BLOG: Why a fearful market can create opportunities for investors
Emotional biases sit deep in our psyche and, in many cases, have served us well in an evolutionary sense. Fear, for example, has played a central role in the ‘fight or flight’ response, which has helped protect humans from predators.
In modern life, while predators in the wild are less of a threat for most humans, fear is still a very real emotion and impacts our judgement and the choices we make in situations, for example amplifying perceptions of risk.
This is understood by those looking to influence decision makers, such as marketers and politicians. Look no further than Donald Trump’s campaign in the US, where the focus is on the fear of immigration, the fear of China’s economy and the fear of gun laws being tightened (gun ownership itself is partly driven by fear for personal safety). Closer to home, the risks of Brexit have risen largely owing to the increased fear of immigration.
So, feeding fear can increase the chance of a desired action but, in many ways, this is nothing new; fear has always been one of the more powerful emotions. Perhaps it’s more easily manipulated in an environment of low growth (our base case scenario for some years now), where fears of recession and economic security become a central issue for many.
Fear has been the overriding characteristic in markets this year, as investors worry about a slowing China and the growing chance of a recession in the US. It would be too simplistic to sweep the negative sentiment aside and argue that the moves downwards were driven solely by fear and are therefore unwarranted.
Financial conditions remain tight, for example stressed US high yield markets and a strong US dollar. A key concern is that this forms a negative feedback loop. Just as confidence is a very important driver of business and credit cycles, so is fear – if investors fear a recession for long enough, it will come about.
Talk in policy circles has been dominated by what is the most effective circuit breaker to this ‘doom loop’. The G20 meeting of finance ministers towards the end of February might produce some attempt to soothe fears over currency wars, and more specifically, uncertainty around the Chinese currency. Then there are the scheduled upcoming central bank meetings or, if it becomes more urgent, unscheduled ‘coordinated’ action.
In the meantime, as ever, we try to minimise the impact of such emotions on our decision making. We focus on the underlying raw data rather than the juicy headlines when trying to understand the environment, and we look to construct portfolios around a number of scenarios, rather than allow overconfidence to deceive us into thinking we can predict the future accurately. Likewise, overconfidence commonly leads to misguided conviction at a stock level, so we scale positions based on their contribution to risk, rather than personal conviction.
However, it’s not just about minimising risk, it’s also about ensuring we take the right amount of risk, and an over fearful market can throw up opportunities in parts of the equity and bond market for those investors looking beyond the emotion.
Anthony Rayner is a fund manager at Miton