing the fear and greed cycle.
Looking back over my thirty years in financial services, I can say unequivocally one of the most challenging times for investors is a market downturn. Things are going great and all of sudden, wham, a selloff takes hold, a correction or a bear market? Whatever the case, it can be very disturbing to watch the value of your savings and investments decline.
Last week, our measure of fear & greed was providing irrefutable evidence that fear is driving investment decisions. We use several metrics to gauge stock market movements and the correlation between fairly priced stocks and overvalued stocks. Logic holds that excessive fear tends to drive down share prices, and too much greed tends to have the opposite effect.
Don’t let emotions cloud your decisions or affect your long-term plan. Prepare for different scenarios so you will not be taken by surprise with sharp adverse price movements. For those of you working with a reputable wealth management firm, managing fear is part of the value add. Sharp declines and losses can increase the fear factor and lead to panic decisions in the heat of battle. Similarly, sharp advances and outsized gains can lead to overconfidence and deviations from the long-term plan. From our perspective, you can be a much better investor by keeping your head about you while others are losing theirs. When the emotions are running high, take a breather, step back and analyze the situation from a greater distance.
During times like these, many investors succumb to fear and take actions that damage their ability to reach their financial goals. The fear and greed cycle works like this:
- Feeling greedy: During bull markets, everyone wants to invest. The market is moving higher, and nobody wants to miss out. As a result, investors become so enthusiastic that they are willing to pay higher share prices than companies may be worth. Former Federal Reserve Chair Alan Greenspan called this “irrational exuberance.” While many gave an insouciant wave to his advice, he got it right.
- Feeling fearful. During corrections and bear markets, when the market is moving lower, no one wants to invest. Some investors become so concerned, they sell, which drives prices even lower. Investors who sell accept a loss of principal; a decision that can negatively affect their ability to reach long- and short-term financial goals.
It’s counterintuitive, but many think the time when investors should be greedy is when the market nears a bottom. That’s when it may be possible to find shares with strong fundamentals that are selling at attractive, even undervalued, prices. Since no one really knows when a turning point will occur, investors who decide to buy low may experience losses before they realize gains.
Last week, major U.S. stock indices moved lower.
If you’re feeling fearful, let us know. One of our most important things we do for clients is keeping them focused on financial goals, maintain a disciplined investment approach, and a long-term perspective, especially in difficult markets.
|Data as of 5/20/22||1-Week||Y-T-D||1-Year||3-Year||5-Year||10-Year|
|Standard & Poor’s 500 Index||-3.1%||-18.1%||-6.2%||11.2%||10.3%||11.5%|
|Dow Jones Global ex-U.S. Index||1.8||-15.5||-16.3||2.5||1.3||3.6|
|10-year Treasury Note (yield only)||2.8||N/A||1.6||2.4||2.3||1.7|
|Gold (per ounce)||1.3||0.8||-2.4||12.8||7.8||1.5|
|Bloomberg Commodity Index||1.8||31.6||43.6||17.8||8.9||-0.4|
S&P 500, Dow Jones Global ex-US, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods. Sources: Yahoo! Finance; MarketWatch; djindexes.com; U.S. Treasury; London Bullion Market Association.Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.
LOSS AVERSION, BEAR MARKETS AND RECESSIONS…Here’s something to remember during volatile markets when the desire to sell may be strong, even overwhelming: Our brains are hard-wired to avoid loss. In fact, studies have found the pain of loss is far more powerful than the pleasure of gain. This is called loss aversion, and it is a powerful emotion.
Overcoming loss aversion isn’t easy. One thing that may help is understanding more clearly how these emotional periods effect your long and short-term goals. For example, knowing more about bear markets may help reduce the fear of these market declines, particularly when they don’t derail your long-term plans. Here are some facts to consider:
- Bear markets are not uncommon. There have been 11 bear markets since 1956, reported Mark Kolakowski of Investopedia. The shortest bear market lasted one month (February 2020, onset of Covid Pandemic) and the longest was 31 months.
- Bear markets are price declines of 20 percent or more from a previous peak, reported Georgina Tzanetos of Bankrate. A major stock index (like the Dow Jones industrial Average, Standard & Poor’s 500 Index or Nasdaq Composite), an asset class (stocks, bonds, etc.), or an individual stock can experience a bear market.
- Bear markets sometimes precede recessions, but not always. Stock markets reflect what investors think may happen in the future. When they drop, it’s often because investors see hard times ahead. Eight of the last 11 bear markets have occurred before a recession.
What is a recession? A recession is often defined as an economic slowdown or contraction that persists for two consecutive quarters (six months). The United States economy contracted during the first quarter of 2022. Although forecasters say there is a low probability (19.6 percent) the economy will contract again during the second quarter, according to a survey conducted by the Philadelphia Federal Reserve. That prognostication hasn’t been debunked, but current conditions suggest it may fall short on accuracy. Nevertheless, the probability of a quarterly contraction increases (28.2 percent) in early 2023. That is more in-line with our outlook for the next recession.
At this stage, it’s unclear whether the U.S. will experience a recession but that isn’t fazing the abundance of soothsayers. A lot depends on the Federal Reserve’s fight against inflation, which has been made even trickier by the Russia-Ukraine War and lockdowns in China. The president of the United States made statements regarding our “promise to protect Taiwan” if China moves toward takeover. Tack on inflation and acrimony amid leaders in Washington and you have the potential for several outcomes.
Investing is a long-term strategy that will always be visited by pullbacks, recessions, and incredible stages of growth. Understanding these events are normal can help you maintain a cool head and avoid knee-jerk reactions. After three decades, several recessions and pullbacks, I say confidently, we will get through these challenging times. Those who stay the course and avoid crowd following (another emotion) will likely be rewarded.
Weekly Focus – Think About It
“What good is the warmth of summer, without the cold of winter to give it sweetness.”
—John Steinbeck, author
Phillip L. Clark
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