Reason for Market Freefall in One Word

"Because your brain uses information from the areas around the blind spot to make a reasonable guess about what the blind spot would see if only it weren't blind, and then your brain fills in the scene with this information. That's right, it invents things, creates things, makes stuff up! It doesn't consult you about this, doesn't seek your approval. It just makes its best guess about the nature of the missing information and proceeds to fill in the scene..." ~ Daniel Gilbert

Just before turning out the light, you finish reading a news article about unexplained murders in the city where you live.  As you turn out the light, you hear an odd sound; the room is dark and you are alone.  In the instant before turning on the light, what rushes through your mind?

Anxiety is caused by the imagination, which is the same mechanism that thinks monsters lurk in the dark.  In this previous scenario, what might fill your imagination if you had seen your cat or dog walking across the room just before turning out the light?

When there is missing information--when there is uncertainty--the imagination will fill the blind spot of your mind with information largely based upon the emotion or experience that immediately precedes the event.

"And as imagination bodies forth the forms of things unknown, the poet's pen turns them to shapes, and gives to airy nothing a local habitation and a name." ~ Shakespeare

Imagination is the primary culprit in the recent stock market decline.  When the light eventually turns back on, something terrible (i.e. the murderer) may be standing before us or there may be something much less frightening (i.e. the family pet).  Personally, I believe that the debt ceiling standoff, which ended with the S&P downgrade of the US credit rating was the psychological event that set the stage for filling the investor herd's collective imagination with monsters that may or may not exist.

It has been said many times before that uncertainty is the greatest enemy of the investor.  While this may be true, I would add that it is the imagination that creates the scene from which one acts and reacts.  For this reason, and placing the current market decline in perspective, the present reality, which is currently in the dark, may not be pretty but it is likely attractive in comparison to what is now being imagined. 

Comments

[Andrew]

"Nothing can trouble you but your own imagination."

Nisargadatta Maharaj

[superdry uk]

just makes its best guess about the nature of the missing information a

[mike]

and anxiety and uncertainty (in others) are the great friends of the value investor.

[Kent @ The Financial Philosopher]

Good point, Mike. Extreme emotion often causes prices to fall below value. However, it is also important to note, to paraphrase John Maynard Keynes, "Investors can remain irrational longer than you can remain solvent."

Overall, I lean toward Buffett's advice that prudent investors make their best money in down markets.

Thanks for the comment...

Kent