Monday saw the worst day for U.S. stocks in nearly two years.Reuters
You’re probably kicking yourself right about now if you recently put money in the stock market.
That’s because a decent chunk of it promptly vaporized when financial markets lost their composure in recent days. Out of nowhere, a ripple of panic upset the calm of summer trading, forcing investors to worry about the state of their own finances.
There wasn’t much in the way of a catalyst to pin the episode on, which culminated in the worst day for U.S. stocks in nearly two years on Monday. That makes it awfully difficult to trust the rebound that was already in play by Tuesday morning.
While order has been restored for now, investors are alive to the risks lurking in the markets. Fear has made a comeback. How one responds in these moments is crucial. And the right thing to do, almost always, is stay the course.
The losses amounted to as much as 8.5 per cent in the S&P 500 index before the reversal, while the S&P/TSX Composite Index spent Tuesday catching up on the action it was spared from on holiday Monday. It ended the day down 4.9 per cent from its peak about a week ago.
Those aren’t particularly scary numbers. But the math can get to you when you survey the personal damages.
It’s not a nice feeling to log into your investment account and see a number that is smaller by thousands of dollars than it was just a few weeks ago. You might think of how long it took to earn that money. Or of what you could have spent it on otherwise.
Most people are hard-wired to loathe losing money. Studies have showed the psychological impact of a financial loss to be roughly double that of an equivalent gain.
Loss aversion is a potent force that can compel investors to make big mistakes, for a couple of reasons.
First, whenever turmoil engulfs the markets, the impact to each investor exists only on paper. Unrealized losses are made permanent only when those positions are sold.
Second, the stock market’s greatest days tend to follow its worst. Look at Tuesday, which saw the S&P 500 cruise to a respectable 1-per-cent gain.
“Yesterday’s misery often turns into today’s punchline,” wrote Stephen Innes, managing partner at SPI Asset Management, in a note.
“The swift twists and turns of trading can transform what seemed like a dire situation into a fleeting memory, one that’s often laughed about in trading rooms the next day.”
The harsher the downfall, the grander the snapback. After the stock market bottomed out from the shock of the COVID-19 pandemic in 2020, the S&P 500 rose by 18 per cent in three trading days.
Those returns are the spoils for enduring the market’s corrections and crashes. As Morgan Housel said in the bestseller, The Psychology of Money: “Volatility is the price of admission.”
To many investors, these moments can still come as a shock, perhaps now more than usual. Up until two weeks ago, the S&P 500 had gone 17 months without a daily loss of at least 2 per cent. That’s the longest stretch since the global financial crisis, according to data compiled by CNBC.
Over that time, U.S. stocks have followed a steady upward trajectory with very little volatility, fuelled by the fading risk of a recession and the great riches afforded American tech giants by the rise of artificial intelligence.
Throw in the typical summer quiet period, and you have an investing populace that was easily caught off guard.
And yet, sell-offs such as the latest one are the rule rather than the exception. History shows that the average year will have about three pullbacks of 5 per cent or more, and one 10-per-cent correction, according to a Bank of America strategy note.
Even the more severe stock market events are surprisingly common. There is one 15-per-cent market dive every other year. And a 20-per-cent bear market every 3½ years.
It isn’t easy to stick it out through that kind of volatility. The urge to limit one’s financial damages is powerful. But it’s in those moments an investor can earn the superior long-term returns that the stock market will eventually bestow.