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Did You Notice?

Issue: August 2009

By: Jerry Mosher, CFP

If we stop and reflect on the last one and a half years of market volatility we might find some classic reminders of how human nature and emotion are affected by stock market swings. These observations are an opportunity to learn and perhaps be more prepared for the future.

The decline of 2008 was one of the largest one-year declines since the Great Depression. The year saw many unusual, even unprecedented, events that fostered this decline. We have experienced this magnitude in market volatility several times in the past but it usually happened over a few years and not in such a concentrated period of time. Fear was rampant and fear usually contributes to a declining market because people sell their holdings to prevent further decline. Unfortunately this practice only feeds the decline. The year 2008 was followed by two months of additional declines, which had everyone on edge and concerned about depression. Most people living today hadn’t experienced a decline of this magnitude during their lifetimes. In periods of uncertainty there is a tendency to forget the past and reach the conclusion that “this time it is different.” I’ve found that the circumstances change but the fact that the market is volatile does not.

Obviously no one can predict or guarantee what is going to happen to the market even though we would like to find someone who could. The best you can do is estimate probabilities based on historical experience. You can’t tell someone their predictions of a depression, the market remaining down for years, an economic disaster, etc. can’t happen, because it could. You can only estimate the probability or likelihood of it happening based on an assessment of the circumstances and situations you are in at the moment. I found that quoting probabilities is not that psychologically reassuring when you are experiencing the pain of a relentless decline like we experienced during the past year and a half.

When the media is bombarding us with negative scenarios because fear sells magazines and papers and you have to fill the airwaves 24/7, it’s no wonder we end up in a crazed state. I don’t think it was any more crazed than in February and early March of this year, when the S&P 500 had just added another 25% decline on top of the 37% decline that occurred in 2008. Adding to the gloom was the fact there wasn’t any solid economic data that would suggest a positive outlook. History, of course, tells us that markets reach bottoms or are oversold when fear and panic are the greatest and the people who were going to sell have finally capitulated and sold. This piece of knowledge wasn’t much comfort in February/March and many advisors were beginning to wonder if “this time it is different.” With the gift of hindsight, we now know that on March 9 the S&P 500 took off on a 39% ascent through June 12. History tells us markets can move quickly but everyone was convinced in February/March that it wasn’t going to happen anytime soon.

Psychologists tell us that pain shapes our view of the world. When I’ve talked with clients more recently and relay the fact that the market has just risen 39%, they don’t believe me. I’m guessing that the relentless and prolonged declines of those one and a haf years were so traumatic that it shapes our view of what is happening in the market and doesn’t allow the rapidity or magnitude of an ascent to register.

There is also a human tendency to extrapolate and predict that situations, circumstances and scenarios will unfold without any changes to those situations and circumstances or without changes in behavior. I contend that the latter is one of the most unpredictable factors. It also doesn’t help that the stock market is a leading indicator of what people believe will be happening in the future, not what is happening in the current moment. This is why we need to guard ourselves against a certainty that any given scenario will unfold. Causes and effects often become apparent with reflection, not necessarily with predictive foresight.

I know the market will continue to be volatile over time. It may return to previous lows or establish new lows or it may not. One key is to understand that no one knows for sure and that we can’t anticipate how human behavior will change. I’m going to use all of this knowledge and reflection to increase my ability to manage my emotional response to the market.

Jerry Mosher, CFP® is a 30 year veteran of the financial planning industry and is president of Mosher & Ellis Financial Planning in Lafayette, California. He has been selected three times as one of the 150 best financial advisers for doctors by Medical Economics. Jerry may be reached at (925) 284-9470. Securities offered through AMERICAN INVESTORS COMPANY Member NASD/SIPC.

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