Imagine finding out that today, the S&P 500 lost -20.47%.
This happened on October 19, 1987, when the S&P 500 lost -20.47% in a single day.1
How would you react? Would you hold firm with your investment, or would you employ what we call Emotional Market Timing and sell all of your stock investments at a loss?
We define Emotional Market Timing as when an investor, nervous about domestic, world, or market events, in essence, panics and engages in an almost spontaneous act of selling their investments.
While every market is different, and past performance is not an indication of future results, in our view, Emotional Market Timing may not be the ideal strategy to use when dealing with stock market fear because it centers on alarm rather than conscious rational action.
We believe that the key to grasping the dangers of Emotional Market Timing lies in the understanding that markets will generally rise and fall in cycles, typically moving in large chunks and many times in what we consider to be short periods.
After a significant event like the crash of October 19, 1987, an investor who employs Emotional Market Timing and panics out of the market will lock in their loss. In addition, they may find themselves sitting on the sidelines as the market is moving back up with nothing but their losses and what is left of their investment.
We have given numerous examples of this in other editions of the Emotional Investor Series of white papers. This edition of the Emotional Investor Series will examine the fear created when the stock market crashed on October 19, 1987.
No single cause could be identified for the –20.47% single-day drop of the S&P 500 on what would be called Black Monday. Computer trading, overvaluation of the market, trade and budget deficits, and illiquidity have been identified as reasons for the market decline. However, none of these have been viewed as the sole cause.2
Anxiety, concern, and even panic ensued as the market closed on Black Monday. Fears and comparisons to the 1929 stock market crash and the Great Depression were prevalent. Remaining an investor in stocks and not employing Emotional Market Timing was undoubtedly difficult.
However, we believe it is important to remember that markets will generally rise and fall in cycles, typically moving in large chunks and many times in what we consider to be short periods. We suggest that the dangers of Emotional Market Timing may be illustrated by the October 19, 1987 crash and the days that followed.
When the market crashed on Black Monday, would you have sold all of your equities? If you had, you would have missed the 5.33% positive return for the S&P 500 the very next day and the additional 9.10% return the day after that on October 21, 1987.1
After seeing a return for the S&P 500 of over 14% in only two days following Black Monday, would you have reinvested in equities?
Well, from October 21, 1987, until December 4, 1987, the S&P 500 lost –13.34%.1 Would fear have taken over once more, and would Emotional Market Timing lead to you selling all of your stocks again?
Interestingly, one month after the December 4, 1987 low, the S&P 500 returned 14.3%.1
Furthermore, three months, six months, and one year after December 4, 1987, the S&P 500 returned 19.4%, 19.0%, and 21.4%, respectively.1
If hypothetically, on Friday, October 16, 1987, the trading session before Black Monday, you invested in an investment that was able to generate the returns of the S&P 500, and the very next session the market crashed, you would have recovered all of your losses on a total return basis by June 22, 1988, which is a little over eight months.
In fact, 26 ½ months later, on December 31, 1989, the S&P 500 earned an annual compounded return of 14.74%, despite the punishment it took on Black Monday.1 We must stress that each market will be different in severity and length of a downturn and past performance is not indicative of future results.
However, historical evidence may suggest that employing Emotional Market Timing could lead to poor results. Clearly, events similar to the Stock Market Crash of 1987 will typically magnify the volatility in the markets.
It is natural for investors to get nervous.
However, because the markets will generally rise and fall in cycles, typically moving in large chunks and many times in what we consider short periods, Emotional Market Timing may not be a prudent strategy to employ.
(1) Bloomberg and Dunham & Associates Investment Counsel, Inc.
(2) Facts on File
Investments are subject to risks, including possible loss of principal. Investors should consider the investment objectives, risk factors and expenses of any investment carefully before investing. Diversification does not guarantee profit or ensure against loss.
The S&P 500, or the Standard & Poor’s 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 Index components and their weightings are determined by S&P Dow Jones Indices. It differs from other U.S. stock market indices, such as the Dow Jones Industrial Average or the Nasdaq Composite index, because of its diverse constituency and weighting methodology. It is one of the most commonly followed equity indices, and many consider it one of the best representations of the U.S. stock market, and a bellwether for the U.S. economy. You cannot invest directly in an index.
A bull market indicates a sustained increase in price, whereas a bear market denotes sustained periods of downward trending stocks - typically 20% or more. The term “bull vs bear” denotes the ensuing trends in stock markets - whether they are appreciating or depreciating in value - and what is the investors’ outlook about the markets in general. Bull markets generally coincide with periods of robust economic growth; investor confidence is on the rise, employment levels are generally high, and the economic production is strong. During the bearish phase, companies begin laying off workers, leading to a rise in unemployment and, consequently, an economic downturn.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market.
All examples are hypothetical and are for illustrative purposes only. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues. The solution for an investor depends on their and their family’s unique circumstances and objectives.
Information contained in the materials that are included in the Bull & Bear in a CloudSM Marketing Campaign is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information. This document is provided for informational purposes only and should not be construed as individual investment advice.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/ Dealer. Member FINRA / SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.Subscribe to the Dunham Blog