Labor Day Update -- Five Stages of Fear
January is always a good month for Behavioral economics: Few things
illustrate self-control as vividly as New Year's Resolutions. February is even
better, though, because it lets us study why so many of those resolutions are
broken. .... Sendhil Mullainathan ...
Robert C. Waggoner Professor of Economics at Harvard University.
It would be good to remind ourselves
how fickle human behavior is or to be more precise how capricious investors’
reactions can be. Just a year ago the Stock Market reeling from the fear of the
Chinese contagion sold off 10% from its May 2015 highs. It was followed by a
recovery to a modest extent to end the year at a level of 2043.94 on the
S&P-500 Index. Whatever New Year resolutions were made by investors of staying emotion-less with regard to investing was soon forgotten in January when the markets
tanked in the first two weeks of 2016. The hemorrhaging continued well into
February with the markets at one time hitting the lows of 1810.10. This represented
a downturn of 15% from the peak of 2134.72 set in May 2015. Just as the prophets
of gloom and doom were gloating with their self-congratulatory “I told you so”, the Stock Markets have rallied. Slowly but steadily wiping out all the
year's losses, the Stock Market has been setting new all-time highs of 2193.81 and ending the
Labor Day week-end at 2179.98. The Markets shrugged off the momentary fears of
Brexit in June 2016, reminding us once again that political events need not necessarily be
economic events spelling disaster to the Markets.
The following graph illustrates the
up and down nature investors have been subjected to over the past one year.
This brings me to the topic of
categorizing and classifying various terms used to describe market volatility.
We shall confine ourselves to discussing and defining classic phrases used by
market pundits during any sell-off. It is important for a disciplined investor
to take stock and get a handle on the exact situation prevailing. One goes by the
dictum that what one cannot measure is also difficult to manage. Hence these definitions give a
guideline to maintaining our sanity during periods of extreme volatility.
Table 1 … Five Stages of
Fear
|
|
Description of Various
Stages of Market Sell-Off
|
From the Market Highs the
S&P-500 Index is within
|
Trading Safely Close to The Top
|
0%
- 3.5%
|
Hiccup … Market has suffered a Hiccup
|
3.5%
- 7%
|
Pull Back … Market has suffered a Pull
Back
|
7%
- 10%
|
Correction … Market has Undergone a
Correction
|
10%
- 20%
|
Bear Market …Markets In Bear Markets
Territory
|
20%
- 33%
|
Meltdown…Markets have had a Major
Meltdown
|
>
33%
|
Though the above definitions may not
be all inclusive, it is definitely worth keeping in mind in which stage of
”Fear” the markets are currently trading. It is important to neither over-react
nor be complacent when any kind of market sell-off occurs.
- "Never think that lack of variability is stability. Don't confuse lack of volatility with stability, ever" ....... Nassim Nicholas Taleb ... Author of Best Seller The Black Swan
The following table will illustrate on
a monthly basis how the “Five Stages of Fear” evolved over the past volatile
year.
Table
2 … Stages of Fear During 2015-16
Month
|
S&P-500 Index
|
% Down From the Market
Highs of the S&P-500 Index
|
Stage of Fear
|
July 31, 2015
|
2103.84
|
-1.4%
|
Trading Close to the Top
|
August 31, 2015
|
1972.18
|
-7.6%
|
Pull Back
|
September 30, 2015
|
1920.03
|
-10.1%
|
Undergone Correction
|
October 31, 2015
|
2079.36
|
-2.6%
|
Trading Close to the Top
|
November 30, 2015
|
2080.41
|
-2.5%
|
Trading Close to the Top
|
December 31, 2015
|
2043.94
|
-4.3%
|
Hiccup
|
January 31, 2016
|
1940.24
|
-9.1%
|
Pull Back
|
February 29, 2016
|
1932.23
|
-9.5%
|
Pull Back
|
March 31, 2016
|
2059.74
|
-3.5%
|
Hiccup
|
April 30, 2016
|
2065.3
|
-3.3%
|
Trading Close to the Top
|
May 31, 2016
|
2096.95
|
-1.8%
|
Trading Close to the Top
|
June 30, 2016
|
2098.86
|
-1.7%
|
Trading Close to the Top
|
July 31, 2016
|
2173.6
|
-0.2%
|
Trading Close to the Top
|
August 31, 2016
|
2170.95
|
-1.0%
|
Trading Close to the Top
|
September 02, 2016
|
2179.98
|
-0.6%
|
Trading Close to the Top
|
It is worth noting that in the past year the S&P 500 Index has had “Hiccups”, “Pull Backs" and “Corrections” apart
from establishing new all-time Market Highs.
Every time the markets sell off, it need not be a cause for panic but definitely one which needs investigation especially if the market undergoes a “Correction". Such sell-offs may suggest the necessity of taking a defensive posture to preserve precious capital. Additionally in certain cases it may be an opportunity to buying selected stocks at a relatively cheaper valuation.
To paraphrase an aphorism … Eternal Vigilance is the Price For Investors Sanity. It always "pays" to pay attention to details, some old sayings are indeed eternal.