Markets have become like a caged animal

Stephen McGinty on the psychology of fear

RED, the colour of danger and distress, illuminated the computer screens of City traders yesterday as a new virus infiltrated the money markets. This was no malicious computer program, but a piece of human software, one far more destructive: Panic.

Driven by a tidal wave of fear that began the previous night on Wall Street, and which gathered speed as it roared through the markets of the Far East, it slammed into the UK yesterday, wiping more than £100 billion off the value of Britain's biggest companies to signal the end of the worst week's trading since Black Monday in 1987.

In trading rooms across the City, almost every deal processed was a "red" sell, with only an occasional "blue" buy to break up screens that had taken on the fiery hue of a financial apocalypse. Men and women in dealing rooms realised that the uncertainty and fear driving those withdrawing from shares were now affecting them.

As one senior trader said: "We were worried about the valuations of our positions last week. This week, we don't even know what our positions are."

The position was, in a phrase, not good. The market had the momentum of an elevator in a lift-shaft with the cable cut. Investors stampeded for the exits as the Footsie tumbled 8.9 per cent – surpassing even Monday's record sell-off. In the past week, the Footsie has plummeted 21 per cent – wiping more than £250 billion off the value of top-flight stocks in the process.

The index eventually finished below the 4,000 mark at 3,932.1 – its lowest close for over five years. As Henk Potts, director of investment strategy at Barclays Stockbrokers, said: "It's very close to panic. We're drowning in a sea of red numbers, and fundamentals have gone out the window."

THE international financial markets, so long viewed as an obedient machine into which those "masters of the universe" typed the right numerical codes to achieve strong returns, has been revealed as more akin to an animal whose behaviour its keepers can no longer judge.

Despite the promise of being fed $700 billion by the US government and billions more by the British government, it still will not behave as hoped. Banks continued to take the worst beating. Royal Bank of Scotland lost 25 per cent and is down a mammoth 61 per cent over the week, while HBOS fell 19 per cent, and by 37 per cent over the week.

The atmosphere was perhaps best summed up by Manoj Ladwa, senior trader at ETX Capital: "Markets are normally held in equilibrium by the balance of fear and greed. But at the moment, greed has gone into hiding and fear rules the roost."

Misery, it is said, loves company and yesterday no major nation was immune. Fear rolled round the world from east to west. In Japan, the Nikkei slumped in its biggest one-day fall since the 1987 crash, forcing the first Japanese institution, Yamato Life, into bankruptcy.

Yutaka Miura, a senior strategist at Shinko Securities, said: "Investors were gripped by fear. Selling is unstoppable."

We have the Greek gods to thank for panic. The roots of the word lie in the behaviour of the mischievous forest sprite, Pan, who entertained himself by inducing fear and a sense of foreboding among travellers.

The demi-god would rustle leaves and bushes behind people as they passed through the wilderness between the city states. If they picked up their pace and nervously looked around, Pan simply pushed ahead of them and delighted in their heavy breathing and erratic heart-beats. He would hint at danger, and imagination would provide the rest.

The point about panic is that it can be triggered by perception as easily as hard reality. Professor Pamela James, a psychologist at John Moore University in Liverpool, explained that panic begins with a small level of anxiety, triggered by events real or imagined, which then moves along a sliding scale.

Depending on the individual, various amounts of adrenalin begin to flood through the body, a physical hangover from our ancient ancestors, who, faced with mortal danger, would harness the "fight or flight" hormone.

AS PROF James said: "If people see a perceived risk and do not have a full understanding of the economic reality, and so perceive that they will lose money, this can result in panic."

The problem with the financial markets is that, just like in the human body, panic begets panic.

As anxiety blossoms into full panic, the heart rate rises and the body begins to perspire heavily. The appearance of such symptoms to an already agitated individual induces further anxiety, which can affect the cognitive process.

It was a point President George W Bush was keen to press home when he stepped into the Rose Garden of the White House at 3:30pm GMT, one hour after Wall Street opened and the Dow dived. He said he understood how Americans were concerned, but added: "Anxiety can feed anxiety and that can make it hard to see all that's being done to solve the problem."

HE WENT on to discuss the $700 billion rescue plan he signed into law a week ago, authorising the Treasury Department to use a "variety of measures to help banks rebuild capital" including "purchasing equity of financial institutions".

It was the first time the president had mentioned suggestions that the US government might buy shares of banks, although it has been mentioned by other officials.

The antidote to the poison of panic is nerve and steadfastness. Rudyard Kipling wrote in If: "If you can keep your head when all about you are losing theirs … yours is the Earth and everything that's in it."

It is a maxim investors with steely nerves and plenty of time are taking to heart. In Glasgow, Alan Mackie, an independent financial adviser with Walker Cumming, sees cooler heads prevailing.

"We had panicked calls at the time of Halifax, but now our clients are seeing this as an opportunity," he said.

"The market is down 35-40 per cent on where it was last year. If you take a long-term view, three to five years, and pick wisely, then you can pick up cheap stock which will come back. Some people are seeing this as a time to get bank stock."

Still, at least one market defied the trend. The Baghdad exchange is booming, the general index up by nearly 40 per cent. Investor Saad Jalil said: "The world banking crisis won't affect us; our market is sealed off from the outside. We don't even have electronic trading."