Improving Investor Behavior: Fear is a Very Powerful Emotion

After almost 45 years as a financial advisor, one realizes that there’s truth behind the phrase, “Reality is made up of circles, but we see straight lines.” Market cycles, crises, and investor behavior are all echoes of things we’ve seen in the past and will likely experience again in the future. No doubt the COVID-19 crisis impacts us all, and while it may feel like something completely new, it really isn’t. This is especially true when focusing on finance.

You’ve likely heard the comparisons of this crisis to the Spanish Flu of 1918. While there are many parallels, this event was long ago. With so many innovations and improvements in the meantime, it’s hard to wrap your head around their similarities and differences. The “what-ifs” prevail. What if they had had better hospitals? What if they had better testing, doctors, technology?

So, for comparison’s sake, let’s consider more recent events. My career includes four large fear-driven market “crises” that come to mind: Black Monday in 1987, Y2K in 1999, the World Trade Center attacks in 2001, and the recession in 2008. Though these events are all unique, they were all the same in many ways.

With the perspective time has provided, we can say these events:

• Were driven by fear of the unknown.
• Were impactful in many ways not immediately apparent at the time.
• Were seemingly an end to “the way it’s always been.”
• Were going to endanger the “American way of life.”

While none of these ultimately resulted in those fears, they did represent a significant buying opportunity for long term investors.

I don’t draw these comparisons to make light of the current situation. Each of these events altered the course and landscape of our country. We lost lives, jobs, savings, and sleep. Yet our country has always performed best when the chips are down. That’s when we pull together to do what must be done, and it can be an excellent opportunity to purchase assets from those overcome by fear.

Fear is a difficult emotion to tame. It goes against our innate nature of fight or flight. Deep down in our subconscious is a warning bell developed over thousands of years designed to keep us alive and out of harm’s way. Combined with the herd mentality (my neighbor is stocking up on toilet paper, so maybe I should too), and we get situations quickly spiraling out of control. Consider how this applies to each of the events listed above.

October 19, 1987, saw a decline of about 23 percent in the Dow Jones, the largest single-day percentage drop in the history of the market. The cause? Investors utilizing computers designed to provide “portfolio insurance” that, when triggered by a decline, would sell assets. The computers took over, selling begets selling, and what do you have at the end of the day? A mess. Only when someone unplugged the computers and human judgment and reason took hold, did things calm down. Three months later, the market was back in positive territory.

The last quarter of 1999 had people in a frenzy. Convinced the computers we all relied on for everything from piloting aircraft to monitoring our library checkouts would not be able to reconcile the rollover of their internal calendars from 99 to 00 at midnight, people started to panic. They filled bathtubs with water, sold all their stock, and returned their library books lest they owe 100 years of late fees.

The attacks on 9/11 had a much more significant impact on our country than the previous examples. The outcome was more serious, and the effects more lasting. We are reminded of this lingering fear every time we step in an airport and pass through TSA screening. Immediately following the attacks, few wanted to travel for fear of another attack. The market closed for an entire week.

From 2008-2009 the market indices saw a broad decline of about 57 percent thanks to a financial system that was overleveraged, overbought (mostly real estate), and entirely over its skis. The fear was the system itself wouldn’t survive; that the rottenness had embedded itself so profoundly, there would be no way out. Yet liquidity returned to the markets, and they began to function again. From March of 2009 until this past February 2020, the S&P 500 delivered an annualized rate of return of 16.7%. On February 19 this year, the index stood some five times higher than the March 2009 temporary trough in just 11 years.

Now we have COVID, and it feels very different. The speed at which everything has happened feels surreal, with the market losing about a third of its value in a little over a month. The change in employment from record lows to record highs is staggering. The response from both the Government and Federal Reserve is so massive  it is difficult to comprehend.

But the more things change, the more they stay the same.

People are afraid, and perhaps rightly so. But as investors, we cannot let fear drive our investment decisions. There’s a reason most elevators aren’t made of glass. If they were, people would be terrified to watch as they’re buzzed up and down floors. Instead, our nature prefers to get in, push a button, and just be told when we’re at our level. We don’t need to see it happen; heck we don’t want to see it happen. All we want is to know the system works, and that we’ll make it to the 23^rd floor without having to climb all those stairs. In March, the market declined 12.5 percent. In April, it rose 12.6 percent. Twelve stories down and then back up would be very stressful if we saw the elevator working.

Our system works. It always has. Sure, it’s broken down a time or two, but America is the best repair company in the world. It may seem difficult for us to imagine that one day COVID-19 will be a distant memory. It will join those “black swan events” about which people write financial Armageddon books. This is not a prediction nor a statement of fact, rather an observation of human nature and behavior. We seem to have these periodic, unpredictable, unknown times when we are rattled temporarily, then march higher to new levels of productivity, progress, and accomplishment.

What has rattled you the most over the past eight weeks? What new lessons have you learned? Are there new things that you trust, or things that you don’t?

What I do trust is that when the economy is freed up again to serve the needs and desires of the 330 million American consumers as well as the other seven billion people around the world, the economic advance will resume. We’ve learned a lot in the past two months, and we’ll learn more. We rise to meet challenges. This time will be no different. I would never bet against America.