Myopic Urges

The recent sharp correction in markets has clearly surprised a lot of investors. No doubt this is partly due to the standard myopia people seem to exhibit as soon as the last crash is out of sight, but it also seems to be connected to the fact that the seemingly inexorable rise in share prices and the continuing low-interest rates on deposits has tempted new people into stocks. Faced, for the first time, with nasty losses they’re casting about for some kind of strategy to deal with the situation.

In truth, if you need to find a strategy after markets have started falling it’s too late. For most of us, the only sensible approach is to only buy things we’re comfortable holding through any kind of downturn and to then do nothing when volatility strikes. But even experienced investors face the urge to do something – anything – in the face of mounting losses. This is action bias, in action.

What |Goes Up …

Corrections – 10% market falls – are not uncommon. The S&P500 suffered, on average a 10% fall about once every 3 years or so from 1926 up to 2015. This is not a rare event, and the idea that the average investor can somehow time their way around these occurrences is a nonsense. Frankly, most professionals will call a significant number of these wrong, and the only people who will call them correctly 100% of the time are the people who are bearish 100% of the time.

Despite this people will tend to be caught by surprise by these kinds of falls. This is particularly true after long periods of low volatility, where they become lax about their buying criteria. If all share prices ever do is go up it’s easy to be lulled into forgetting that you’re just on the level section of the rollercoaster. Share price falls cause psychological pain and anxiety, the flight or fight reflex encourages people into action and, all too often, when investors don’t know what to do they take refuge in herding and appeals to probably false authority.  As so often, behavior that was perfectly adapted to a life in pre-industrial times is perfectly wrong in the stock market.