Greed and the fear of missing out

The S&P 500 is the leading US equity index and a powerful barometer of investor sentiment across the world. In September 2018, the market capitalisation of its companies was US$25.7 trillion – close to 30% of the global total. The S&P 500 fell by 19.8% over 65 trading days between 20 September and 24 December 2018, one of its biggest-ever falls outside of a US recession. Its market capitalisation fell by US$5.2 trillion over this period. This was a destruction of wealth, at least on paper, on a scale the world hardly ever sees.

Over the next 59 trading days the S&P 500 rose by 21.4%, and its market capitalisation gained US$4.2 trillion. Millions of investors worldwide were, suddenly, a great deal richer.

Much of the credit for the bounce-back in markets and investor sentiment has been attributed to the Fed – with Chair Jay Powell announcing a pause in the interest-rate hiking cycle at the end of January. But while this certainly boosted investor confidence, the rally began several weeks before Mr Powell opened his mouth. Why?

We believe the explanation is simple – the familiar companions of human fear and greed. Through December 2018, many investors sold stocks due to a rash of scary news headlines… reflecting fears about trade troubles, problems in China, US recession and other economic threats. Then, when markets began to rally after Christmas and into January, greed and the fear of missing out pushed those investors to begin buying again.

This episode demonstrates how short term thinking can hurt long term capital growth. Many of those investors sold after the market had fallen a long way, and only bought back in after the market had already risen. Their active trading through this period lost them money.

Looked at from a long-term viewpoint, we are not convinced that the fundamental drivers of global equities and earnings were very different between September, December and March. The US and world economies slowed a little over this period but long term growth prospects remained pretty much the same. If you plan to hold onto a company’s shares for 20 years, then the slight slowdown in global growth last year should not have affected your views much. Likewise, the milder noises from the US Fed this year should not have changed your view of things.

We suspect this US equity turmoil was driven by extremes of investor emotion on the way down and then back up. Furthermore, computers and algorithmic trading possibly magnified the market behaviour.

Our goal as investment managers is to take a long term view of economies and financial markets. Last quarter, we thought that the world’s economic fundamentals were basically sound, and that equity markets would recover. So we resisted the hype and didn’t sell during the December panic – indeed we picked up a few bargains along the way – and we were able to bank some profits as the rally continued into March.

We still think that the global economy is in fair shape. Quite likely, though, a long grind lies ahead before it levels out and growth picks up again.