You don’t need me to tell you the stock market has been on quite a roller coaster earlier this year. In the first twelve days of 2016 the Dow Jones lost over 10%. This is the worst decline to start a year since 1897.
We have said before and I am sure we will say again, the best definition of the stock market we know of is: “The market is only indirectly related to economics. It is a function of human fear, greed and apprehension all overlaid on a business cycle”. The stock market is not business news but how we humans filter all this news through our emotions. We like to think of ourselves as consistently rational but alas, we are not.
What caused the emotional meltdown at the beginning of the year? A lot of things but the sum total is that investors went from seeing the world as a glass half full to a glass half empty. The Bull Market which started in the winter of 2009 is getting long in the tooth, which concerns investors, the price of oil has been in freefall, the Chinese economy is slowing, Europe is breathing hard to keep its head abovewater and many emerging markets, Russia and Brazil in particular, are in disarray. So take your pick, there are plenty of things to worry about.
So what do we make of all this? We think you need to look to behavioral economics for the answers. We all seek the comfort of being part of the herd and feeling the warmth of conventional wisdom. When prices start snowballing down we often don’t question the logic, we just join in and sell. And as the chart below shows, most individuals feel more pain from a dollar of loss than pleasure from a dollar of gain. So when prices go down we are even more eager to sell to avoid the pain of further losses.
The stock market works very successfully at making us do the wrong thing at the wrong time. It will shake us out of stocks at market lows and it will get us back in, with excitement, at market highs.
Our best advice now is similar to the advice we would give at most times – diversify your portfolio so you’re not dependent on any one stock or any one sector, exercise extreme patience (‘this too will pass’) and allocate your assets in such a way that you own some things which will stay stable (bonds) and some things that will grow over time (stocks).
The worries about the global economy today are somewhat analogous to an airplane slowing to “stall speed”. The fear is that with everything growing less rapidly and with interest rates near zero, Central banks have few arrows in their quiver to combat the slowdown. This is all true but we wouldn’t bet against growth in the future. As Warren Buffett said in his recent 2016 letter to shareholders, “for 240 years it has been a terrible mistake to bet against America, and now is no time to start”.