Calm through the crash, calm through the bounce
11 Jun 2020
Ben Kumar , Senior Investment Strategist

Stay invested. It sounds simple. It is simple. But for many investors, the simplest thing to do is often the hardest. We’ve often written about controlling your emotions – caging the lizard.

The investment facts are clear. Moving to cash and trying to “time” the market doesn’t work. No-one calls the top successfully, and no-one calls the bottom either.

But. Facts don’t matter to the lizard. Moving to cash is always tempting, because the lizard in our heads is loss-averse.

Loss-averse lizards

I hate losses. I’m sure you do too. It’s a basic rule of human psychology – people everywhere hate the thought of something they own being taken away from them. And these feelings drive our behaviour.

In fact people hate losses about twice as much as they like gains. Imagine a coin toss where if the coin lands on tails, you lose £1000. How much would you have to win, before you decided you wanted to play? For most people, it’s at least £2000. The thought of losing £1000 is so painful, that it takes £2000 of winnings to make it worthwhile.

This loss-aversion comes from the primal part of our brains. The lizard in our heads will do everything it can to avoid pain. Most of the time, we overrule the lizard in everyday life – we don’t look at every situation from a fight-or-flight perspective.

But in a situation of uncertainty and panic the lizard often reacts first and we struggle to control it. And the lizard will always look for the safe option. So for loss-averse investors (i.e. all investors), the last few months have been very difficult.

In general, there are two particularly dangerous periods for people struggling to stay invested.

The crash – maximum fear

The first danger period is when things start going wrong, like March of this year when coronavirus really started to be taken seriously outside of Asia. Sharp falls in the FTSE 100, and scary headlines about death created a perfect storm of fear and panic.

At this moment of maximum fear, we expect calls and emails (my rough rule of thumb is that if the FTSE 100 is in the main newspaper, rather than the business section, the phones will be ringing).

At these times, it is understandable that investors want to sell everything – they may have lost money already, but it feels like the world is going to end. The lizard in their heads is going crazy, telling them not to lose any more, to get out with what they have, to take the safe option and sell.

The bounce – maximum relief

The second danger period is more subtle and unexpected. It’s the recovery phase. When things get back to where they were before the crisis. For investors who stayed the course through the pain and have seen their portfolios rebound, there always comes this bit of time. They start to feel relieved that the money wasn’t lost. Phew.

But then they start thinking about how bad the pain was when they thought they’d lost the money. What if markets fall again? What if it’s worse? Shouldn’t they just be grateful to get out without a loss? The loss-averse lizard starts to panic, resulting in the same old suggestion to take the safe option and sell.

This is the period we’re at now.

So … should I sell?

This week, the US equity market fully recovered from all of its COVID-19-related losses. The S&P 500 is now flat for 2020.

We’re starting to see the questions creep in, with people asking whether they should sell now, and buy back in lower down “when the market falls again”. Or they’ll ask whether the market has gone too far, and if now is the time to hold cash.

Two points on the fundamentals. First of all, while the US market overall is back to where it started the year, it’s a very different looking market. Airline and cruise companies have still lost over half their value this year, and oil companies are around a third smaller than they were – and rightly so. Tech companies, logistics businesses and health care companies are doing far better, again, with good reason.

Secondly, the wave of global stimulus is unprecedented; estimated at over $24 trillion globally – around one quarter of global GDP. In the face of such support, an equity market rally is reasonable.

Overall, economically, we think global growth is going to be ok over the next few years – and while equity markets may have reached that conclusion a little more quickly than in previous recessions, there’s no cause for alarm.

Of course the economics don’t matter much to someone who’s scared. The desire to hold cash comes from a psychological place, not an economic one. Our view is that abandoning a long-term investment plan due to short-term fears is, and will always be, a bad idea.

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