On the fear and greed cycle.
One of the most challenging times for investors is a market downturn. Whether markets are experiencing a correction or a bear market, it’s really disturbing to watch the value of your savings and investments decline.
Last week, the CNN Business Fear & Greed Index showed extreme fear was the emotion driving investment decisions. The Index “is a way to gauge stock market movements and whether stocks are fairly priced. The theory is based on the logic that excessive fear tends to drive down share prices, and too much greed tends to have the opposite effect.”
During times like these, many investors succumb to fear and take actions that damage their ability to reach their financial goals. The fear and greed cycle works like this:
Feeling greedy: During bull markets, everyone wants to invest. The market is moving higher, and nobody wants to miss out. As a result, investors become so enthusiastic that they are willing to pay higher share prices than companies may be worth. Former Federal Reserve Chair Alan Greenspan called this “irrational exuberance.”
Feeling fearful. During corrections and bear markets, when the market is moving lower, no one wants to invest. Some investors become so concerned, they sell, which drives prices even lower. Investors who sell accept a loss of principal; a decision that can negatively affect their ability to reach long- and short-term financial goals.
It’s counterintuitive, but many think the time when investors should be greedy is when the market nears a bottom.4 That’s when it may be possible to find shares with strong fundamentals that are selling at attractive prices. Since no one really knows when a turning point will occur, investors who decide to buy low may experience losses before they realize gains.
Last week, major U.S. stock indices moved lower.
If you’re feeling fearful, let us know. One of our most important roles is helping clients stay focused on financial goals, maintain a disciplined investment approach, and keep a long-term perspective in difficult markets.
About Loss Aversion, Bear Markets and Recession
Here’s something to remember during volatile markets when the desire to sell may be strong: Our brains are hard-wired to avoid loss. Studies have found the pain of loss is far more powerful than the pleasure of gain. This is called loss aversion.
Overcoming loss aversion isn’t easy. One thing that may help is understanding a situation more clearly. For example, knowing more about bear markets may help reduce the fear of these market declines. Here are some facts to consider:
Bear markets are not uncommon. There have been 11 bear markets since 1956, reported Mark Kolakowski of Investopedia. The shortest bear market lasted one month (February 2020) and the longest was 31 months.
Bear markets are price declines or 20 percent or more from a previous peak, reported Georgina Tzanetos of Bankrate. A major stock index (like the Dow Jones industrial Average, Standard & Poor’s 500 Index or Nasdaq Composite), an asset class (stocks, bonds, etc.), or an individual stock can experience a bear market.
Bear markets sometimes precede recessions, but not always. Stock markets reflect what investors think may happen in the future. When they drop, it’s often because investors see hard times ahead. Eight of the last 11 bear markets have occurred before a recession.
A recession is often defined as an economic slowdown or contraction that persists for two quarters (six months). The United States economy contracted during the first quarter of 2022. Although forecasters say there is a low probability (19.6 percent) the economy will contract again during the second quarter, according to a survey conducted by the Philadelphia Federal Reserve. The probability of a quarterly contraction increases (28.2 percent) in early 2023.
It’s unclear whether the U.S. will experience a recession. A lot depends on the Federal Reserve’s fight against inflation, which has been made even trickier by the Russia-Ukraine War and lockdowns in China.
“What good is the warmth of summer, without the cold of winter to give it sweetness.”
—John Steinbeck, author
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