The Anatomy of Fear
“Fear. Deep rotting fear. They were infected by it. Did you see? Fear is a sickness. It will crawl into the soul of anyone who engages it. It has tainted your peace already. I did not raise you to see you live with fear. Strike it from your heart. Do not bring it into our village.” - Flint Sky (character in the movie Apocalypto) to his son Jaguar Paw.
Every time the market corrects sharply or deeply, as it has these last few weeks, we remind ourselves of this quote. While not being fearful didn’t quite work out for Flint Sky (he dies in the next scene, sorry, spoiler), we’ve found this quote is one that serious investors must heed when there is panic in the streets. We, and you, dear reader, must make sure that when there is a strong decline in prices, you do not allow fear to take over your decision making process, and you must not bring fear into your portfolio (“village”). We understand this is easier said than done, it’s widely recognized by behavioral economists that people feel losses twice as much as they feel gains. But below we outline suggested steps to take (which we took) when you’re faced with a market correction, or worse, a recession, that can help you strike fear from your heart. (We will in this post constantly refer back to the quote, yes it might be a bit cheesy, but we apologize for nothing.)
1) Turn off the financial news/opinion pieces – In this context news anchors, market ‘experts’, bearish sell-side analysts, and buy-side investors are all disseminators of fear. Each will have their opinion on how far the coronavirus will go, how deep the correction will be, when to buy, when not to buy, and will be spouting on about how “this time it’s different”. But you have to remember these are just opinions. And because there are so many of them, and many of them presented in a data-driven & professional manner, they will do nothing but confuse you. As the old saying goes, “when the world gets too noisy, turn off the noise”. Okay we made that quote up, but it works. When the virus effect first hit western stock markets we found ourselves looking to these online sages for direction, quickly remembered the quote above, and turned off the news, blocked cnbc.com on our browser and phone, and refused to let fear taint our peace. Do note, when things are bad, also ignore oracles who are overly bullish, their words, just like the ones of the fear mongers, are also just opinions. Now we’re not saying don’t look at the news for data points or to adjust your travel plans, but don’t use it as a source of investment advice.
2) Don’t listen to casual investors – Everyone and I mean everyone who has put a dollar into stock markets has an opinion on it. Whether you are at work, the gym, or even taking a taxi ride home, everyone will have an opinion on the market. Here the casual investor is the villager who has let fear into their heart. You can’t stop them from expressing their opinions/fear, just listen, smile, and think of Flint Sky. Two anecdotal stories illustrated the pervasiveness of this fear. A gym-buddy expressed taking a $50K loss by selling at the market lows, only for the market to bounce 4.5% the next day (and again 2 days later). Our checks with robo-advisors confirmed fear had permeated the retail market, with withdrawals piling up as the market corrected (even though they are meant to have long-term money).
3) Don’t sell in a panic – As we stated above, humans (whether they be professional investors or not) feel losses deeply. We know how hard it is to see your net worth declining, but you must resist selling in a panic. Try this instead; 1) Don’t look at your portfolio every day (Even if you are a professional investor), it will make you sick with fear. 2) Hopefully you only own assets you really like, so instead try to look for prices where you would love to buy more. Remember that stocks and bonds are just like any other item you buy, if you like it, and it goes on sale, you’re going to want to buy more. Do note, if you own assets which you find risky/don’t like – we can’t help you much, there’s really no good time to own those. If you must sell, recycle that capital into an asset you’re happy to own regardless of the current environment. If you decide to sell and sit on the cash because you think assets will get cheaper, make sure you put in limit orders (see the final point below for more on this).
4) Look at value not at price – This is for all the ‘buy-on-the-dip’ folks (see our previous blog post on why we think this by itself is an unsound strategy). If you feel the market was significantly overvalued before the outbreak of the virus, a 10% correction just means it’s a little less overvalued, it doesn’t mean the market is now cheap. Thus, look for where you think price is fair value or less. In case you were curious, in our humble opinion we felt that US markets were moderately overvalued before the crisis (probably about fair value now), and EM markets were cheap, and have gotten cheaper. Don’t get us started on credit markets (see our tirade on valuations in the credit market in this post).
5) You have no idea what will come next; The coronavirus spread could slow in a few weeks (as data is showing has happened in China) or it could accelerate if governments around the world fail to take strong measures. The Fed is expected to cut rates some more, but it could choose not to. China looks like it’s getting back to work but a secondary outbreak could stop that progress in its tracks. The point is, any prediction of the future is just a guess. So if you are buying now, don’t buy all at once. We have been recommending a 25-50-25 strategy to our clients. Spend 25% of the spare capital as you start seeing value, 50% if things get really bad, and 25% for the rebound. The downside to this strategy is if markets rebound after the first 25% tranche you will think “man, I should have been more aggressive”, but hindsight is 20-20 and at least you bought something!
6) Take the fear out of your decision making process; Once you’ve decided on the prices you want to start buying, immediately call your broker and leave long-standing limit orders. Say a stock is at $30 and you leave a buy limit order at $25, you order won’t get executed until the stock falls to $25, but if it does reach $25 your order will get executed automatically. This has two benefits 1) It saves you from watching the market daily to track your target price 2) it will protect you from fear overtaking your decision making process when the stock price is approaching your buying price (‘what if the stock goes lower?’).
We’ve been using the above techniques to recommend various strategies to our clients. Over the last few weeks, it has worked quite well. Going forward, could things get a lot worse if the virus continues to spread at rapid rates? Absolutely. But eventually this event will pass, and your fear will be replaced by FOMO (fear-of-missing-out) and you’ll kick yourself for giving into your fear. When this happens, you’ll get no sympathy from us, because after reading this post we can safely say “we did not raise you to see you live with fear.”
Happy investing all! Oh, and watch Apocalypto if you haven’t already – it’s a great film.