Why Fear & Greed Make Investing So Difficult

We’ve experienced a real rough start to the year in the markets as fears over rising inflation have led to fears over global war with Russia’s invasion of Ukraine. I wouldn’t put too much stock in any particular gauge of market sentiment, but when you see indicators like this, you’re not really surprised that investors are as worried as they are.

Flight or fight Response to Fear with Investing

When human beings are afraid, our brains revert to instinctual behaviors.  These are the so-called “fight or flight” response to fear. In investing, the “flight” response usually leads to an urge to sell out of an investment, if only to stop the pain of continued losses in it.   The urge to get out of a losing investment can be very powerful and it is one of the more common mistakes investors make.

Another behavior which is derived from the “fight” response is that investors feel the need to do something.  They feel the need to make trades or try and move into what they perceive are the right investments for the time.  This is why many people are now looking to sell their technology stocks which are down and trade them in for commodity stocks which are now on the rise.  Other investors are looking to “buy the dip” without properly assessing if the company’s prospects have changed.  To the extent that these urges or impulses to act affect an investor’s ability to make rational decisions, they are extremely harmful. It may be the correct decision to invest in energy companies (we own some as discussed below) but if your decision is driven by fear over losses, then it’s unlikely you will get the correct decision very often.

Controlling Our Impulses and Emotions

A lot of investors assume that they are not affected by their emotions.  One of the biases we tend to have is that we are overconfident in our ability to control our impulses and our emotions.  We believe that when markets are crashing we will calmly buy low and sell high.  Well if that is the case then NOW IS THE TIME TO BE GREEDY!

Identifying a Good Business

Many technology names have fallen 50-70% from their all time highs.  This is reminiscent of the tech wreck in 2001 except this crash has happened in a much shorter timeframe.  In some cases these businesses were never as good as they were promoted to be and they justifiably have been repriced to something more appropriate.  However there are a lot of very good companies who have been equally punished and unjustifiably so in my opinion.  The trick is obviously identifying which ones are the good ones and that involves a lot of homework.  However if you have identified the winners then this is unquestionably a good time to be buying them.

But even if you’ve correctly identified the right businesses, your mind can still play tricks on you.  One of the businesses we own is Sea Limited (SE).  It is one of the high growth technology names whose stock price has come down a lot in the last six months.  It’s all time high was $372 and today (March 7, 2022)  $89 was approximately the daily low on the day.  That’s a 76% drawdown.  In times like this our brain plays tricks on us.  Even if nothing has changed with their business we start to see all of the negative aspects of the business that were so hard to see when the stock was at $372.  What’s more the road back to the all time high can seem so insurmountable when a stock drops as much as it has.  Our industry has little sayings like, if you’re portfolio drops 50% you have to make 100% return just to get back to where you were, which while mathematically correct (and certainly true if you sell at the bottom), does not really accurately depict the journey of a business owner in a quality business.

Take for Example Amazon

Amazon was founded in 1994 and went public in 1997.  As one would expect, as a high tech internet firm its share price did very well in the latter stages of the tech bubble as it’s price rose from $1.50 a share in 1997 to $113 by December of 1999.  However the popping of the tech bubble followed by the aftermath of 9/11 drove Amazon’s stock price all the way down to $5.51 by October 2001.  That’s a 95% drawdown.  For those who are mathematically inclined, that would mean you would need to 20x your investment in Amazon just to get back to even if you had bought at the all time high.  Put another way, a 20x investment is the same as a 10% annual growth rate over 31 years. In other words, if you sold after a 95% drawdown you probably never made that money back.  It was lost forever.

But if you had the knowledge that Amazon was a great company whose value was not reflected in the stock price, you had a much different experience.  By October of 2002 your shares had risen from $5.51 to as high as $20.26, a nearly 300% return in one year from the bottom.  By October of 2003 your investment had gone as high as $61.15 a share, an 11x return in just over 2 years.  Of course if you had bought at the top and ONLY at the top you would still be down about 45% on your initial investment.  And you’d have to wait another 6 years to be made fully whole (Amazon went above $113 a share in October of 2009).  Of course in the following decade post 2009 you would have made another 18 times your money and your long run returns even going back to your ill timed purchase in December of 1999 would still look pretty good.

This is an extreme example so we can’t extrapolate Amazon’s results to much else. But it is an extreme example which proves my point.  If you had invested in Amazon at $113 in December of 1999 and you continued to believe it was a good company even as it plunged all the way to $5.51 a share, you WOULD NOT have only invested once but you would have continually added at much lower prices.  By so doing you would be much better off if you had simply invested once at $113 even if Amazon had never dropped at all.  

This example also proves that just because you are a high quality business like Amazon does not mean you can’t have severe drawdowns in the price of your stock. Jeff Bezos is probably the greatest businessman of the 21st century so far and his company’s stock lost 95% of its value at one point.  That should give pause to any investor who thinks it can’t happen to a particular blue chip company they own.

Dropping of Whitecap Resources

While this is an extreme example it is hardly a unique one.  During 2020 the price of Whitecap Resources fell from a price of $5.71 share in December 2019 to as low as $0.73 a share in March of 2020, a drop of 87% in just over 4 months.  We owned Whitecap throughout that whole period and I can tell you that very few people thought it was a good idea to invest in energy at that point in time. But if you did manage to hang on to your Whitecap your reward would be a share price of $10 a share just two years later (plus dividends) which is equal to a return of 14x from the very lows. Not only did we make all our money back, but the share price nearly doubled from its December 2019 high of $5.71.

High Tech Growth Names

None of this is me predicting that just because these share price recoveries happened with Amazon and Whitecap that it will also happen with Sea Limited.  While I think SE is a great business, it’s not yet proven to be the next “Amazon” and so we can’t be sure what will happen in the future.  However I think the extreme pessimism that we saw in Amazon stock in 2001 and that I saw personally in Whitecap stock in March of 2020 is now present when it comes to high tech growth names like SE.  I fully expect we will see a strong recovery in SE and other high growth names we own.

Buying Sea Limited, Not Selling It

I don’t know when SE will get back to it’s all time high of $372 a share and it could take years.  What I am sure of, given that SE remains a very high quality business, is that now is the time to be buying SE, not selling it.  If we make the rational decision to buy, I am very confident that our investment in Sea Limited will generate satisfactory returns, even though we had to suffer through a 75% drawdown.  In fact, I think it’s very possible (perhaps even probable) we may actually be better off by virtue of the fact that we’ve been able to buy a much larger stake in SE at much lower prices.

Making Rational Decisions to Be Greedy

The fact that taking this course of action seems so difficult is exactly why investing can be so hard, and why it can be so difficult to overcome our emotions.  In addition in turbulent times such as this, it does make sense to be more defensive because we don’t ever want to risk permanent loss of capital, and its certainly possible markets could fall lower still. But if we are to achieve above average returns, then making rational decisions to be Greedy when prices are as low as they currently are is absolutely necessary.  By controlling our emotions we are paving the way for investment success.  Just don’t tell me that it’s easy!

- Craig White, BA, LL.B., CIM®

Craig White is a Portfolio Manager and Investment Advisor at Endeavour Wealth Management with iA Private Wealth, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White a Portfolio Manager and Investment Advisor for iA Private Wealth and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.