Sam Sivarajan is a wealth management and fintech executive with a doctorate in behavioural finance. He is also the author of Money Talks: Lessons from Canada’s Wealthiest.
In September, 1946, in his Address on Unified Co-operation in Europe, Winston Churchill asked, “Is the only lesson of history to be that mankind is unteachable?”
In the past week, bystanders saw history repeating itself with the Russian invasion of Ukraine. The largest ground war in Europe since the Second World War has everyone anxious and uncertain. As fellow citizens of the world, we can, and should, be emotionally moved by the events taking place in Ukraine. But, as investors, reacting emotionally can only harm one’s portfolio. It is important for investors to separate their heart from their head. Of course, you can follow your heart to use ESG criteria (environment, social and governance) to choose investments that meet your personal values, and still use your head to avoid impulse buy/sell decisions based on headlines. After all emotions change, and often, but investment decisions are, or should be, based on long-term strategic goals.
Human beings do not like uncertainty. In behavioural science, this is known as ambiguity aversion – we prefer options that promise a certain outcome versus options that offer an uncertain, even if more favourable, outcome. Loosely related is another concept known as loss aversion, discovered by Nobel-prize winner Daniel Kahneman, and Amos Tversky. Given the choice of a sure win of $100 or a 50 per cent chance of winning $220, people preferred the certainty of a $100 gain. Conversely, however, given the choice of a sure loss of $100 versus a 50 per cent chance of losing $220, the same people preferred the uncertain outcome. This means that for gains, we are typically risk averse; for losses, we are typically risk-seeking. Because, in the latter case, there is still the possibility of not experiencing loss at all.
Stocks have overcome short-term events
to move higher
Growth of US$10,000 in the S&P 500 index,
Dec. 31, 1940 to Dec. 31, 2021
Plotted on a logarithmic scale so that comparable
percentage changes appear similar.
$76,503,719
2/19/20
COVID-19
pandemic
Average annualized
return: 11.67%
$1`0,000
9/11/01
10/19/87
12/7/41
11/22/63
Pearl
Harbor
Kennedy
assassination
Financial
panic of
1987
Sept. 11
terrorist
attacks
1940
‘50
‘60
‘70
‘80
‘90
‘00
‘10
‘20
This graph represents a hypothetical US$10,000 investment in the
S&P 500 index, an unmanaged index of common stock performance.
You cannot invest directly in an index.
the globe and mail, source: putnam investments
Stocks have overcome short-term events
to move higher
Growth of US$10,000 in the S&P 500 index,
Dec. 31, 1940 to Dec. 31, 2021
Plotted on a logarithmic scale so that comparable
percentage changes appear similar.
$76,503,719
2/19/20
COVID-19
pandemic
Average annualized
return: 11.67%
$10,000
10/19/87
9/11/01
12/7/41
11/22/63
Sept. 11
terrorist
attacks
Pearl
Harbor
Kennedy
assassination
Financial
panic of
1987
1940
‘50
‘60
‘70
‘80
‘90
‘00
‘10
‘20
This graph represents a hypothetical US$10,000 investment in the
S&P 500 index, an unmanaged index of common stock performance.
You cannot invest directly in an index.
the globe and mail, source: putnam investments
Stocks have overcome short-term events to move higher
Growth of US$10,000 in the S&P 500 index, Dec. 31, 1940 to Dec. 31, 2021
$76,503,719
Plotted on a logarithmic scale so that comparable
percentage changes appear similar.
2/19/20
COVID-19
pandemic
Average annualized
return: 11.67%
9/15/08
12/17/90
$10,000
Lehman
bankruptcy
Gulf War
ultimatum
12/7/41
6/25/50
11/22/63
9/11/01
8/9/74
10/19/87
Pearl
Harbor
Korean
War
Kennedy
assassination
Nixon
resigns
Financial
panic of 1987
Sept. 11
terrorist
attacks
6/23/16
Brexit
1940
‘50
‘60
‘70
‘80
‘90
‘00
‘10
‘20
This graph represents a hypothetical US$10,000 investment in the S&P 500 index, an unmanaged index of common
stock performance. You cannot invest directly in an index.
the globe and mail, source: putnam investments
Uncertainty and emotions combine to drive investor behaviour. Researchers have found that, in conditions of certainty, a low-emotion prize (such as cash) is preferred to an emotion-rich prize (a kiss from your favourite movie star, for example); however, in uncertain conditions, this preference is reversed.
How does this phenomenon affect investment decisions? Research suggests that an emotionally charged positive view of a company increases the return expectations for that stock. A negative view of a company leads to lower return expectations. This leads to a sell-off that further reduces the price of the stock, and from that lower base, increases future returns. A classic example is from studies of “sin stocks” (tobacco companies, for example, can generate emotionally charged negative sentiments in investors, thereby reducing interest and investment), which showed that subsequent stock price returns outperformed the market.
An emotional response to the Russian-Ukraine situation may prompt investors to flee the stock market indiscriminately. The S&P 500 opened 2 per cent lower on news that Russia had launched an offensive against Ukraine, although the markets have since recovered. Despite the volatility that results from this conflict (quite separate from concerns about general valuation, etc.), any short-term correction will form the basis for strong future investment returns. Certainly, history shows this. When Nazi Germany invaded France in 1940, what is today known as the S&P 500 fell by 18 per cent between May and June of that year; but ended up more than 5 per cent a year later.
Similarly, in the tense months before and during the Cuban Missile Crisis, from August to October, 1962, the S&P 500 dropped almost 10 per cent, but finished up almost 16 per cent a year later. The U.S. invasion of Iraq in 2003 saw the S&P 500 drop about 2 per cent in a couple of weeks but power up 35 per cent a year later. These are all perfect examples that trying to time the market rarely works – which is why most investors in stocks are strongly advised to have a long-term investment strategy so that they can avoid the perils of reacting to short-term emotions.
It is human to crave certainty. While we don’t yet know the outcome of this current conflict or the final toll in terms of lives and destruction, as investors we can be certain that people will still need food, energy, clothes, cars, computers, travel, hospitality, etc. The producers and manufacturers of these items will still have customers – meaning that investors in those companies can take some comfort in the certainty that the laws of demand and supply will help good companies survive, and thrive, after this conflict.
As citizens of the world, let’s push for a speedy and peaceful resolution of this conflict. As investors, let us remember Warren Buffett’s adage of being “fearful when others are greedy, and greedy when others are fearful.”
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