I did a yard walk this week to survey the winter’s effect. Of main concern was a retaining wall in the front yard that had begun showing gravity’s pull. I’d been meaning to address it as I knew what the fallout would be. Sure enough, like a jack-o-lantern puking seeds, the wall had given way. While my anticipation of damage control was spot on, I failed to act accordingly.
It got me thinking to the parallels of financial market risk. Especially in light of the past few weeks' dramatic price action. The stock market basically regurgitated 3 years gains in 2 weeks. The easy headline is to attach the Corona Virus as the culprit. A catalyst? Absolutely. And certainly, acerbating the velocity & severity of the move. But I would assert the markets were likely to move south regardless.
I won’t bore you with fundamental metrics like P/E, cash flow, earnings growth etc. I’ll leave that to the Ivy League eggheads. Rather, let’s examine something far more rudimentary: human nature. While people are emotional, markets aren’t. I would contend the 2 biggest wealth destroyers are ourselves and inflation. We get in our own way. We emotionalize cycles with the markets from greed to fear to greed to fear - always repeating. We all like to believe we think and behave rationally – unfortunately our actions disagree. Consider the book: The Art of Thinking Clearly – Dobelli.
One basic indicator I utilize is the Fear/Greed Index. Certainly, a bit interpretational but it gives the general investor risk appetite over specified time periods. For example, March 9th, the indicator was at an extreme fear level of 3, nearly an all-time low. Contrast that with early February when the market was on the cusp of all-time highs: a greed reading of 57.
This index is not the end-all of behavioral finance but it’s a very helpful tool – especially at extreme readings. Tongue-in-cheek, I also check the TMI (the Molly Index) on occasion. My 91 year old mom usually drops some pearls at market inflection points. Heading over there soon for a Friday afternoon bourbon to social distance & catch her market 411. Sadly, it comes with a heaping side of Fox News.
So now that a market rout has taken place and we’re arguably in some kind of Bear market. Our first instinct is to ‘react’, thinking it will immediately help the situation. Not usually. What’s done is done – best to survey the damage, try to determine what just happened and calmly resolve what investments are worth saving. Oh, and turn off the business channels – that’s financial porn that will cloud any sensible judgement.
To provide some historical perspective from past market beatings of 20% or more - consider the duration of the drawdown is around 16 months (we’re only at 3 weeks!) and it takes a median 2 years to recapture the previous losses. My 2 cents is automated trading exaserbates moves in both directions. Coupled with the swiftness of news, social media and zero commission phone trading, knee jerk reactions are becoming commonplace. And of course, adaptive behavior, or herding. Basically, when the keg runs dry, everyone rushes to the exits.
Besides a halted economy, what’s next? I would suggest letting things settle. It usually gets worse before it gets better. There will be plenty of time to rumage the lost and found. It will take time for the markets to grapple with Virus’ effects and re-price the economy. Let volatility (VIX) and the credit markets calm down. Personally, I take inventory of what mistakes I’ve made, usually position sizing and asset allocation & avoid the woulda coulda shoulda game - counter productive. I also raise some capital and make a wish list of opportunities that are inevitably ahead. I constantly remind myself that these are temporary price dislocations due to illiquidity.
Unfortunately, choosing this profession means dwelling on it. I don’t recommend that. Bear markets are like bad golf: you never think it will end. It will. These are unprecedented times but unprecedented doesn’t mean impossible.
Stay safe.