Image Credit: Christophe Vorlet
By Jason Zweig | 12:41 pm ET Jan. 22, 2016
There’s nothing like a 10% drop in the stock market in the first few days of the year to rev up Wall Street’s myth-making machine.
Although stocks regained some lost ground late this past week, the usual cliches about “panic” and “capitulation” have been flying — and investors should take a moment to winnow fact from fiction.
Myth No. 1 is that individual investors are especially prone to panic.
While some individual investors have undoubtedly been selling, the overall picture suggests patience.
This past Wednesday, when the Dow Jones Industrial Average dropped more than 500 points before closing down by 1.6%, was one of the 10 busiest retail trading days ever at Fidelity Investments, says Fidelity spokesman Robert Beauregard.
But, as they have done consistently so far this year, the firm’s individual clients added much more to their accounts than they withdrew, he says. Through Jan. 19, customers of the brokerage arm of the Boston-based financial firm have invested seven times as much new money in stocks and stock funds as they did in the last three months of 2015 combined.
At Wealthfront, a Palo Alto, Calif.-based automated online investment service that manages portfolios of exchange-traded funds, fewer clients have requested a less-risky investment mix so far in 2016 than did so in 2015, says chief executive Adam Nash.
William Koehler, chief executive of FCI Advisors, a financial-planning and investment-management firm in Kansas City, Mo. that manages $6.5 billion, says about a dozen of the firm’s more than 2,800 clients have either telephoned or emailed this week.
All were in or near retirement, he says, and primarily wanted to make sure they had enough cash to withstand another fall in the stock market.
Jon Stein, chief executive of Betterment, another online firm that manages ETF portfolios, says only 0.4% of its 130,000 clients have initiated any trades so far in January. However, 30% more clients have made new deposits so far this month than the New York-based firm had projected late last year, he says.
There are other reasons investors aren’t running for the hills. An analysis of data from retirement accounts held at Vanguard Group found that investors are less likely to check their balances after sharp declines than after days when the market is flat — a tendency to stick their heads in the sand that researchers have aptly dubbed “the ostrich effect.”
Like most people, investors prefer to savor good news and would rather ignore bad news. When your portfolio goes up, your self-esteem rises with it. In a falling market, you don’t just lose money; you lose face. Who would want to dwell on that?
If investors are ostriches, it isn’t any wonder that there are also problems with Myth No. 2: the chimera of capitulation.
The last thing most investors want to do after losing money is to lock in their losses by bailing out at the bottom. That would force them to admit a mistake — and forgo any chance of recovering those losses later.
But history shows that falling markets tend to hit bottom not with a bang but with a whimper. So if you are trying to time the market by waiting for capitulation, watching out for an orgy of selling is probably the wrong way to recognize it.
Look at what happened in 1929-1932. The Dow peaked at 381.17 on Sept. 3, 1929; a total of 4,439,000 shares traded hands on the New York Stock Exchange that day. By the time the Dow hit rock-bottom in the depths of the Depression, at an index value of 41.22 on July 8, 1932, only 720,000 shares were traded.
Those are not typos: The Dow had fallen 89.2% in less than three years. And trading volume had declined 84% from 1929.
Does that sound like a trading frenzy to you?
More recently, on March 6, 2009 — the nadir of the financial crisis, when the S&P 500 hit the “devil’s low” price of 666 — total volume was 12.6 billion shares. That was right on average for the previous two weeks and well below the levels of the previous autumn. Talk of “capitulation” had peaked months earlier.
So you shouldn’t view the volatile trading and fearful mood so far in 2016 as clear signs that stocks can’t drop much more.
If you have a high tolerance for pain, it’s fine to “buy on the dips” as falling prices make stocks less overpriced. But, as the behavior of many individual investors has been showing, we’re a long way from the quiet despair that has so often been a sign that stocks have finally reached bargain prices.
Source: The Wall Street Journal