Fisher Investments Editorial Staff
Investor Sentiment

Fear of Heights

By, 06/09/2009
   

Story Highlights:

  • As of last Friday, the S&P 500 notched 11 positive weeks out of the last 13—a 38% gain.
  • When stocks rise too fast, we worry stocks must fall. And since humans hate losses more than they like gains, the fear of downside dominates.
  • Some of the market's steepest gains—and greatest downside fears—happen in the first year following a bear market.

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Most investors would agree the last few months felt pretty good (at least those who weren't short). As of last Friday, the S&P 500 notched 11 positive weeks out of the last 13—a giddy 38% gain since the global March low, pushing the index into positive territory for the year. But as markets hesitated Friday despite a better-than-expected employment report, and were mixed Monday, that feel-good mood is turning into gloomy caution. This is the proverbial "wall of worry." 

Investing is no short of an emotional rollercoaster—even during bulls. Humans handle slow and steady better, not surges. Surges hurt our brains and make us fearful. When stocks rise from market lows, investors gradually regain confidence and begin buying again. Markets climb, and initially, investors greet higher prices with glee. But human psychology soon takes over. Our innate fear of heights—an instinct for survival—pulls us down from our emotional highs. New higher prices scare us, especially if prices move higher and faster than expected. Investors fear there must be a reversion to the mean—that stocks must fall. And since humans hate losses more than they like gains, the fear of downside dominates.

But investors should take comfort knowing some of the market's steepest gains—and greatest downside fears—happen in the first year following a bear market. First-year S&P 500 returns following true bear market bottoms, from 1932 to 2002, average an astounding 45%,* yet sentiment is almost invariably fearful and negative. Even today, investors fret over risks (inflation, government debt, too low interest rates, rising interest rates, the dollar, the next asset bubble, the Fed, China, housing, banks—you name it) more than they celebrate gains. The terms "head fake," "sucker's rally," and "dead cat bounce" make their way into mainstream media. But historically, there have always been risks and doubts during economic recovery, and the economy and stock market have recovered just fine. 

Economic and market recovery will not happen in orderly fashion, despite human nature's preference for it. During initial market rises, price movements—up, down, or sideways—will all induce short-term unease. But stocks, unlike humans, don't remember what they've done and where they've been, and can generally keep rising for much longer than we think. Heights can be scary—but the longer stock prices climb, the more likely this rally has staying power.

 

 *Source: Global Financial Data

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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