What is fascinating when reflecting on the great recession has little to do with bank leverage or sub-prime mortgages. Nor should one be distracted by the controversy of government bailouts — though this topic promises to occupy economists for some time to come. Rather, it is precisely the human capacity for irrational behavior that is to be focused on. And, while there was severe panic that bloomed during the downturn in 2008 — when the Dow and all other major market indices collapsed — it is the activities of investors that are beginning today which should be highlighted and studied.
There are a rare few, if you look closely enough, that stomached loss in such a way that they will never psychologically recover. But this constitutes a mere handful of personalities programmed as such who will at no time fully heal, not ever erase from their memories the losses brought on by a capital collapse outside of their control. For all others, therefore meaning the sweeping majority, the terrible pain experienced just a short few years back will eventually respond to time’s inevitable numbing effect. In fact, enough time has passed to see many having already forgotten. And while every investor responds with a varying degree of time exposure, we are today approaching a psychological threshold in markets.
Plainly, what is so truly notable about the great recession, what we must focus on if we have any chance at stopping the cycle of escalating booms and busts, is extremely granular and taking place in real-time before our eyes. During these recent days of higher highs and higher lows, we have begun to see the actual tipping point in the relationship between a) those capable of forgetting how much they lost just a little while ago (and moreover why they lost it), and b) time’s numbing continuum of healing. And, although it is the beginning of the crack, we can already notice its telltale signs in headlines, conversations, and attitude and allocation shifts globally.
Investors of the non-speculative type do have a certain capacity for patience and common sense — the residuals from lessons learned remain sufficiently to mitigate a rising market’s initial temptations. But for most, enough will soon become enough. Investors will eventually begin to ignore allocation policy en masse; they will exchange their more conservative and non-correlated assets for the opportunity at making more, doing “better”, or finally catching up. There is still a lot of dry powder for this market to consume. And when it does — when the cracks in allocation policy begin to widen — it will become an animal that feeds on itself, one so powerful many of the most disciplined investors and fiduciaries will even be tempted.
Today is an opportunity for investors to remember, to slow down and remind themselves of market history, of bulls and bears, of greed and fear. Now is the time to be aware of our human program, our innate and unfortunate tendencies toward buying high and selling low. We can continue to participate in the up-trend, fueling the boom from overvalued to hysteria, or we can look toward our allocation policies set in calmer times with balance and correlation at their core.
Admittedly, in some of life’s cases, we need the numbing effect of time to enable us to carry on. But not insofar as learning and improvement, particularly with regard to financial markets. Here we must not ever forget. Think of the fear brought on in 2008, think of what was learned from those losses, think of humbleness.
Sadly, the realities of human behavior are very strong and considerably hard to circumvent. With the Dow Jones Industrial Average near a non-inflation adjusted peak, and markets around the globe — including Japan’s Nikkei and many European markets – near their all-time highs, irrational behavior has commenced in earnest. And, despite this very effort to the contrary, when the wall of fear separating investors from excessive risk-taking is torn completely down by the continuing market trend, all-too-eager portfolios will succumb to the unstoppable momentum and undergo allocation shifts that in the end will result in great and painful capital loss, again, for the third time in just over a decade.