Educating, Protecting & Empowering the Investor

The day of capitulation arrived last week. What is capitulation and what do I mean?

 

Imagine a rollercoaster that represents the fluctuating market. As you leave the gate you slowly climb and climb. And as you do, you feel a sense of excitement and thrill. This is synonymous to a rising market. You start out feeling optimistic and as the market keeps rising you feel a thrill. Money you have invested keeps rising and you are feeling richer and richer. Even when the market makes small dips, it quickly rises once again. It’s thrilling and you’re feeling really smart. This can go on for a long time and actually reach a point of euphoria. This was last seen at the top of the Tech Bubble in 1999 and top of the real estate market in 2006.

 

Now…think for a moment; this feeling of euphoria and feeling this thrill and feeling so smart. Was this the best time or the worst time to be investing in those particular markets? The worst, right? Actually, the way we put it is it was the “point of maximum financial risk.”

 

Moving on… markets start declining. Well the last time that happened, there was a quick dip and the start of another rise. But this time, the market falls a little further creating some anxiety on your part and a little concern. But low and behold the market rebounds, but not higher than the top, just a bit lower.

 

And then it drops again and you feel more anxiety, but you think; “my portfolio or that stock was worth “X”, I’ll just wait until it gets back and then I’ll sell”. We would say at this point that you are in denial. The trend has obviously started to change but you have not re-adjusted in your own mind. So as I said, you’re in a state of denial.

 

Now the market drops again and you start to feel fear. The high which was hit 6 months ago is now a distant memory, but you do remember the value at that time. Who doesn’t know the approximate value of their home at the top of the market back in 2006?

 

You start to realize that denying what is going on in front of you is a mistake but you now are suffering from what psychologists call “loss aversion”. This is the human characteristic of feeling greater pain for a loss than the pleasure you would feel for an equal gain. But we FEEL more pain for the loss.  So you don’t sell. And your investment continues to decline.

 

Now you feel desperation. Your mortgage is worth more than your house. Your retirement is just a few years away and you’re worrying about not having enough. Desperation is starting to settle in.

 

And the market declines more and gets nasty. Selling begets selling. The media is rife with tales of woe and talk of terrible times ahead. Desperation turns to panic and panic turns to capitulation.

 

Capitulation. Defined as the act of surrender or giving up. It’s the last straw, so to speak. This is when you call your broker and say. I can’t take it any more, sell everything. The market is declining at a fast pace, everyone is selling and you imagine your comfortable life slipping away from you forever. You sell everything.

 

I have experienced this twice in my career. I remember vividly the day I got the call. This was in 2002. My client had a conservative portfolio with perhaps 50% invested in diversified stock mutual funds. The rest were in bonds and other safe investments. We had talked many times and I had calculated a worst case “what if” scenario every time. What if the stock market declined by another 20%? How would it affect your net worth? Is this acceptable to you? Could you sleep at night? No? Let’s reduce, while the market is still higher, your stock exposure to 35%. Now, if the market declined another 20%, your entire portfolio would decline about 7% is that okay? Yes.

 

And the market still declines. Two weeks later, another call. I’m losing sleep. Okay let’s reduce your stock exposure again. To 20%. Now if the market goes down another 20%, you’ll lose just 4% okay? Yes.

 

Then on October 9^th of 2002 it got very nasty— the Dow hits its lowest point.–7,286. I get the call; Sell everything I’m going into CD’s. I can’t take it. I beg and plead to stay the course to no avail. I sell.

 

No one knew it at the time but it was the bottom of the market. And these people have capitulated. After that, the market rose to 14,000 in 5 years. Almost double the low hit in October 2002. That’s about 14% a year.  CD’s yield 3%.

 

Was this terrible time in the market the best or worst time to invest? The media is filled with dour news. Scary stories abound about huge companies on the brink of bankruptcy. The government sends us a stimulus check to ease our pain. You would have to be very courageous or a little nuts to invest when things seemed so bad. But alas…. it was the best time to buy. It was the point of Maximum Financial Opportunity.

 

Remember we are on a roller coaster and now we are at the bottom. The scary stuff is getting ready to end and the roller coaster car is turning up once again. The market is going higher.  We feel a little optimism and excitement and anticipation. As we climb higher we feel a thrill of where we are and what is to come. We feel smart once again and think we can see ourselves living our best financial lives ever. Euphoric and everything is wonderful.

 

Then there’s a dip. Here we go again.

 

What would you do this time?