Investing Caffeine

Historical Trampoline Cycles of Fear & Greed

February 18, 2011 at 1:36 am Leave a comment

What goes up, eventually comes down, and what goes down, eventually comes up. Like an adolescent jumping on a trampoline, emotions in the financial markets jump sky high before crashing down to earth…and then the process repeats itself. The underlying reasons behind every market gyration are different, but the emotions of fear and greed are similar. Since 1919, there have been 29 recessions, and 29 recoveries (pretty good recovery batting average). Over that 92 year period we have also witnessed the Dow Jones Industrial Average go from around 100 in 1919 to over 12,300 today – not too shabby.

The blood curdling panic experienced in 2008 and early 2009 has turned to ordinary fear among retail investors – although the doubling of the equity markets from two years ago has instilled a good dosage of animal spirits into professional traders and speculators. When trillions of low yielding cash and Treasuries ultimately come barreling into equity markets, thereby extending equity valuations, then I will become extra nervous. Until then, plenty of opportunities still exist – there just is not nearly as much low-hanging fruit as two years ago.

More of the Same

To make the point that “the more things change, the more things stay the same,” you can go all the way back to 1932 and read the words of Dean Witter – I also wrote about the history of panic in the 1970s (see Rhyming History).

Even some 80 years ago, Witter was keenly aware of the doomsday bears:

“People are deterred from buying good stocks and bonds now only because of an unwarranted terror…All sorts of bugaboos are paraded to destroy the last vestige of confidence. Stories of disaster which are incredible and untrue are told to foolish and credulous listeners, who appear willing to believe the worst.”

The bugaboo purveyors I called out in 2009 included Peter Schiff, Nouriel Roubini, Meredith Whitney, and Jimmy Rogers. I’m not sure who the next genius du jour(s) will be, but I am confident they will be prominently paraded over the media airwaves.

Cherry Price for Consensus

As firmer signs of an economic recovery finally take hold, investors slowly regain confidence about investing in risky assets. The only problem is that prices have skyrocketed!  Witter captures this dynamic beautifully back in 1932:

“Some people say that they wish to await a clearer view of the future. When the future is again clear the present bargains will no longer be available. Does anyone think that present prices will continue when confidence has been fully restored? Such bargains exist only because of terror and distress.”

Herd Gets Slaughtered

History proves over and over again…the general investing public suffers the consequences of following the herd of fear and greed. Or as Witter states:

“It is easy to run with the crowd. The path of least resistance is to join in the wailings that are now so popular. The constructive policy, however, is to maintain your courage and your optimism, to have faith in the ultimate future of your country and to proclaim your faith and to recommend the purchase of good bonds and good stocks, which are inordinately depreciated.”

In the short-run, markets move up and down in an unpredictable fashion, like an irresponsible teenager jumping on a trampoline. In the long-run, investors can do themselves a favor by ignoring the masses, and sticking to a disciplined, systematic investment approach that includes controlled valuation metrics and contrarian sentiment factors. That way, you won’t fall off the investment trampoline and permanently break your portfolio.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Entry filed under: Behavioral Finance, Financial Markets. Tags: 1932, behavioral science, Dean Witter, Dow Jones, emotions, investing, Jimmy Rogers, Meredith Whitney, Nouriel Roubini, Peter Schiff.