Investor behaviour during stock market chaos
US capital markets are crashing – when have we seen this before, and how many times have we experienced it?
It’s probably the first time if you are a young investor, for the rest of us it is déjà vu all over again.
It’s nothing new; the cause may be different; the investment, economic and policy pundits may be different, but the debate about the causes of the capital market volatility a couple of days ago on one of the “money” shows became just another routine of “axperts” shouting to each other and their audience.
Whatever their intent, their messages became repetitive as my thoughts wondered about all those investors who had tremendous gains (on paper) during the Covid investment run-up. We saw the value of some stocks, such as Gamestop, rocket to artificially high levels, after becoming social media investor darlings, an echo of patterns seen during the 2000 dot.com tech bubble. Back then, numerous new internet companies never made a profit. Their stocks became vehicles for speculation, until the venture capital cash ran out.
It’s a long-documented fact of investor behaviour that when capital markets go up, ordinary individuals become genius investors, buying and rebuying securities because there is no way things could reverse.
The euphoria of feeling rich can be so great when seeing such fabulous gains on paper, or one’s digital phone, that credit card purchases increase too! More on this behaviour in a future article.
The same thinking, but reversed then applies to unrealised losses.
The more volatile the market, the more emotional distress occurs, until it becomes to see reason.
So, when market valuations continue to drop, regretfully, investors succumb to that distress, and cash out, only to see those same investments later recover value. The investor then regrets missing out, and rushes back into the market, paying higher prices.
This classic investor behaviour, repeated again and again, can decimate long-term appreciation in retirement accounts, particularly.
Dalbar’s Quantitative Analysis of Investor Behaviour has more than 37 years of documentation. Your author, now retired, can correlate the same client investor behaviour during my years of professional practice.
Reality lesson: an increase in riches on a screen is not real, actual hard cash, until it is realised in one’s bank account.
Conversely, a loss is not a real loss until the loss vehicle is sold.
Causes and comebacks of a few major crashes
In October 1987, on what became known as Black Monday, US capital markets crashed more than 20 per cent in one day.
Causes: overvalued stock market, computer-driven models linked to portfolio insurance malfunctioned, and investor panic.
Recovery time: In two days – fifty per cent of the point drop gained back and within less than two years, new market highs.
1999-2000 dotcom bubble
Causes: overvalued internet stocks and euphoria over new internet technology companies that never succeeded. One website, called deathwatch, tracked their ultimate demise.
Recovery: started at end of 2002.
2007-08 subprime mortgage crisis, global financial crisis and recession
Causes: failures of US financial institutions exposed to securities of subprime mortgage loans, credit default swaps markets, the US housing bubble, easy credit, and high default rates.
Recovery: time varied by country, but generally, markets had recovered by end of the next year. The recession, however, lasted far longer.
May 2010 flash crash
The Dow Jones Industrial Average saw it worst intraday points loss, of 1,000 points or 7 per cent, which happened in minutes before recovering same day.
Cause: high-frequency traders, and market manipulation with spoofing, layering, and front running, criminal charges followed.
2020 coronavirus crisis
Causes: market anxiety and worldwide recession caused by Covid-19 lockdowns.
Recovery: a couple of months, as the US government fed stimulus payments and aid packages to millions of individuals, families, and businesses while the Federal Reserve slashed interest rates to increase liquidity into markets.
Financial media, advisers, prognosticators, and optimists all come to the fore during these times, and what do we hear for advice?
Basically, the same common sense that we’ve been told about every other market crash! Don’t panic! Stay the course.
Wealthify, a UK financial advisory company states this succinctly.
“Will financial markets always recover? Since we can’t predict the future, we can’t really say markets will always bounce back.
“However, if you look at how markets behaved in the past, you’ll notice that they’ve always recovered at some point. This is what markets do – they have ups and downs, and as an investor, it’s important to learn to live with them.
“Seeing markets fall can be stressful, but if you react and sell your investments, you could potentially harm your investment journey and miss out on some really good days.
“If you want to smooth out the bumps whilst taking advantage of the good times, it could be worth sticking with your investments for a number of years. The longer you remain invested, the more likely you are to make a gain.
“People who invested in the FTSE 100 for any ten-year period between 1986 and 2019 have had an 89 per cent chance of making a positive return – this time frame includes Black Monday, the Dotcom Bubble, and the Global Financial Crisis of 2008.”
For the do-it-yourself investor:
• Invest wisely – research everything,
• Keep learning about investments
• Refrain from the get rich quick hype
• If there is no underlying asset for a security, and you don’t understand it, avoid it.
For professionally managed investments:
• These are qualified, experienced investment professionals
• Review their track record
• Let them do their job
On the positive side of recent events, interest rates on savings, term and certificates of deposit will be increased, reflecting US Federal Reserve and other country central banks initiatives.
Wikipedia: List of stock market crashes and bear markets
Wealthify: A history of market crashes and how they recovered
Bermuda Islander: Book One, the Dawn of New Beginnings: Step 13 Do-It-Yourself, https://www.royalgazette.com/bermuda-islander/article/20210209/bermuda-islander-step-13/
• Martha Harris Myron is a native Bermudian journalist and author of Bermuda’s First Financial Literacy Primer: The Dawn of New Beginnings – A Back-2-Basics Financial Review to Dramatically Improve Your Lifestyle. All writing net proceeds go to Bermuda registered charities.