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The Psychology of Investors

The Psychology of Investors

  • 03.26.20
  • Markets & Investing
  • Article

Mike Gibbs, director of portfolio and technical strategy, discusses the important role emotion plays in the stock market.

As we move through this bear market, our goal is to help the true long-term investor remain so. It’s easy to be a long-term investor when stocks are gliding higher, as they were a few weeks ago; not so much now.

Although we have no idea what tomorrow holds with clear clarity (do we ever?), we’re comfortable in our belief we will get through this period. The virus spread will eventually be contained, the economy will return to growth, and stock prices will advance. How bad it gets before then is unknown. Market liquidity and credit concerns along with the spread of the virus in coming weeks will likely keep pressure on equities. Policymakers are expected to continue to aggressively address market liquidity concerns, and fiscal measures will dampen the stress in the credit markets. How deep the economic damage will be is a moving target and depends on the length of time this drags on. Once the virus outbreak peaks, the economic impact will be better understood.

Emotion plays a vital role in the equity market. Below reflects the emotional cycle often repeated with every bull and bear market. From the peaking point of invincibility to the bottoming phases of “just get me out” to “I’ll never recover my losses,” the cycle repeats itself over and over. We feel we are in the panic and capitulation phase currently. In the coming weeks, a better understanding of steps necessary to slow the virus spread (such as additional lockdowns or promising medical treatments), as well as success or failure to restore order to the credit markets, will likely dictate if we can move through the final phases of this bear market. During the rate of ascent on the other side, concern of additional outbreaks as weather cools along with the challenges of restarting the global economy are likely factors contributing to the wall of worry stocks will climb.

The Psychology of Investors

Unfortunately, the stages of emotion do not give any guidance regarding price. The levels of decline and duration are byproducts of the magnitude of the catalyst and impact on the economy. The uncertainty surrounding the virus and the economic fallout leaves investors in limbo and a bottom elusive for now.

Despite the uncertainty regarding when this period will end and how the other side will look, we are confident the global economy will eventually heal and long-term investors will profit. After every economic contraction (and corresponding earnings decline), the economy resumes an upward path and earnings move to a higher high. Stock prices do as well. After the twelve bear markets since 1957, stocks recovered to new highs in just under 24 months on average, with a median of about 14 months (FactSet). We are entering a period of falling corporate profits due to the shutdown of the global economy as we attempt to halt the COVID-19 virus spread. Stock prices are already down substantially to reflect the fear and pending decline in earnings. At some point, the virus spread will become less of a drag on economic conditions, and commerce will restart. Earnings, likewise, will resume an upward trend. Stock prices will rise.

All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital.