Humans love to think of themselves as incredibly logical actors. The truth is, we're hopelessly irrational animals. Just look at these markets for proof.
In little more than a year, the S&P/TSX composite index soared 30 per cent, propelled by a peculiar case of amnesia. Amid warning signs that the European economy was sputtering and that China's lending boom had run its course, investors kept piling into Canadian stocks.
The same is true in myriad other markets. Take oil prices, which hung in around $100 (U.S.) a barrel no matter what happened in the Middle East or how many new barrels came onstream in emerging plays such as the Bakken.
Now investors are acting as if the world is imploding, and all it took were some predictions of a market peak.
Here's some logical advice for everyone who's panicked: We've been here before; we got through it then; we'll get through it now.
Remember the summer of 2011, when the United States had its debt downgraded and the S&P 500 tumbled 17 per cent in two weeks? How about July, 2012, when Spain's 10-year bond yields skyrocketed to 7.6 per cent amid fears that countries on the euro zone's periphery couldn't control their spending? In every case, investors freaked out.
Yet somehow we survived.
Above all else, that's the most important story of this rocky recovery. Our progress can be frustrating, because it often feels like two steps forward, one step back. But we manage to improve. Although there is a lot of noise, unemployment rates in Canada and the U.S. keep falling.
This is all very normal in the grand scheme of things. Throughout history, full-blown recoveries from horrible financial crises have always taken much longer than expected, according to research in the seminal book This Time Is Different. The last crisis turned ugly in late 2007, and seven years of uncertainty can seem like forever, but history proves otherwise.
If anything, these red alerts can be helpful, because they force craven policy makers to stop caring about political calculations. People typically don't like tax and fee hikes, but they'll stomach them if it means the markets will be okay. Funny things, these irrational minds of ours.
To stay focused, remember that we've seen this all before. By now the meltdown playbook is pretty obvious. Investors panic and then flock to safe havens such as U.S. Treasuries. As fear spreads, politicians come forward and promise to do whatever it takes to fix the key problems. Eventually investors realize corporate profits haven't suffered too badly, so they start buying stocks because they need better returns than those offered by the bond market.
The latest correction is ugly, no doubt. It is especially scary because this can feel like uncharted territory. Few fundamental investing theories hold up in this era of rock-bottom interest rates, fuelled by central banks flooding the world with money.
But there is one truth that is universal: Nothing goes up forever. Which is why the market had to correct at some point. Keep that in mind the next time you look at Canadian house prices.