Labor Day Update -- Five Stages of Fear

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.