32Behavioral Finance and Market Corrections

All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.

Warren Buffett

Market panics and the subsequent bear markets occur in a few fairly predictable steps. First, there is a trigger to the panic. Most recently we had the coronavirus panic. But there are others as we know: the crash of 1987, the Asian crisis of 1998, the collapse of Lehman Brothers during the popping of the housing bubble in 2008–2009. In these cases, stock markets fall rapidly and, often, unexpectedly. Other assets including risky credit, real estate, commodities and others also fall. Then investors want cash and sell good assets to raise cash. More market pressure on the downside. Potential buyers get spooked and decide to wait to buy. The “negative” animal spirits pattern takes over and a recession is typically the result. What happens during these times, from a behavioral finance perspective, is what will be covered in this chapter. The proper course of action is to stay invested through panics; markets can and do recover.

The Most Recent Panic

With the price action on March 20, 2020, the U.S. and global equity markets moved into a “bear market” (20% or greater loss) due to the novel coronavirus. At the time, all signals were that the U.S. would have at least one quarter of negative GDP. In just over a month, the market traded off about 35% from its peak on February 19, 2020. The headlines ...

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