Only a few weeks ago I wrote that investors were asking the wrong questions, with endless debates about market valuations. Now only weeks later it looks like investors are making the same mistakes mentioned in that article. The environment has switched from Euphoria to one of caution and in some cases gloom. Whether the market will go down over the next week, month, or year NO ONE (besides maybe Stevie) knows the answer. However, that question is irrelevant as investors have already shown themselves to be unequipped for the emotional turmoil which comes with a downturn.

2008 Crash

In the great crash of 2008/2009 the S&P 500 dropped by 57%. However, as I pointed out last week, it felt much worse than the numbers even indicate. A 57% drop is not just a massive loss, as we learned in elementary school math, it is more like (and feels more like) one 10% drop followed by another, followed by another, followed by another. You get the point, as I showed in the charts in that article.

The S&P 500 dropped only 3.6% from its peak and look at how investors are reacting!

Via CNN

GREED&FEAR-index 2008 Crash

The VIX

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Fund flows

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What’s the point here? The point is not what the market will do; I have no idea and neither do you. The point is that investors are panicking from a four percent drop. If the market drops 50% they will surely panic more.

Some might argue that my stats are misleading. They will note that the markets hardest hit have been EM and the losses have been far greater than 4%. That is certainly true – MSCIEF was down 6% in January, while some individual countries were down far more.

However, this argument is faulty. Investors with holdings in EM must expect volatility. The Russian ETF (RSX) was down over 75% during the financial crisis. However, investors seem to already be panicking by a ‘mere’ 10% drop in RSX over the past month.

Furthermore, even if one is not invested in EM it seems that they are selling domestic stocks. The S&P 500 is down, the VIX is up, domestic outflows have soared etc.

Asking the wrong questions

Once again, history has quickly shown that investors have not learned the lessons of the crash. The question now should NOT be “are markets cheap or expensive?”. The question is not even “should I buy or sell?”. The question is: why am I panicking over losses which are ‘minimal’? The question is, can I (or my clients) stomach possible huge losses? While some investors might be able to answer “yes,” if you panicked from the recent drop (which most investors seem to have done)  you should certainly answer no. Getting into a debate about profit margins, whether CAPE is a good valuation metric, where markets are cheap is a waste of time and harmful if investors cannot stomach monthly losses like those of January.

Good luck investing!

I want to add one caveat to the last article. For an individual investor it is hard enough to stomach losses. If you have nervous clients, you not only have to stomach them yourself, you have to be able to stand the stress of clients asking why their stocks are dropping 3% a day.