This too will pass

Market and finance commentators have expended enormous energy writing on the subject of the collapse of Silicon Valley, Signature and Silvergate banks, and the subsequent challenges faced by Credit Suisse. And equally expert commentary will soon speculate about who’ll be next and then about those that subsequently do collapse (First Republic Bank anyone?)

Commentary has spanned the subjects of why it happened (lack of regulation, rising rates, Private Equity funding drying up for customers, poor risk management, bank equity being massively leveraged, interest rates x duration), whether better regulation of smaller U.S. banks is necessary (yes, when there are 5000 banks), whether the U.S. Federal Reserve’s 12 reserve bank branches, which regulate the banks in their districts should have bankers from the institutions they regulate on their boards (no), and even whether the Fed should be fired and banking treated as a public utility rather than a profit-motivated corporation (perhaps).

Precious little however has been written about investor behavior before, during and after the events, and arguably those that are still underway.

Have a quick look at the changes in price for some of the U.S. regional banks from daily highs to next the day’s low and back again during the last few days; Fifth Third Bancorp fell as much as 30 per cent on March 14, before jumping as high as 34 per cent the next day, and falling as much as 18 per cent the day after. Bar Harbor Bankshares fell 20 per cent and then bounced 25 per cent over five days. Meanwhile, First Republic recorded a 52 per cent share price range on March 10, the same day it closed 15 per cent above its open.  It then fell as much as 76 per cent the following day.

Why do those without proper information trade at all?

Now, some might point out that in a financial world virtually defined by an uneven distribution of information, the consequent vacuum created is the reason for the wild volatility. If that’s true it prompts the question; why do those without proper information trade at all? Why do they buy or sell? 

Part of the answer is that many are just punting – taking a bet there will be a bounce in the share price, that others are wrong, and they do this knowing they have incomplete information. It’s just a bet for them. Some investors, as opposed to traders however, are trading out of fear – fear that losses already accumulated could worsen. In order to prevent the pain from becoming worse, or complete, they realise the losses hitherto experienced. It’s referred to as Myopic Loss Aversion.  The more often an investor looks at their share portfolio (online for example), the more likely they are to see a loss or a potential one, spurring turnover.  And this is despite research from the likes of professors Brad Barber and Terrance Dean showing those who trade the least make the most and vice versa.

While countless investors and mountains of research have demonstrated the biggest rewards accrue to those who stay the course, the reality is that doing so isn’t always easy. A planned long-term investing mindset can quickly give way to unrestrained panic when the unexpected befalls even the most prepared.

In situations such as we are currently enduring, investors can quickly lose sight of this reality. Faced not only with the demise of some regional and industry-concentrated mid-tier banks, but also with record inflation, rising interest rates, and geopolitical unrest, it’s only natural for investors to want to act. To do something.

Doing something is surely better than doing nothing, right?

Not always. In fact, not very often at all. Sometimes sloth is the very best strategy. You may get rich buying and selling but you only get wealthy buying and holding.

Is buying and selling the answer?

For the twenty years to August, 2022, the Russell 2000 index recorded a 463 per cent return. Missing just the ten best days saw that return fall to 164 per cent. Can you be sure your buying and selling will result in you missing the worst days and experiencing the best days? Unlikely. But hope springs eternal.

Moreover, according to Plancorp, the chance of the S&P500 falling over the course of a day is about 45 per cent.  The chance of it falling over a one-year period is just over 20 per cent, and the chance of it falling over a five-year period is about 10 per cent.

Think about it another way; Why should what is happening amid U.S. regional banks right now have anything to do with, for example, the rate of store openings by Lovisa (ASX:LOV) – a company selling affordable fashion jewellery to a cohort of consumers who have no mortgage and no share portfolio? Why should it impact the long-term success of ARB’s (ASX:ARB) OEM deal with Ford in the U.S.? Or why should it impact the long-term trend from awful coffee to barista-style coffee in the U.S. and the benefit that will be for sales of Breville’s (ASX:BRG) in-home coffee machines there?

Some might draw a link between the collapse of regional banks to an increased probability of recession, or to a financial crisis and therefore to a stock market collapse. But it’s a long bow to draw because the events aren’t certain to transpire even if the links had merit, which arguably they do not.

And anyway, we got through the last GFC and the market went on to record new all-time highs. Will we get through the next one? Probably. Perhaps the four most useful words for an investor to remember is: This too will pass.

Changing strategies or pulling out of the market are among the ways that some investors try to insulate themselves from volatility. It’s how they try and make the experience of investing more comfortable. All it does however is compound the risks, and both lengthen and narrow the road to recovery. Acting amid fear, panic or impatience rarely yields the desired outcome over the long-term.

There are two ways to approach the market; The first is to buy and sell bits of paper that wiggle on a screen and try and bet on the ups and avoid the downs. Doing so however is akin to gambling. It’s the same as betting on black or red. Alternatively, you can approach the stock market as an avenue to access pieces of extraordinary businesses – a proven way to build wealth.  Provided you own quality businesses capable of long-term growth, the only thing you have to fear is acting on the fear itself.

I believe, in the long-run, the events transpiring today in the U.S. banking system will prove to be another opportunity.

The Montgomery Small Companies Fund own shares in Lovisa and ARB. This article was prepared 17 March 2023 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial advice.


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