|Robert Shiller, the Yale University economist who shared the Nobel Prize in economics in 2013 for his analysis of how human behavior shapes asset prices, has long tracked investors’ expectations of stock returns. I discussed this a year ago, but I think it bears considering again given today’s investment climate.
Shiller produces what he calls Stock Market Confidence Indices. They are created from surveys compiled monthly by the International Center for Finance at Yale University. What they indicate is that investors are more likely to believe a market crash, on the scale of 1929 or 1987, is imminent in the coming six months if a recent sharp decline in the markets was prominently covered in various media.
The greater the magnitude of the recent market decline, and the more prominent the news coverage, the more investors will tend to believe that a more severe crash is coming. And that perception in not limited to so-called amateur investors.
Shiller is of the opinion that investors may be better at reading balance sheets and income statements, but not at evaluating whether we will soon see 1929 all over again.
It seems that negative events sear themselves into the human mind more deeply than positive outcomes. To put it another way, evolution appears to have sensitized humans to danger, whether it is a hungry bear or a bear market.
Shiller uses the example that a caveman seeing a horrible mauling by a bear on a certain path, will tend to avoid that path even if the bear is not around. It is burned into the caveman’s mind to do so. Whereas a path with delicious fruit will also stick in his mind, but the vision is not as important to survival and therefore not as memorable.
Given that we have recently witnessed a sharp market decline are we therefore biased towards the idea that another similar or worse debacle is in the offing? Maybe. Nonetheless, you should not succumb to mass hysteria. And never hold a fire sale of your holdings.
The problem lies in part with the Street’s prognosticators. Whenever the level of uncertainty begins to rise, out they come promulgating the supposition that the risk of investing in equities outweighs the potential returns.
Such comments are misleading, dubious at best and at worst they are simply wrong. It takes little in the way of ingenuity to postulate a biased set of circumstances in defense of a strategy or position.
Time, not timing, is the key to portfolio growth. Yet, even during a bull market it is not unusual for some investors to chalk up negative returns. Likewise, positive returns can be achieved when the markets have a glide path equivalent to a falling brick. Having analyzed countless portfolios over the years, I can personally attest to the validity of those statements.
Peter Lynch, the former manager of the Fidelity Magellan fund said it succinctly in his 1989 book, “One Up on Wall Street.” Lynch wrote, I’ve always believed that investors should ignore the ups and downs of the market and remain fully invested.”
And many before Lynch reached the same conclusion. Famous British economist John Maynard Keynes once commented that from time to time it is the duty of a serious investor to accept the depreciation of his holdings with equanimity and without reproach.
Periodic declines in the stock market are as inevitable as are rallies. Benjamin Graham deftly pointed out in his well-known book, “Security Analysis,” that your investment strategy should always be to select only quality companies in which you desire to become a partner.
Keep in mind that “Security Analysis” was first published in 1934, a time when the public faith in the stock market had all but totally collapsed.
Nonetheless, investors are continually encouraged to move in and out of the market or in and out of specific stocks, all in the name of market timing, and with the encouragement of so-called “experts” and their sanguine analysis.
As Peter Lynch once said and I have quoted many times, “Far more money has been lost by investors preparing for corrections than has been lost in the corrections themselves.”
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.