A reality check on investors’ current beliefs about the likelihood of a crash.
You almost certainly are exaggerating the likelihood that the stock market will, in coming months, suffer a crash as bad as that of 1987.It’s entirely understandable that investors are worried about a crash, given the many analysts who are declaring the stock market to be forming a bubble.
That means 66.1% of investors believe that the risk is above 10%. And that’s what is plotted in the accompanying chart. Notice that there has been a distinct uptrend in this percentage in recent years. In 2015, its 24-month moving average stood at 64%, versus 74% today — down only slightly from its high from last year of 77%.
Why investors have become increasingly worried about a crash A big reason for the secular uptrend in investors’ belief in the likelihood of a crash is that the stock market suffered two bear markets in a recent two-and-a-half-year period: February-March 2020 and January-October 2022. It’s rare for two bear markets to occur in such quick succession, and that has soured many investors’ long-term outlooks.
In her study, “Asymmetric Learning from Financial Information,” she reports that there is a significant difference between how investors update their beliefs following losses than how they do that following gains: Losses generate disproportionately more pessimism than gains lead to optimism. This tendency, rooted deep in how our brains work, leads to what she calls a “pessimism bias.
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