Should We Panic Over The Market Now?

This Article was first published on 30th October 2018 on our Asia-In-Focus Newsletter. To get the latest newsletters, click here.

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Asia In Focus

Should We Be Panic Over The Market Now?

How has the market been to you lately? If you have been invested in the stock market over the past few months, you might have noticed that your portfolio might not be doing that great lately. I have not done a full calculation but I think my portfolio fell close to 10% just this month.

Should we start panicking now?
Due to the increased market volatility, I am getting more questions regarding how the market will react in the next few months, what will be the trend and how can we still invest in the market?

I am also seeing more and more people suddenly having strong opinions about the market, explaining with much confidence why the market is just having a correction and how it is time to be “Greedy when others are fearful”.

The Unpopular Truth
The truth is No One Knows. It seems hard to imagine that so many market practitioners are sharing their “expert” views on the market every day and yet I am basically saying that none of them know?

Well, essentially yes. No one will know what will happen tomorrow to the market, just as no doctors can know for sure that the medication she is giving you will truly cure you.

During the 2008 financial crisis, a small group of people have been hailed as geniuses for correctly predicting the market crash. One of them is Nouriel Roubini, a famous economist, known to the media as Dr Doom. Mr Roubini was one of the few market commentators that correctly guessed the 2008 financial crisis. However, what was less well-known is that he has also been predicting a market crisis in 2004, 2005, 2006, 2007, 2009, 2010, 2011 …
You get the idea: a broken clock is still right two times a day.

The Trick Our Brain Is Playing On Us
We will feel that the market is on a downtrend mainly because the market has been declining for many days within the last month. And because we are seeing more of market declines, we tend to feel the recent market trend will just continue.

This is a type of behavioural bias called Representative Bias.

Representative bias happens when our brain tries to simplify the complex issue for us to process in a more time-effective manner. As we are seeing more of market declines, our brain will just hint to us that because the market has dropped for the past 5 days, it would most likely drop today as well.

However, that feeling or “hunch” has no real logical basis at all. And what most financial experts try to do is just to follow that hunch first and find a logical explanation to explain that feeling afterward.

How Will We React?
If the market started to rally again for 2 weeks straight from today, will we start feeling more optimistic about the market? Yet logically, there is no correlation that just because the market has been going up for 2 weeks straight, it will go up on the 3^rd week.

How Will The Greatest Bull Run Of This Century End?
We have indeed been experiencing the greatest bull run in the stock market of this century. Yet, all good things must come to a stop.

Source: Dr Jean-Paul Rodrigue, Dept. of Economics & Geography, Hofstra University

A typical financial bubble would take many years to develop. It would start off at a stealth stage where some smart investors are able to find bargains in the market before anyone finds out about it. They would make the first round of profit. Then, as market raises, it will peek the interests of more investors, but typically still among investors who are in the know.

Next, the market rally has become too big to ignore and it got the attention of the media and the public started to enter the market for the fear of missing out (FOMO). Then, it would reach a series of peaks as more greed plows into the market.

It would finally reach a point of inflection and fear would kick in and everyone would rush out the door all at once. We have seen the crisis play out almost perfectly during the recent Cryptocurrencies craze.

We all understand that financial bubbles occur. In most investment book or educational course, we are often taught to be greedy when others are fearful and be fearful when others are greedy.

Yet from my experience, I find this advice hardly useful. This is because the assumption of that advice is that we are able to detach ourselves from feeling the same as the “others”. It assumes that somehow we are special and would not fall into the trap of being influenced by the market sentiment.

However, that has never been my experience. I have always been as ordinary an investor as anyone else. In most cases, when the “others” are fearful, I am equally fearful.

Unless we are able to train ourselves to not feel and be as logical as an investor like Warren Buffett, I believe you would feel very similar to me. After all, we are emotional creatures.

So instead of seeing the financial bubble develops as if we are just an emotionless 3^rd party observer, we are more likely to be an highly-emotional and active participant within it.

So this is how I would typically feel during each stage of the financial bubble:

Stealth Stage
I would feel that the market is still too expensive as most companies are still struggling to turn around. Thus their earnings would be minimum. And after a long stretch of the market downturn, the uptick in the stock market feels more like just a short-term rebound rather than a full term recovery.

Awareness Stage
I would have restarted investing but have missed out on the first stage of recovery in the stock market. Yet, I would be ultra-conservative in my investment as the memory of the market crash is still very fresh in my mind. Thus, my investment would be small and unable to gain the full returns from the market recovery.

Mania Stage
After years of market boom, I finally convinced myself that the bull is here to stay. Stocks are going up, companies are reporting record earnings and it is just good news all over. It is hard to lose money in this market and thus I might get more and more confident in my portfolio, and venture out into buying much higher risk investments.

Blow Off Stage
When the market starts to turn, I would most likely just see it as a short-term correction. Moreover, this is the point where I started to feel I am indeed “special” and should be practising the “Greedy while others are fearful” mantra. I might be aggressively buying as stock prices drop, thinking that it is a great time to average down.

Full Crisis Mode
This might be the point I realized we are in a full-on the crisis but sadly I might already be fully invested in the market already, losing most of what I invested.

The Real You
Does that sound like you as well? Well, you don’t have to feel bad about it as that is most likely how 98% of all of us will feel at the different stage of a financial crisis.

In fact, that is my actual experience during the 2008 crisis and it taught me a great deal about how my brain would keep tricking myself at a different stage of the stock market.

If you have not experienced the entire financial bubble cycle before, I highly encourage you to participant in the stock market to try it out.

This is because only by truly understanding how we would really react at a different stage of the financial bubble can we prepare ourselves for the next crisis.

As investment is a lifelong journey, we would most likely experience multiple market crashes in our lifetime.
By experiencing the 2008 crisis and remembering how I have felt at a different stage of the stock market allows me audit myself when I feel greedy, asking if that might be a sign that market is in fact too good and I am getting carried away. Or when I start to feel fearful of my investments, that might be the point where I should actually try to fight my fear and start investing in the market again.

I have found by listening to my own emotions a much better guide on where we are in the stock market compare to listening to hundreds of “experts” sharing their thoughts on the market.

But hey, no one knows anything, that includes me too. So don’t listen to me.

Try it out yourself.
Till we meet again,

Invest Safely,
Stanley Lim
Editor

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