The S&P 500 index has been on a tear since reaching a bottom on 23rd March 2020, surging by nearly 43% to hit a high of 3232. Then it hit the ceiling and collapsed -5.81% today. What’s the matter? Why aren’t you using this opportunity to top up on your stocks?
The Bandwagon Effect
The reality is that fear is contagious and you are genetically programmed to follow crowds. The bandwagon effect is a cognitive bias whereby people think or act in a certain way, for no other reason than the belief that others are doing the same.
Look at this chart of the S&P 500 today:
Notice anything? The index opened lower at around 3110. However once people got the sense that there was fear in the market, like an inflatable with too much weight on it, people piled out of the stock market driving it down further and further.
Two days ago it was fear of missing out (FOMO) that drove the stock market. We were reaching new highs on the NASDAQ and Covid-19 looked to be disappearing. Today, 11th June 2020, Covid-19 looks set to re-surge and the Federal Reserve has informed us that the recovery might take a lot longer than expected.
There are definitely serious risks from both of these events. Investors who piled into stocks over the past 3-4 weeks have likely purchased at inflated prices. That being said, what I want to focus on here, is what you should be doing on days like today.
Buying and Selling Decisions – A Simple Rule
Never buy on an ‘up day.’
Never sell on a ‘down day.’
Seems simple right?
That’s interesting though because according to this chart investors have done the opposite today. They are doing the opposite right now, as I write this. There has been a 95% decrease in advancing volume, or the volume of stocks advancing today (39.40) versus a surge in declining volume (4322.44). See below:
In simple terms this means that there are 109.1 times more stocks declining, because they are being relentlessly sold, than there are stocks advancing.
Nobody is buying stocks today.
Which is why you should be buying stocks today!
Future Returns After 4%+ Daily Falls
The investing arm of Schroders did a great study on the returns of the stock market after major one-day falls. They compiled a chart of major one-day falls and then worked out the future returns after 1 year and again after 5 years. Here are the results:
Total returns after one year were positive in all but two years, and positive across the board after 5 years.
This means that investors who put money to work on those days (like we have today!) have generally seen strong 1-year returns.
The direction of the market
Nobody really knows what tomorrow will bring. We could very well have a second wave of Covid-19 infections. It is entirely possible that the Federal Reserve is right and we’re going to have a much slower, Nike-swish shaped economic recovery.
The government might stall on bringing in further relief funding and stimulus for the economy, which similar to 2008-9 could cause a second downturn in equity prices.
However, if you are selling today because fear and the desire to ‘lock in your gains’ has caused you to have this reaction, you need to stop and think about what you’re doing.
Unless you have a crystal ball you can’t predict what the future holds. So stop trying. Instead focus on managing your fear and emotions, and rationally, putting money to work when other investors are too fearful or worried to do so.
That’s why I am buying stocks today, on a big down day, because the future value of high quality businesses will be higher than today over the long term.