by Jason Bodner
July 27, 2021
Everyone must deal with risk. The word makes us think of doing stupid stuff: risking death, crazy life-savings’ bets, or risking horrible permanent injury. For humans, this fear is normal.
Risk is daily for all of us. Crossing the street, whether or not you wait for the light has inherent risk. What if a car runs the light? What if it jumps the curb?
Are you ever truly risk-free? Some people at home were unlucky victims of planes, or even meteors crashing through their roofs.
We can never rid ourselves of all risk. That’s an emotional thing, right? Risk of loss, injury, or death conjures up fear which was a great safeguard when we were evolving from apes. However, nowadays, fear still serves its purpose, but when it comes to investing, it’s usually more harmful than good.
In sweetly trending bull markets everyone’s happy, except maybe the bears. Stocks and 401ks rise gradually, smoothly, and reliably. It’s worry free.
But inevitably, volatility comes. Stocks that rose a dollar a day suddenly drop 5 dollars a day. What was up 10% in a month falls 10% in a day. Day 1 gets written off: “It’ll bounce back.” Day 2 of selling gets uncomfortable. Usually, by the third day, nerves rattle and stopping the bleed gets seriously considered.
This is where fear doesn’t help and could in fact, hurt. No one likes losing money, unless you’re a financial masochist. We all know that stocks go up and down. The “up” part, we have no problem with, it’s the down part where emotion takes over. Thoughts like these arrive:
- I can’t risk it
- I must stop loss
- I can’t take the pain
- I know this will end but I can’t take anymore
This is usually when the biggest investing mistakes are made. Investing is flip-flopped. We should be worried when everything goes up and confident when everything goes down. Crazy as it sounds, Warren Buffet knew it when he said, “Be fearful when others are greedy, and greedy when others are fearful.” When everyone high-fives themselves for their investing wizardry, caution should be high. And when everyone is drowning their sorrows with a stiff drink, saying, “Today just set me back ten years,” is precisely when greed should kick in.
It may be that the trick of investing is mastering the mind, and not the ability to sift through balance sheets or technical indicators. It’s no easy feat, but many older investors have had to do exactly this. They’ve seen trouble many times. But for newer investors, when volatility hits, they might consider shifting perspective.
While the Big Money Index plummeted in the last few weeks, we knew the market should follow suit eventually. It’s a mind-twister when the BMI falls while the S&P 500 rises. Big Money Index of buying falls, precisely because buyers left and sellers may have arrived. But when indexes rise while the BMI falls – it’s confusing.
Ultimately, things catch up. We saw small cap stocks get punished first, while the bigger indexes rose. We see this clearly in the four major indexes’ charts below from June 1st.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Looking at the Russell chart in yellow, we can see July’s downtrend was present before the other big three finally felt the pressure. The Dow got sick but quickly recovered in June, while the NASDAQ stayed strong until July’s dip. The S&P 500 was somewhere in between.
All these charts really show is that we remain in a “washing-machine” market. Capital continues to rotate, chasing returns with unfolding headlines. Fears of rates, inflation, China, Delta variant and COVID resurgence, along with normal summer volatility are all contributing to choppy markets.
So, what if we flip-flopped the general investment mindset? Let’s turn fear of loss into opportunity, and FOMO (fear of missing out) into prepping for opportunity.
At my research firm, that’s what we do. We make light of as much as we can: life, stocks, tragedy, or whatever. We have no control over anything: pandemics, market crashes, or even plane crashes. Admitting this is a great first step at managing attitudes towards risk. So, when pain comes in the form of great stocks, we like to say that we’re helping people who are forced to sell. They may be fearful retail investors, or professional traders given sell instructions from portfolio managers who may be in over their heads. And after all, these pressured folks need buyers to sell to!
We’re helping them out of a bind.
It turns out we might also be getting high while doing it. There is a psychological state called “helper’s high”. Research shows helping others juices the pleasure center of the brain. Giving actually produces endorphins that create a mild version of a morphine high.
Who knew that helping scared investors and forced sellers could be so fun?
But how do we buy confidently on dips?
Markets may turn and continue to get ugly. While this is true, it’s unlikely right now; rates are low, and likely to continue until 2023. The economy is booming, as earnings show. According to FactSet, for Q2, with 24% of S&P 500 companies reporting so far:
- 88% beat EPS
- 86% beat sales
- The blended earnings growth rate for the S&P 500 is 74.2%, highest since 2009
- The estimated earnings growth rate is 63.2%
The trick in buying on dips is waiting for the payday. We don’t know when that will come, but it will eventually: today, or next year. As a wise bond trader said, who aggressively bought when things got ugly, “Pay me now, or pay me later.”