Work in finance long enough, and you’ll hear the war stories. 1987 Black Monday, 1997 Asian financial crash, 2000 dotcom bubble burst, 2008 mortgage crisis. More recently, I remember the crazy few weeks in February and March of last year when the S&P 500 declined by 34% because of the COVID-19 pandemic.
In most asset management firms, investment banks, etc. there are TVs mounted to the walls tuned to CNBC or Bloomberg all day long, so it is impossible to escape the endless firehose of financial news. Purveyors of that news know their business. They are in the business of selling advertising, and nothing sells ads like breathless, can’t-look-away coverage.
It has been a weird year in financial markets. Meme stocks like GameStop and AMC Theaters traded untethered from any relationship to the underlying business fundamentals, part of an entertaining “slobs versus snobs” storyline pitting the denizens of Reddit’s Wall Street Bets community against the pedigreed hedge funds Melvin Capital and Citadel. A classic short squeeze. Another weird story has been Non-Fungible Tokens, or NFTs. People have spent absurd sums of money on jpeg images of pixelated monkeys. Underpinning all of this is the Fed’s “accommodative” monetary policy. When the Fed starts buying up NFTs, then we’re really in trouble.
The point of all this is that sometimes I get the feeling that we’ve entered the “silly” phase of the market cycle. I could be wrong, of course. A famous aphorism is “the market can stay irrational longer than you can stay solvent.” And yet, I still find myself wondering how much longer we can persist like this. The answer is: for a longer time than you think, and for a shorter time than you hope.
The Stoic philosophers had a mental habit of negative visualization, or futurorum malorum præmeditatio (pre-studying a bad future). The purpose of this exercise was to meditate on negative outcomes that are common in real life, and to desensitize one to real life losses or setbacks that routinely occur. It also had the effect of inducing a feeling of gratitude for the things or advantages one enjoys in life. When Roman soldiers returned home from a successful campaign, the joy of their victory would be tempered by the aide whispering in their ear “Remember that you are mortal.” If this seems odd to the modern American, it is because our culture has conditioned us to be so relentlessly positive. The disease can always be cured; the obstacle can always be overcome; the market only goes up.
I have tried to employ this technique of negative visualization in thinking about investments. In doing so, my hope is that I can control my emotions and avoid making bad decisions when the financial news is blaring the end of the world. I try to imagine how I will feel on that day which is surely coming when I log into my portfolio and see that the value has declined by 20%, 30%, 50%. Will I have a queasy feeling in my stomach? Will I want to panic and sell, thereby realizing an actual loss rather than a paper one? In trying to visualize how I will feel when things go badly wrong, I hope I can maintain some level of calmness when they actually do.
Calmness in the face of crisis is a state of mind that is enviable and hard to maintain. Humans are primarily driven by fear and greed. In a market crisis, fear prevails. It builds on itself and causes otherwise rational people to make bad decisions. Those folks who gave into their fear and sold out in March 2020 probably missed out on the subsequent 76% rally. If more people took the time to really visualize and anticipate how they would react when things go south, they might be able to protect themselves from making decisions based on fear.
The next crash is always coming. It may not be this week, or this year, or even the year after. But it is coming. It must be so. The only way for positive future returns to exist is for asset prices to be chopped down every so often. The key question to ask yourself is: what will you do when the next crash comes? You can safely be assured that you will not see it coming. People who are paid many hundreds of times what you are, who live and breathe the markets every day, cannot see it coming. You can only control how you will react to it when it does come. Visualize today how bad it can get, and what you will do when it happens.
Excellent points. Thanks