‘Investors need to know how to cope with a declining market’

Clarity Capital’s chief strategist Eran Peleg on the new environment created in capital markets – and the psychological tendencies that affect investors.

 GLOBAL INFLATION currently high: Traders work the floor of the New York Stock Exchange.  (photo credit: REUTERS/BRENDAN MCDERMID)
GLOBAL INFLATION currently high: Traders work the floor of the New York Stock Exchange.

‘The stock market has been declining since the beginning of the year,” says Eran Peleg, chief strategist at Clarity Capital, the investment management company that provides wealth management and investment services to private and institutional investors in Israel and around the world. 

“Some thought it was a short-term negative correction and that it would balance itself relatively quickly,” explains Peleg. “As early as last year, we started to see an increase in inflation. At the time, the central bank of the United States, the Federal Reserve, tried to calm the situation by claiming that inflation was transitory and delayed raising interest rates, which is the common remedy for stopping high inflation. My view was that inflation was probably not temporary and that this was a significant phenomenon.” 

Peleg says that since then, perspectives have changed and that nowadays, the prevailing view in the capital market is that inflation will not disappear anytime soon. “It is true that some of it may be temporary and is due to difficulties with the supply chains, which have remained since the Coronavirus period, some of which may be related to the Russian invasion of Ukraine,” he notes.

GLOBAL INFLATION currently high: Traders work the floor of the New York Stock Exchange. (Credit: Brendan Mcdermid/Reuters)GLOBAL INFLATION currently high: Traders work the floor of the New York Stock Exchange. (Credit: Brendan Mcdermid/Reuters)

“Some of these things will balance at some point, but there are other factors that won’t go away as quickly. Global inflation is currently high, running at up to 10% in some countries. Fortunately, here in Israel, we are on a more moderate rise, but still, it is higher than it was in recent years. Even if the trend moderates, it will still not be around the percentage or two we have been accustomed to in the last decade.” 

Another issue, he said, that is affecting markets is the expectation that interest rate increases will lead to an economic slowdown. “There is a concern that this will lead to a slowdown in economic activity,” he explains. “The monetary tightening and interest rate increases have greatly weighed on the financial market in recent months, and now there is a growing concern that growth will be affected, to the point where talk of the possibility of a recession in the next year or two is being discussed. Recently, there have been signs that growth is slowing. This is evident, for example, in the reports from giant retailers in the US showing an increase in costs and lower demand. These companies reflect the American economy and the local consumer.”

ERAN PELEG, chief strategist, Clarity Capital. (Credit: Eric Sultan)ERAN PELEG, chief strategist, Clarity Capital. (Credit: Eric Sultan)

The bear market Clarity Capital (formerly KCPS) was founded in 2006 by Tal Keinan, David Steinhardt and Jay Pomrenze and has offices in New York and Tel Aviv. The company is under the jurisdiction of the Israel Securities Authority, the US Securities and Exchange Commission and the authorities in Ontario and Quebec and currently focuses mainly on private wealth management and family office services. The partners in the company have an extensive background in the financial field and are skilled at identifying trends in the market. 

Peleg explains that we are in a bear market phase, the term used to describe the capital market when it is trending negatively. This is compared to a “bull market” when the trend is positive. While it is common to talk about a bear market after a decline of about 20%, Peleg explains that in reality, this is measured in market dynamics and not necessarily in a decline of one scale or another. “There’s no fundamental difference between an 18% drop and a 22% drop,” he says. 

When the market enters a negative trend, says Peleg, the most important thing for the investor, or one who handles an investment portfolio, is to remain calm. “There is always a concern when investing money in the capital market, but it increases especially during unstable times, when the value of the investment begins to decline.” It is true that investors tend to say that it is time to reexamine investment policy during times of stress, but investment policies should not be determined during a period of crisis. “There is a concern that you will make the wrong decisions under pressure,” he reports.

We are in a ‘bear market’ phase

“If the investment policy was done correctly in advance, it should protect the investor,” Peleg adds. “When we sit down to write investment policies, we consider that there will be ups and downs in the market, for all sorts of reasons. Of course, one can’t anticipate every situation, and no one thought a year and a half ago that Russia would invade Ukraine, but the fact that there is cyclicality in the market is nothing new, and we are preparing for it as much as possible.

“For example, an investor who needs money in the near term should have taken this into account and established a low-risk investment policy with relatively low exposure to shares. On the other hand, if another person has a long-term investment horizon and a higher risk tolerance, he is more suitable for investing in stocks. In order to deal with the declining market, it is important to remember our long-term goals. We can be calm if we bear in mind that our investment horizon is long and that we don’t need money in the short term.

“The attempt by some investors to exit the market usually does not succeed, and it is advisable to remain invested over time. It’s very difficult to return and have a feel for it once you have left. Usually, when you leave the market, it takes time to regain the confidence to return, and by then, the prices have gone up.”

Psychology behind the investment Peleg points out that even a bear market will eventually end. “The negative trends do not last forever, and we have seen much tougher markets in the past, with much sharper declines than there have been so far,” he explains. “Even the crisis that was in 2008, which was a deep financial crisis, ended, and the markets returned. However, in the meantime, we are in a market that is on a negative trend, and we need to understand that the market regime has changed. Since 2009, we have become accustomed to the market rising, going down a bit, correcting itself, and then rising quite quickly. 

“We need to abandon this mentality because the market environment has changed, and it is quite possible that the negative trend will continue for some time. Historically, negative markets that occurred in the context of a significant slowdown in the US economy continued on average for just over a year, and there are bear markets that lasted two and a half years, as in the financial crisis of 2000.” 

Beyond the ability to analyze the companies and assess the value of their shares, there is also a considerable psychological aspect to the investment management process. This becomes even more pronounced in a period of decline and uncertainty. “Sometimes people have a feeling – perhaps more correctly – an illusion, that if a stock is down 70%, for example, that it can’t go lower, but that’s not true,” Peleg says. “Even as far as the market as a whole is concerned, it is difficult to know in real time what the bottom is, and one only knows in hindsight. Therefore, it is better not to try and be too ‘smart’ about it, and one should rather work systematically and balance the portfolio over a period of time – to make the changes gradually and not all at once.“In general, people tend to be overconfident about their ability to understand the market. Usually, it’s a self-generated illusion when the markets are constantly positive. Now, under different market conditions, their confidence will gradually decline.

“Another psychological issue that investors encounter is called ‘anchoring.’ This occurs when an investor considers information that is no longer relevant. For example, when investors make a decision about a share they own, they tend to refer to the share price at the time of purchase. Perhaps they made a mistake when they purchased it? Past share prices are not particularly relevant for the future. The only thing that is relevant for the investment is the expectation of what will happen in the future. The question is what will happen in a year’s time, not what was a year ago. 

“Another issue is the lack of symmetry between risk-taking and risk aversion, and this is reflected in the way that people treat certain loss or profit. People like upward market volatility but do not like downward volatility. If an investor has purchased a stock and its price has risen, meaning that in selling it he is facing a certain profit, he will act as a risk-averse person and realize the profit. But, in the event of a decline in its price, that is, when in its sale it will suffer a certain loss, he suddenly becomes a risk-loving person and is willing to wager that the price will go up.” 

The difficulty with this, explains Peleg, is that sometimes investors sell all their good shares and are left with less attractive assets. This problem, he adds, is connected to another issue – “regret aversion.” People don’t like to admit, not even to themselves, that in the past, they have made mistakes in investment decisions.

“We need to be prepared that the negative trend may continue for another period of time, as well as for as many scenarios as possible. We need to maintain flexibility of thought and investment management,” Peleg concludes. “Regarding the global economy, no alarm bells are ringing at the moment, but there are warning lights. We are not yet in a place where it is absolutely clear that we are going into recession, but the probability of that is increasing.”

This article was written in cooperation with Clarity Capital.

Translated by Alan Rosenbaum.