Today, October 19, 2017 marks the 30th anniversary of ‘Black Monday’. On that fateful day in 1987 the Dow Jones Industrial Average, aka the Dow, had its worst single day drop in history. By the time the closing bell mercifully sounded at 4 p.m. the market had lost 508 points or 22.6% of its value. In our world today with the Dow at 23,000, that’s equivalent to a 5,100 point drop.
Since we’re at a nice round anniversary of this event, there will no doubt be several articles published today on the interwebs asking some version of the “How did this happen?” and “Could this happen again?” questions. They will no doubt point to the rise of computerized trading along with the usual suspects of geopolitical risks and government policy decisions. One cause that may not be talked about as much though is the role of human nature.
Our Lizard Brains
The oldest part of our brain, the amygdala, is responsible for our ‘fight or flight’ instincts. It’s what kept our ancestors alive back in the days when we weren’t at the top of the food chain. In today’s world, we don’t find ourselves in daily life threatening situations and so our brain spends most of its time operating in the more highly evolved frontal lobe. However, our lizard brain still has the ability to hijack our rational brain in times of stress. Usually those stressful situations are not life or death, but our brain shifts into survival mode nonetheless and fear overwhelms us. The result is we make decisions that more often do more harm than good.
The stock market is custom made for taking advantage of our basic emotions. Most of the time we can control them. At the extremes, however, our amygdala takes over. Sometimes it happens slowly over an extended period. In the late ’90’s some investors, fearing they were missing out on the tech boom, eventually loaded up on any company that had a dot com in their name. Likewise, in early 2009, after the market had already dropped 30%, some investors that had held on throughout the worst of 2008, decided they couldn’t take any more and capitulated.
And 30 years ago in 1987 investors’ fear reflex all kicked in at the same time, collectively forming a huge lizard brain and driving the market lower than it ever had before or since.
What Happened on October 20, 1987?
Some of those articles will also fail to mention what happened after Black Monday. How long did Godzilla stick around?
As it turns out, not long. Although there were some who, fearing the selloff would continue, wanted to keep the markets closed, they did open for business on Tuesday. And after what was I’m sure a sleepless night for most investors, their rational brains took control again and decided that the selloff had been overdone. The market went up 6% that Tuesday and another 10% on Wednesday. Even with the quick bounce, there was still a lot of fear. It took months for most investors to realize that the economy was still going strong and the long term bear market that had begun in 1982 was still intact. In all it took the better part of 2 years to repair the damage.
Controlling the Lizard
Since our primitive brains can hijack our rational brains at inopportune times, is there anything we can do about it? As it turns out, yes. At the most basic level, make sure your investments are appropriately diversified for your situation and emotional stamina. Know the worst case scenario for your asset allocation. How far would it have dropped in 2008? How would you have felt about that?
Next, make sure you or your financial advisor is following a disciplined investment process. If it’s not buy and hold, make sure it’s one that is supported by valid research. Write your process down and the reasons behind it. Know its strengths and weaknesses.
Finally, when you find yourself in the middle of the next stressful market event, take a time out. Listen to or read what other long-time professional investors who have been through rough times are saying. They are usually the voice of reason. Warren Buffet is a great example. He wrote a beautifully simple Op-Ed in the New York Times during the midst of the 2008 financial crisis when many people were fearing the banking system was ready to collapse.
While we’ll never be able to totally overcome our lizard brain, we can be better prepared for it when it shows up during the next financial crisis.