Rising Fear, China, and Applied Behavioral Finance

The MarketPsych Fear Index is rising (it was already fairly high before today's selloff). Apparently there was a considerable amount of nervousness before the market opened today, and that nervousness escalated into outright fear by day's end. Maybe a front-page (C1) WSJ article about buying on dips sowed doubt in investors today. "When Crash Means Buy" - brings out the Chicken Little in me.

BUYING ON DIPS

There was no useful info in the WSJ article (such as when to buy on dips and when not to), except that it sowed doubt about what has seemed a surefire strategy. Essentially, since buying on the dips has worked so well for so long (definitely since 1987, excepting the 2 1/2 years for tech stocks after 2000), many investors have become used to increasing their position sizes every time there is a downturn in shares. The article is a little ominous, and certainly hit the market at an already nervous time.

SIVs are the newest "What the...?" to come to the attention of the market. And uncertainty is almost always a negative, especially when the cause is interminably murky and needs $100 billion bailout packages organized by the largest global banks. Once the damage of SIVs comes to light, then the market can rally again, but for now it doesn't look good that another hidden risk has emerged to damage the financial sector.

CHINA A-SHARES

If you've been a regular visitor to our website since it opened - which is doubtful :), then you've known that I've always been bullish on China, and even set up an Investing in China webpage in 2004 to facilitate research. As I mentioned last month, the market is topping now (though may have a little more juice until February, after which it's best to steer clear). Appears that Hong Kong H-shares are doing spectacularly as an arbitrage play. Also via the WSJ (fine journal, that).

As long as Hong Kong remains in anticipation of local Chinese monetary inflows (and as long as it hasn't started arriving), then that market (especially H-shares) will have upside pressure. Ironically, Chinese investors are having tremendous difficulty opening accounts in the one city where outflows to the Hong Kong markets will be permitted (Tianjin Binhai New Area), and the pilot program was ultimately postponed, so no Chinese cash has made it to Hong Kong legally yet. But that is the genius of the Chinese authorities. By announcing the impending program, the premium of A-shares over H-shares has started to dissipate. And if history is any guide (as when the Chinese gov't announced in late Feb 2001 that the B-share markets would open to local investors in June 2001), then the actual financial inflows from China will probably mark a medium-term top in both markets.

WHAT'S THE USE OF BEHAVIORAL FINANCE?

What's the use of behavioral finance? That's the motivating philosophy behind a wonderful organization in Los Angeles -- the Behavioral Finance Working group of the CFA society. Here's their discussion group online.

I was fortunate to give a talk to the group yesterday. I met some great people and got lots of new ideas about how to apply behavioral finance to several areas:
1. Defeating you own investing biases.
2. Helping advisory clients to understand and avoid making biased decisions.
3. Finding opportunities in the markets.
More about those in upcoming posts...

Happy Investing,
Richard