What are we looking for during market upheaval?

16 April 2020

5 minute read

In an increasingly complex world, checklists can help us take a more disciplined approach to investing.

Who's it for? Investors with basic investment knowledge

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • Why we often rely on mental shortcuts to make decisions
  • How ‘checklist’ practices picked up from the medical and aviation fields can help avoid investors falling into behavioural traps
  • The importance of maintaining investment discipline during stock market uncertainty.

Before beginning a hunt, it is wise to ask someone what you are looking for before you begin looking for it.

Pooh’s Little Instruction Book, by Joan Powers.

Avoiding mental shortcuts

Three centuries ago, English philosopher Francis Bacon foretold modern behavioural psychology’s notion that humans have a proclivity to “suppose the existence of more order and regularity in the world than it finds”1.

Essentially, individuals like to seek out patterns and connections where none exist.

In an increasingly complex world, people often rely on mental shortcuts or experience to make decisions. Often these rules-of-thumb are handy, so we don’t need to spend too much time over-analysing every situation.

However, in a highly complicated world where an expert task is required time and again, or at moments when emotions are running high, these shortcuts can pose problems.

In a book by a top Harvard Medical School surgeon Atul Gawande, called ‘The Checklist Manifesto’, he describes why it is so crucial that some fields or expert jobs have checklists.

Aviation has been one of these sectors to embrace checklists early on, as pilots are required to run complex tasks while at the same time maintaining a low failure rate.

In the medical field, the US-based Johns Hopkins Medical Centre used the checklist strategy to help eradicate a common problem in its intensive care units – infections in patients receiving medicine via intravenous lines. It helped cut infection rates from 11% to zero.

Checklists as a guide

Investing also comes with huge complexities and among other things requires a good understanding of economic and financial theory. There are plenty of influences and relationships to consider when it comes to investment decision-making.

How do investment managers – and individual investors – adapt to avoid falling into the trap of putting too much emphasis on a single development (such as central banks making interest rate cuts), while calmly focusing on the big picture?

Our team of investors often rely on ‘checklists’. This allows us to tune out the noise from day-to-day upheavals in the markets, while maintaining discipline in the investment process.

With markets suffering their worst losses since the Great Financial Crisis, what are we looking for to indicate whether a recovery is due?

Here are four key things we are watching to assess whether investor behaviour might be signalling recovery.

Good news being ignored

When fear is widespread the light at the end of the tunnel can often be ignored by investors. Initially.

Policy actions

Once central banks and governments have acted following an economic shock, this will often start to turn around the mood of investors.

Shifting consensus

Once most of the bad news it out there – and influential economic forecasts are adjusted lower – investors often take comfort in the fact a lot of negativity has already fed through to prices.

Impact on financial markets from the movements of investment trading

During the final stages of continuously falling markets the prices of shares and other assets often slump on weak trading activity. Conversely, prices tend to go up on days of busy trading2.

All in all, it can be tempting for investors to wait for economic data to improve before getting back into the markets. However, history suggests markets tend to bounce back well before that. The best time to buy is usually when fear is rampant, before the data looks better, otherwise it can be too late. It’s easier to do this with hindsight than at the time when your worry is that things could get even worse.

Investment conclusion

It is important to remember that every shock is unique in some way, so there are no strict rules to follow this time round. Nevertheless, it’s helpful to have a checklist to navigate through such uncertain times. Without a disciplined process, there is a high risk of falling into behavioural traps that prevent us making good investment decisions.

The checklists we use contain more than the list above, but some of the conditions for a market rebound are already starting to show. We have seen a lot of bad news reflected in lower prices in certain pockets of financial markets – and investors have been making some purchases where prices have fallen particularly sharply.

We have also seen action being taken by central banks and governments (including rate cuts and emergency loans) in the face of highly negative investor feelings.

We may not be out of the woods yet, but it is good to be on the lookout for the signs of recovery.

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The value of investments can fall as well as rise. You may get back less than you invest. Tax rules can change and their effects on you will depend on your individual circumstances. Smart Investor doesn’t offer personal financial advice. If you’re not sure about investing, seek independent advice.

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