Fear & greed

Pretoria East March Newsletter 2022

A story I recently came across, The Very Hungry Caterpillar by Eric Carle, is a classic children’s tale about a small caterpillar who is born hungry. He eats everything he comes across and, of course, gets a stomach-ache.

In time, he grows quite large and resorts to eating a healthy green leaf. After that, he builds a cocoon around himself – and finally emerges as a beautiful butterfly.

The story of the caterpillar is open to interpretation, but it got me thinking about investor behaviour and the two emotions that drive market movements, fear and greed. Warren Buffett, Berkshire Hathaway CEO, was once asked by Jeff Bezos (CEO of Amazon) why everyone doesn’t simply follow his (Buffett’s) investment thesis, as it is so simple. Buffett’s answer? “Because nobody wants to get rich slow.”

When a bull market beckons and markets show upward trends, a domino effect often ensues, and investors tend to buy more and more stocks. Stock prices keep rising due to high demand and, eventually, asset bubbles are created where the intrinsic value of the stock is much lower than what is reflected in its price. Inevitably, the bubble bursts and investors face a market correction and suffer major losses.
When markets crash and prices fall dramatically, many fearful investors tend to start selling their stocks in a panic – which, in turn, causes prices to fall even further. The law of supply and demand governs stock markets and, when these two emotions – fear and greed – come into play, it can cause extensive damage to investment portfolios.

What must investors do?

• Consult with a qualified, FSCA-accredited professional financial adviser who will help you compile a proper investment plan and determine appropriate asset allocation, and who will also partner with you to ensure that you exercise self-discipline and restraint when it comes to making decisions about your portfolio.
• Stick to the fundamentals that underpin your investment strategy and stick to your long-term plan.
• Do not make hasty, emotional decisions based on market sentiment or trends of the day, week or month. Base your decisions on logic and reasoning, as well as on information available on the companies that you have invested in.
• Review your investment strategy on a regular basis, in consultation with your financial adviser.

In his 1986 letter to shareholders, Buffett wrote: “What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."