The market had a tough day yesterday. The ASX 200 fell nearly 90 points, or 1.5%. It broke support at 5,700 points, increasing the chance that it will go on to test the next level of support at 5,600 points (see chart below).
The RBA keeping official interest rates at record lows of 1.5% yesterday didn’t seem to help. There was a whiff of panic in the air.
If the market does continue to trade down to 5,600, it will represent a correction from the peak of around 6%.
To that I say, so what?
Last year’s correction from early August to the November intra-day low was 10%. Corrections of this magnitude are just par for the course. There is nothing unusual or frightening about them.
It’s only when you read people’s opinions as to why markets are selling off, that the fear factor starts to rise.
In Australia, a market sell-off inevitably means the housing market is about to collapse. The threat of a housing collapse sets off the primal fear button in the part of your brain called the limbic system — specifically, the amygdala.
Your amygdala is a panic merchant. It will have you seeing a bleak future. It will scream ‘SELL, SELL, SELL’ into your (inner) ear, and pat you on the back when you do so, because you’ve taken the fear away. It’s done its job.
But a few weeks or months down the track, when the market bounces back, you’ll be cursing your stupid little amygdala for making you dump your portfolio.
As Tim Urban writes in the always entertaining, Wait, But Why,
‘I’m pretty sure that gaining control over your limbic system is both the definition of maturity and the core human struggle. It’s not that we would be better off without our limbic systems — limbic systems are half of what makes us distinctly human, and most of the fun of life is related to emotions and/or fulfilling your animal needs — it’s just that your limbic system doesn’t get that you live in a civilization, and if you let it run your life too much, it’ll quickly ruin your life.’
The limbic system evolved a long time ago. It is the second most ancient part of our brain. Stock markets weren’t around during this part of our evolution, which is why the limbic system is absolutely useless in helping us navigate a stock market correction.
Its first reaction is to panic. If you’re feeling this urge, tell it back off. Let your frontal lobe come to the fore and do its work.
That’s easier said than done though. You have to train it. As I mentioned yesterday, having a system or an investment process can help.
Like a stop loss system. That is, only sell your stocks if they hit your stop loss exit point. Who cares what the market is doing? Focus on what your individual stocks are doing.
You can also train yourself to focus on the bigger picture, rather than give in to emotion and reacting to every sell-off.
As I mentioned yesterday, one way to do this is to get a hold of Cycles, Trends and Forecasts. It will give you a very good framework for how financial cycles work, and give you confidence to ride out corrections such as the one we’re having, without losing your mind.
So what is causing this correction? The obvious answer is the threat of an economic slowdown in Australia. This morning you’ll see economic growth numbers for the March quarter, and they are widely expected to be weak.
But growth numbers have been volatile for a while now. The September 2016 quarter saw a contraction of 0.5%, followed by a strong 1.1% rebound in the December quarter.
Low or even another quarter of negative growth reported today would confirm that Australia’s economy is barely growing.
This doesn’t mean the stock market is about to collapse. Though it does mean that large stocks will struggle as they depend more on overall GDP growth than smaller stocks.
And that’s where you’re seeing much of the market weakness now. It’s the larger stocks leading the sell-off, especially the banks. And that’s because the larger stocks led the post Trump election victory rally. They had a really good run, went into overvalued territory, and are now correcting.
It’s how market’s work. Stocks rally, they go too far too fast, and then they correct. You can blame everyone’s collective amygdala for this price action.
Ignoring the ‘reasons’ for the sell-off, basic chart reading skills would have alerted you to this correction a few months ago. In early April, I sent this note to subscribers of my advisory service, Crisis & Opportunity.
‘As I mentioned, the Aussie market is strong right now. It’s climbing a wall of worry. But it’s getting close to formidable resistance.
‘It’s nearing the 6,000 point level. Back in early 2015, this was an area of considerable resistance. The market tried to break through it on four occasions, but each time it turned back down, and finally went into a prolonged bear market.
‘I think you’ll see resistance at 6,000 points kick in again. The market will get near 6,000 and sell-off. This will bring about another range of bearish predictions. But instead of a deep bear market, you’ll simply see a correction before the market goes on to break through 6,000 and head towards all-time highs.
‘That’s just a guess, of course. But I want to remind you that history never repeats in the same way, so to think that the market will do what it did last time (go into a prolonged bear market) is a low probability play.
‘I think it’s more likely the market will go on confounding people, and move relentlessly higher. Only when those holdouts throw in the towel and get in will you see the market set up for a more serious fall.’
That’s still my view. As I often say, don’t mistake a correction for a crash. Get a hold of your amygdala and give it a good talking to.