Today looks like it’s going to be a painful day for many investors — not just across stocks, but a whole range of financial assets.
Over the course of the weekend, we heard increasingly gloomy predictions about the long-term impact of the Covid-19 outbreak, a sharp drop in oil prices, and scenes of panic buying across the United States. Even more unsettling was evidence of people and businesses stockpiling and selling medical essentials at outrageous markups. It’s this kind of behavior that can at times put your whole faith in humanity to the test.
In 2007, Jason Zwieg wrote a brilliant book called ‘Your Money and Your Brain’. In it, Zweig looked at how the human brain reacts to financial and economic stimuli — neuroeconomics. Amongst the studies that the book focused on was one that showed that financial losses are processed in the same area of the brain that responds to mortal danger. Think about that for a minute. The same part of your brain that reacts to a gunshot, or a wild animal, or an earthquake, is the part that also reacts to losing money. It’s easy for us to tell investors not to panic when the market goes down, but how can we expect most investors not to panic given what we know about how the brain behaves.
I can almost guarantee that if I asked a hundred investors what happened in the market last week, at least 90 would think that it had gone down. However, it actually went up 0.6%. Investors remember the big losses on Tuesday and Thursday but seem to have totally forgotten about the 4.6% gain on Monday and the 4.2% gain on Wednesday. Loss aversion is a powerful psychological factor that makes us experience the pain of loss greater than the joy of gain.
Mondays hold a special place in the minds of investors – particularly those that witnessed Black Monday in 1987. It makes perfect sense when you consider why. After a weekend of no trading, there’s plenty of time for negative headlines and fears to fester. Doubt can build up and suddenly there is a rush to pull out money and wait to see how everyone else behaves. However, since that historic day in October 1987, Monday selloffs have often signaled the bottom. Six out of the eleven 3%+ selloffs on Mondays have been the bottom of the pullback, and the remaining five were near the bottom. Does that mean it will be the same this time around? No one knows. However, perhaps it can give investors some comfort.
Pretty much every time we see a sustained pullback or correction, we end up writing the same basic thing to help investors not to make emotional decisions.
Pullbacks are a natural part of markets.
Long-term investing allows us to ignore short-term movements.
The pain you are feeling now will likely not even register in your long-term memory.
All of these are true, but it’s hard to accept that at a time of panic.
We’ll be watching the stock market for the rest of the day. However, if it wasn’t my job, I wouldn’t be watching it at all. There’s only so much you can control in life and focusing on something you can’t is a waste of time. Instead, I’d strongly recommend reading Chapter 8 of Benjamin Graham’s ‘The Intelligent Investor’ (which I’m sure can be found online).