To get a sense of the word on the street, I spoke to a few of my friends who have been investing professionally since the early 2000s. The response was unanimous: “I don’t know where the markets will bottom. I haven’t seen anything like this earlier.”
Those who were looking to take advantage of the fall during the first leg of the crash rescinded their views and wanted to wait longer before deploying their funds. Their statements surprised me. I wondered how someone who has been an investor for more than 20 years has not seen anything like this before. The past two decades, especially, have seen a high share of volatility and crashes.
Certainly, they have also read about the market crashes that happened in the last century. I agree this correction may not be exactly the same as the previous ones, but as Mark Twain said, “History doesn’t repeat, but it does rhyme.”
To make superior returns in the market, an intelligent investor is greedy when others are fearful. But what stops us from doing what an intelligent investor must do?
Biases that hold us back from taking advantage of this fall are myopic loss aversion and recency bias. In this note, I will talk about a psychological concept that affects even highly experienced investors. I present a hypothesis, based on the concept of ‘Two Selves’ given by Nobel Prize winner Daniel Kahneman, to explain why people feel “this time it’s different.”
THE TWO SELVES
Daniel Kahneman is the first psychologist to win a Nobel Prize for economics. In his book, Thinking, Fast and Slow, he talks about how there are two selves in everyone—a ‘Remembering Self’ and an ‘Experiencing Self’. He explains it with an example. One of his students approached him at the end of a lecture and told him about a symphony he had been listening to. “It was absolutely glorious music and at the very end of the recording, there was a dreadful screeching sound.” And then he added, quite emotionally, “It ruined the whole experience.” According to Kahneman, the student’s experience was not ruined; it was the memory of the experience that was ruined. Although the student enjoyed those 20 minutes of good music, that experience did not count because he was left with a bad memory of it.
The ‘experiencing self’ lives in the present. It is the ‘experiencing self’ that the doctor approaches when she asks, “Does it hurt now?” The ‘remembering self’ is the one that keeps score and maintains the story of our life, and it is the one that answers when the doctor asks, “How have you been feeling lately?” The ‘experiencing self’ lives moment to moment, but not all those experiences make it to memory. The ‘remembering self’ is a storyteller and keeps what we derive from our experiences.
There are many areas where this concept of two selves applies. Patients tend to have better memories of surgery if the pain recedes towards the end rather than if it ends with peak pain. Take the case of parenting: parents generally have a very good memory of raising their children. However, their day-to-day experience of raising them may not be very pleasant. How about holidays? If you had a great holiday but it ends with you losing your passport and wallet, the ‘remembering self’ will paint the story with quite a bit of pain.
HOW IS THIS ALL RELEVANT TO THE MARKETS?
Here is my hypothesis: a lot of investors have experienced investing during crashes in the past. They carry a memory of how crises are an opportunity to increase allocation towards equity markets, and how, ultimately, they make great returns when the markets bounce back. At the onset of every new crash, these investors recall those memories. The ‘remembering self’ recites to them the story of how profitable investing during bad times is.
However, the ‘remembering self’ has not captured all the moments of the past. The ‘experiencing self’ went through every moment of fear, agony, and anxiety that comes with contrarian investing during previous crashes. But most of these moments are lost, and only the happy endings dominate the story.
During the current market fall, the ‘experiencing self’ is living the pain of a contrarian stance every day. And within a few days of the fall, one feels things are different from what the ‘remembering self’ narrated. “This time it’s different!” Although investors undergo the same fear and pain during every large down move, the story feels different. They are likely to feel that conditions were better the last time. The phenomenon is true for raging bull markets too. Even though investors carry the scars of participating in past bubbles, they are pulled into a new one with the catchphrase, “this time it’s different.”
Every few years, the markets correct and many investors end up selling close to the bottom due to fear and panic. The proverbial market pendulum swings towards extreme pessimism. With the right temperament, an intelligent investor can take advantage of these cycles. True, one cannot catch the exact bottom or top. Staggering investments during such times through SIPs or STPs can help mitigate near-term volatility risk while ensuring participation across cycles.
Happy Investing!
(Source: NSE Indices)
(The author of the article is Nimesh Chandan, CIO, Bajaj Finserv Asset Management Limited)
