Managing Emotions Amid Volatility

Good Evening:

“People are like stained-glass windows. They sparkle and shine when the sun is out, but when the darkness sets in, their true beauty is revealed only if there is a light from within.”
— Elisabeth Kübler-Ross

Nothing is entirely predictable. The German physicist Werner Heisenberg, who came up with the Uncertainty Principle, discovered that even if every single initial condition is known, it is still impossible to predict with any fixed certainty the behavior of waves and particles. Likewise, chaos theory explains how even things on a bigger scale, like weather and the stock market, are not entirely predictable. They can’t ever be. Similarly, neuroscientists have shown us that the structure of our brain, and the nerve cells within it, also act with elements of randomness. A key defining feature of the universe is uncertainty. There is always a space for change, for the unknown. The universe and markets are an ever-evolving possibility.

In investing, it’s easy to be grateful for the power of markets when things are going well. But when the tide breaks against an investor—it happens to even the most seasoned veterans—how do we grow from the experience? Challenging markets can strengthen us.

We learn things about ourselves our portfolio, our risk profile, and goals in down markets that we never could have learned in bull markets. What lessons do we learn? How do we not complain about things outside of our control, but rather see the positive in what ended up happening, and use that information to make better decisions moving forward? Behavior in challenging markets is what sets investors apart. Some of the greatest returns in history have originated in anxiety-filled markets.

It has been same old, same old. The market finished another week lower, its 11^th negative week in the last 12, after some of the most overwhelming selling in history. The Federal Reserve implemented its largest interest rate hike since 1994, taking the threat of inflation seriously by intensifying its campaign against surging prices. Another 75-basis point hike—or a 50-bps move—is also in the cards for the meeting in July, according to Chair Jerome Powell. The uncertainty continues as inflation chugs along. This uncertainty feeds investors’ anxiety. We work in a stubbornly uncertain market, and we must deal with that.

Wars, sky-high inflation, recessions, bubbles, 100-year pandemics, geopolitical events, policy mistakes, and more have all happened over the years, but stocks have always come back eventually to new highs. The challenge is getting there, sitting through the pain, and identifying the right opportunities. How many times have we heard people talk about past bear markets as blessings in disguise? Many of the hard things in life arrive with lessons or silver linings or a welcome new perspective. When the downturns come, what will you put into the vessel for the future?

Amid these challenging markets, after another brutal week, we asked four of our research heads for their favorite thoughts on managing emotions and using down markets as growth opportunities. Here’s what they said:

• Mark Newton, Head of Technical Strategy: I find it essential to strip out as much emotion as possible by utilizing technical analysis as opposed to be relentlessly focused on earnings, economy, or FOMC leanings. Second, get a feel of the bias in the markets. Many times, when investors all feel the same about a certain situation en masse, trends could be apt to reverse course. Thus, having a handle on what sentiment is saying about the market and developing a system toward understanding whether it’s reached bullish, bearish, or capitulatory type readings, can be helpful toward understanding when it might be healthy to consider betting against the trend.

• Brian Rauscher, Head of Global Portfolio Strategy and Asset Allocation: We hear, “When the market is exuberant, we want to be careful, and vice versa.” Sometimes, you must throw analysis out the window. Tops and bottoms are made by fear and greed. At every major top, markets have been overvalued. At every major bottom, markets have been undervalued. Long-term, I believe markets are driven by corporate earnings. Bottom line: you should have a system and stick with it to be disciplined. Using tools to remove not all but good portions of emotion is important, though having some degree of subjectivity is important. Also, wait for your opportunities. As I’ve grown older, I’ve learned how patience helps. Markets overshoot to both sides, which creates challenges, but opportunities as well. Proper sizing and rebalancing are critical actions. Another thing: there’s almost always going to be a bull market in something. People have regret, “Oh, I shouldn’t have missed out on that.” Guess what? The market will always be here. Miss on something? Big deal! Show up and look for the next one.

• Adam Gould, Head of Quantitative Research: With quant, I don’t use emotions. So, trust your plan, trust your models. As good as your plan might be, sometimes you’re going to underperform. You want to have a plan and stick to it. Know your limits and principles. My model, for example, had a great couple of months, and it’s struggled a little in June. I’m not going to suddenly change it. It happens. Do you have the courage to stay the course? Say you’re invested in Bitcoin. How do you look at that and not get upset? You can’t. It’s about staying the course.

• Sean Farrell, Head of Digital Asset Allocation: Letting emotions guide your decisions will ultimately result in untimely exits and entries. It is critical to remember that generational wealth is more often created during market downturns as opposed to trend following. This is especially important to remember in crypto. We encourage clients to become the critical-thinking investors they are, honestly assess their personal risk appetite and near-term liquidity needs, and place longer-term, deep-value bets during price drawdowns such as this one.

Wishing everyone an enjoyable weekend and a restful Juneteenth holiday,

FSInsight Team