Market ups and downs over the course of the pandemic offer important lessons about how investors can psychologically prepare themselves for unexpected events.
The quick read
Investing is usually about looking towards the future, but with vaccination programmes proving effective, there is now an opportunity to reflect on the past 18 months.
There are many lessons for societies to learn about how to respond to the next pandemic. Similarly, investors should take stock of what it has felt like to be living through such a significant time.
How did the events of the past year affect investors’ emotions, and what might they teach us about how to act in the future?
A recap of the last year
In early 2020, it became apparent that the COVID-19 was fast becoming a once-in-a-generation shock. Stock markets around the world reacted, with major indices experiencing drops that were even more severe than those of the Global Financial Crisis of 2007/8.
However, governments and central banks reacted quickly. The support that they injected into the world economy helped stock markets rebound. Between the end of March and the start of June in 2020, the S&P 500 Index of large US companies experienced the greatest 50-day rally in its history1.
In fact, the picture was slightly more nuanced. The share prices of many so-called “cyclical” businesses recovered much more slowly than others. The companies whose value rebounded fastest were large technology businesses whose revenues weren’t badly hurt by the pandemic (or who benefitted from the rapid changes). Many of these businesses saw their revenues grow as people shopped online, worked from home, or entertained themselves digitally while confined to their homes by lockdowns.
Then, as vaccines were announced in November 2020, markets entered another phase. As investors grew hopeful that the end was in sight, many of them ‘rotated’ from the businesses that were beneficiaries of the pandemic into those that stood to gain the most from economies re-opening once more. As a result, stocks in sectors such as air travel, tourism and hospitality saw a resurgence.
Fast forward to today, and the picture is more mixed. Global stocks are close to their record highs, but increasing evidence of rising inflation and the eventual withdrawal of economic support packages mean that there are once again questions about the future.
What was the emotional impact?
Research shows that investors became pessimistic about the future during the early months of the pandemic2. This led many of them to step back from markets due to the uncertainty, as their perception of the long-term risks changed.
Then, as markets recovered in the spring and summer of 2020, another phenomenon emerged. The mood became more positive as people saw the market recovery taking place and felt the urge not to miss out.
The optimism even led new investors to enter the market, often through user-friendly apps that allow people to buy and sell stocks cheaply and simply. Research shows that this became a self-fulfilling cycle, as the media coverage of this new trend-led more amateur investors to get involved3.
So how should investors respond in the future?
Tempting as it can be to react to short-term events, investors need to recognise that their first impulse can be misleading. There’s plenty of evidence to suggest that trying to time the market (by selling when things look frightening, or buying when things look more positive) can be costly4.
Instead, it’s important to have a long-term plan, and to invest in a diversified mix of investments that is designed to weather the inevitable ups and downs in markets.
“Every decision requires not just knowing what the right answer is – we also have to be emotionally comfortable with that answer. And we have to stay emotionally comfortable as things are changing around us,” says Greg Davies, Head of Behavioural Science at Oxford Risk.
He adds that humans are hard-wired towards activity in times of stress. Even if the best thing to do is just wait, we all tend to want to do something in response – a phenomenon that psychologists call the ‘action bias’.
He adds: “You may be in the perfect portfolio, but as markets go up and down, you’re getting constant signals into your emotional brain that lead you towards nagging doubts. Those nagging doubts make you want to do something, because we’re all much more comfortable doing something in times of stress than ignoring it.”
Instead, speak to a St. James’s Place Partner. They can help you to understand the risks and design a plan that is tailored to you and your personal goals. By talking with you about any worries or concerns that you may have about the future, they can help you feel more settled about your financial wellbeing.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and the value may fall as well as rise. You may get back less than the amount invested.
1 LPL Financial Research, June 2020
2,3 Frontiers | The Investor Psychology and Stock Market Behavior During the Initial Era of COVID-19: A Study of China, Japan, and the United States | Psychology (frontiersin.org), February 2021
4 Flattening the Illiquidity Curve: Retail Trading During the COVID-19 Lockdown by Gideon Ozik, Ronnie Sadka, Siyi Shen :: SSRN, May 2021