Click here to listen…
The Cycle of Market Emotions
There is a psychological “sea-change” taking place before my eyes and I am beginning to recognize a sense of fear I haven’t seen so far in this cycle. Many I talk with, think the stock market is headed for a huge fall and absolutely want no part of it. I can understand their fear, but this is starting to feel like the beginning of one of the big mistakes people make when the news is at its dreariest. Allow me to explain.
There is a natural cycle to any “risk” type of investment. Whether we are talking about Gold, Real Estate, Foreign Securities, -even the bond market. As markets rise, people become hopeful and encouraged. They may start to buy-in as they notice the economy and the stock markets improving. This is natural and healthy. As the markets continue to rise, hope turns into optimism and excitement as their earlier decision is reinforced by the rising market. Every new investment is rewarded with a higher value a few weeks or months later. Investors are feeling very smart while being constantly reinforced by the news of improving fundamentals. Companies are hiring and expanding and profits are rising. They are also growing domestically and internationally and Countries, which historically have had impoverished financial systems, start improving bringing wealth to many of their people who once had little hope of a decent material life. All is good. So good, in fact, that now new people are entering the market trying to get in on the action.
Let’s examine Real Estate as a recent example. As interest rates declined and home prices rose, more and more buyers entered the market with sound fundamental reasons behind their purchases. Homes were affordable and rising prices reinforced their decision that the home purchase was a good idea. This continued for many years reaching a point where prices rose well past reasonable fundamental value. By the time speculators entered the market, people were predicting ever higher prices, due a rising economy as far as the eye can see. This had real estate investors stirred up to the point of euphoria and hysteria.
It continued for a relatively long time, well past the point of rationality and reason. Investors just continued to focus on rosy news reports and rising prices until just when everyone involved reached the maximum point of euphoria, the music stopped. This point of maximum euphoria is the point of maximum financial risk. In other words, when you are feeling that investing is easy and low risk, and you are feeling most secure and assured, investing is at its riskiest point and the probability of high future returns are low.
What has this got to do with today’s investing environment? You might be wondering why I’m talking about rising markets when we are in a completely different part of the economic cycle. Prices are low and seemingly continuing lower. Nothing good is being reported by the media and now, even the White House is forecasting doom unless they get their money. In addition, I am starting to get panicked calls from clients and others who think they should be out of the market at any cost.
This is the cycle I just described turned on its head. Let’s see how we got here.
In early 2008, prices began to weaken and the market became more volatile. Investors felt a little anxious, especially as volatility picked up, but the experience of the last few years had demonstrated to them that holding on would be the best thing. This was not unreasonable. Stock prices were nowhere near their highs, relative to earnings, as observed before the dot com crash of 2000. The economic news was still pretty good and while there were some difficulties in the mortgage sector, the FDIC, the Federal Reserve and the Treasury Department seemed to handling things in an orderly manner.
But the news began to get worse and fear rose amongst investors when in October and November Wall Street began to unravel. Banks were in need of huge infusions of cash, brokerage firms were crumbling under the weight of bad investments and too much leverage and access to credit became so restricted that borrowing virtually ceased. The Stock Market had a heart attack.
Fear rose to desperation and panic as the news started to get pretty bad regarding the economy and everyone finally opened their statements and gasped. So now investors’ fear factor started rising but no one really wanted to sell into that great decline. Now, a few months later, clients tell me about so-called sophisticated investors who are saying they are pulling out of the market. I am hearing from liberal radio that the Bush administration didn’t tell Obama how bad it really was and conditions are much worse than they appear. CNBC is full of experts making prognostications about the rest of the year and, day after day, the front page news tells the facts about a deteriorating economy. This feels bad and people are discovering that successful investing is hard to do and can be high risk.
I am suggesting that while this condition can go on for a while, we might be near the flip side of the cycle I described earlier-the opposite of euphoria. Remember I just said the following: “When you are feeling that investing is easy and low risk, and you are feeling most assured, this is the time when investing is at its most risky!
Now I am saying that in these times when investing is hard and seems very risky and you are most fearful about your money, it is the time when investing is actually safer and more rewarding in the future.
That is why Buffett and others are buying today.
Click here to listen…
The Cycle of Market Emotions
There is a psychological “sea-change” taking place before my eyes and I am beginning to recognize a sense of fear I haven’t seen so far in this cycle. Many I talk with, think the stock market is headed for a huge fall and absolutely want no part of it. I can understand their fear, but this is starting to feel like the beginning of one of the big mistakes people make when the news is at its dreariest. Allow me to explain.
There is a natural cycle to any “risk” type of investment. Whether we are talking about Gold, Real Estate, Foreign Securities, -even the bond market. As markets rise, people become hopeful and encouraged. They may start to buy-in as they notice the economy and the stock markets improving. This is natural and healthy. As the markets continue to rise, hope turns into optimism and excitement as their earlier decision is reinforced by the rising market. Every new investment is rewarded with a higher value a few weeks or months later. Investors are feeling very smart while being constantly reinforced by the news of improving fundamentals. Companies are hiring and expanding and profits are rising. They are also growing domestically and internationally and Countries, which historically have had impoverished financial systems, start improving bringing wealth to many of their people who once had little hope of a decent material life. All is good. So good, in fact, that now new people are entering the market trying to get in on the action.
Let’s examine Real Estate as a recent example. As interest rates declined and home prices rose, more and more buyers entered the market with sound fundamental reasons behind their purchases. Homes were affordable and rising prices reinforced their decision that the home purchase was a good idea. This continued for many years reaching a point where prices rose well past reasonable fundamental value. By the time speculators entered the market, people were predicting ever higher prices, due a rising economy as far as the eye can see. This had real estate investors stirred up to the point of euphoria and hysteria.
It continued for a relatively long time, well past the point of rationality and reason. Investors just continued to focus on rosy news reports and rising prices until just when everyone involved reached the maximum point of euphoria, the music stopped. This point of maximum euphoria is the point of maximum financial risk. In other words, when you are feeling that investing is easy and low risk, and you are feeling most secure and assured, investing is at its riskiest point and the probability of high future returns are low.
What has this got to do with today’s investing environment? You might be wondering why I’m talking about rising markets when we are in a completely different part of the economic cycle. Prices are low and seemingly continuing lower. Nothing good is being reported by the media and now, even the White House is forecasting doom unless they get their money. In addition, I am starting to get panicked calls from clients and others who think they should be out of the market at any cost.
This is the cycle I just described turned on its head. Let’s see how we got here.
In early 2008, prices began to weaken and the market became more volatile. Investors felt a little anxious, especially as volatility picked up, but the experience of the last few years had demonstrated to them that holding on would be the best thing. This was not unreasonable. Stock prices were nowhere near their highs, relative to earnings, as observed before the dot com crash of 2000. The economic news was still pretty good and while there were some difficulties in the mortgage sector, the FDIC, the Federal Reserve and the Treasury Department seemed to handling things in an orderly manner.
But the news began to get worse and fear rose amongst investors when in October and November Wall Street began to unravel. Banks were in need of huge infusions of cash, brokerage firms were crumbling under the weight of bad investments and too much leverage and access to credit became so restricted that borrowing virtually ceased. The Stock Market had a heart attack.
Fear rose to desperation and panic as the news started to get pretty bad regarding the economy and everyone finally opened their statements and gasped. So now investors’ fear factor started rising but no one really wanted to sell into that great decline. Now, a few months later, clients tell me about so-called sophisticated investors who are saying they are pulling out of the market. I am hearing from liberal radio that the Bush administration didn’t tell Obama how bad it really was and conditions are much worse than they appear. CNBC is full of experts making prognostications about the rest of the year and, day after day, the front page news tells the facts about a deteriorating economy. This feels bad and people are discovering that successful investing is hard to do and can be high risk.
I am suggesting that while this condition can go on for a while, we might be near the flip side of the cycle I described earlier-the opposite of euphoria. Remember I just said the following: “When you are feeling that investing is easy and low risk, and you are feeling most assured, this is the time when investing is at its most risky!
Now I am saying that in these times when investing is hard and seems very risky and you are most fearful about your money, it is the time when investing is actually safer and more rewarding in the future.
That is why Buffett and others are buying today.
Posted in On The Money! Commentary | Tags: advisors, banking, bear market, economy, finance, financial, interest rates, investing, investments, market, money, money management, money market, stocks and bonds, Wall Street