First time experiences tend to provide people with a lot of anxiety. The uncertainty of the experiences leads to the anxiety.
The unfamiliarity with the situations causes much angst. Just by knowing what the building or room will look like during a doctor’s visit tends to relieve some of the anxiety, but going to a new doctor for the first time is always a bit more nerve-wracking than the second or third visit.
Going to school is also a bit overwhelming. That first day of school always has a bit of anxiety tied to it. The unfamiliarity causes this angst, but by the second week of school, more clarity has come with the school and it now becomes routine and less nerve-wracking.
That first day in a new school is always memorable given the uncertainty that comes with it. Making that jump from fifth grade to middle school or middle school to high school tends to be the most memorable for us.
As we get older, those anxiety laden visits tend to be fewer as our experiences are greater, lessening the likelihood of us experiencing something for the first time. We could use a high school junior as an example. That first day of school tends to be less nerve-wracking for them. Their first experience of high school was conquered two years ago and they will be experiencing their 12th first day of school on the day they walk in the high school doors for their junior year. They have past experiences to rely on, thus letting them deal with that first day better than others.
It doesn’t seem that investors are able to get as comfortable with the markets as students are with their first days of school. Every time the slightest chance of a market correction occurs, everyone reacts the same way they have in the past; no lessons seem to have been learned from the past.
The issues tend to rotate from time to time; whether it’s too much domestic debt, struggles in Europe or turmoil in the emerging markets, the slightest of corrections (even if assumed to be coming) spurs overreaction.
Investors tend to use the VIX index as a gauge of volatility in the markets. A higher number suggests more angst amongst investors. Over the first two months of 2014, we have seen the VIX jump from a reading of 12 to a recent reading of 21—a move higher of nearly 75%. This coincided with the markets falling 5.76%. Media coverage has pounced on this rise in the VIX and investors’ fear led to reactionary selling. But we have seen this story before… actually a lot.
Even in 2013, when the markets had one of their best years ever, we saw the VIX move higher by 65%, 44% and 55%. The S&P fell 5.66%, 4.63% and 4.06%, respectively, in those periods of a rising VIX. Each of these periods were, roughly, a month long. But despite those rises in fear and short market declines, the S&P was up over 30% for the year.
These examples don’t end in 2013; we saw it in 2012 and then the summer of 2011 saw a rise in the VIX of 200%, while May of 2010 saw a rise in the VIX of 191%. The market fell 18.77% and 15.99%, respectively, in those periods, but the return for the S&P for the entire year was 2.11% in 2011 and 15.06% in 2010.
The fact of the matter is that each of these occurrences was spurred by different events, but the markets reacted similarly in the short run. As things played out, the markets became more comfortable and the volatility subsided.
Investors, even new ones, should be seasoned graduates with regards to the markets and volatility and should thus handle it as so. We don’t see juniors in high school dropping out because of that first day or week anxiety, and we shouldn’t see investors bailing because of that first sign of volatility.
The only way for students to graduate is to endure those anxious moments. And the way for investors to retire wealthy is to weather those volatile periods with a diversified portfolio.
(All data used within The Capital Course was provided by Ned Davis Research)