Friday, August 31, 2007

Market Fear: The Poison and The Antidote

If behavioral finance teaches us one thing, it is that Fear trumps Greed. In fact, it's not even close. Fear is like the Harlem Globetrotters playing the Washington Generals. Sure, ostensibly it's a real contest, but despite the ups and downs along the way, we always know who's going to win in the end. The outcome is predetermined, inexorable.

(Authors Note: I used to use the Yankees and the Red Sox for this analogy. But then David Ortiz hit that home run off Mariano Rivera in 2004 and rendered my metaphor obsolete. A pox on your house, Red Sox Nation!!!)

Fear drives the market. Why? Because losing hurts more than winning feels good. Because the future is uncertain, and the default emotion in cases of uncertainty is fear. Because you're not paranoid, the Market really is out to get you, and fear is the greatest weapon in the Market's arsenal.

How do we fight our fear? With "reason"? Well, some people do. And by "some people" I am chiefly referring to Vulcans - the supremely rational beings from the eponymous planet who are not afflicted by such human weaknesses as emotion. (Then again, Vulcans mate only once every seven years, so you can see why emotions could be a big drawback.)

No. For most of us on Planet Earth, we are forced to fight the battle on an emotional level. Reason definitely helps, but only so far as it helps us reacquire our emotional equilbrium.

Fear is a poison. But there is an antidote - Control. Not actual control (which is irrelevant) but the belief that that you have control. Fear beats Greed. Perception beats Reality - at least where our emotions are concerned.

We have seen this play out recently on marketwide level with the recent actions of the Fed Charmain, Ben Bernanke. The market flagged due to fear. (It always does due to fear.) But the fires of fear were stoked in large part because one of the main sources of investors' (sense of) control is the Federal Reserve Board.

After months of hearing "Inflation remains our primary concern", investors began to wonder if the esteemed Dr. Bernanke really "got it". The Market was saying; "Does he understand our concerns? Does he even care?"

Investors were riding shotgun with the Fed Chairman on a dangerous road. They were concerned there may be a cliff up ahead, but they were even more concerned that the Fed Chairman was asleep behind the wheel.

The first shot of control was injected back in July when Chairman Bernanke acknowledged that the mortgage crisis (and credit crunch) were on his radar screen. (Whew! He's not sleeping after all.) The second shot of control came when he lowered the discount rate. (He's awake and he's willing to hit the brakes.)

People called his decision to lower the discount rate a "largely symbolic move". Exactly. Symbols are important, especially when the symbolic gesture tells people, "Relax. I'm on it".

The Market has been calling (or is it whining?) for an interest rate cut. And I, for one, think that would be splendid. But investors got something even more important. They got back their sense of control.

It's like the immortal words of Mick Jagger:

"You can't always get what you want, but if you try sometimes, you might find you get what you need."

Bernanke's awake. It'll do for now.

Saturday, August 25, 2007

Rally Happened, Now What?

The stock market rally I predicted on August 17th came to pass. How did I know it would happen?

First, let's recap the action. The US market is up 2.5% or so (the biggest one week gain in 4 months) since the prediction, the Hang Seng was up 12% last week, and the Kospi (Korea) and Bovespa (Brazil) were both up 9%.

So how was it clear to me that the market would rally for a week? Well, there was a definite sense of panic on the prior Thursday. Jim Cramer's doom-filled rant on Erin Burnett's CNBC show is one obvious example. Watch Cramer lose it here on youtube.

When the panic was over, there was a end-of-day rally -- the first positive sign. Then there was relief when the Fed dropped the discount rate 1/2% -- indicating that the Fed would bail out the markets if need be. That relief gradually spread and encouraged panicked traders to buy back in, prompting shorts to cover, and a rally ensued. Psychologically, if traders are not at peak fear (risk aversion), they are less risk averse (leading to greater buy pressure). Even when they are afraid (but no longer panicking), then the market will rally. It's all about levels of risk aversion relative to their recent extremes.

If another negative event had happened (some small ones did), the market wouldn't have fallen as much because the short-term players were already scared out. It would take a major event to convince the long-term money to sell.

On an individual basis, I know many traders and fund managers had difficulty staying long on that Thursday (August 16th). Most portfolio managers knew it was a good time to buy (as every asset manager has learned, it's a great time to "buy when there's blood on the streets"). But without long experience and tremendous courage, it is extremely challening to emotionally hold the line during such periods. My book Inside the Investor's Brain: The Power of Mind Over Money (Wiley Trading) has some tips for practitioners during market panics.

Happy Investing,

Friday, August 17, 2007

Rally Ahoy and Dr. Murtha on CNBC (again)!!

Setting up for a short-term (week or more) market rally. Yesterday's mid-day panic flushed out the weak hands, and today is time to buy for short-term profits over the next week as the sellers scramble to get back in (at higher prices, oops!). Fear levels have peaked and are now coming down in "relief." (Note: we don't endorse short-term trading).

Dr. Murtha on CNBC three times August 9th, 16th, and 17th, 2007. (subscription required).


Monday, August 13, 2007


I was on CNBC on Thursday, which I enjoyed immensely. (Clip here). They wanted a "shrink" to provide commentary of the current market psychology. We know people are jittery these days. How could they not be? But we also know that panic costs people money big time. So how do you get back to the proper perspective?

Well, start by checking out the picture above. What does it look like to you? If your answer is "not much", than you have something in common with the vast number of investors viewing the market's behavior the past couple of weeks.

The photo above is a painting by Claude Monet. Monet was the founder of a new style of painting, French Impressionism. The style is marked by, among other things, "open composition" and "visible brushstrokes". What that translates into (apparently) is "make a bunch of dots and the dots become a picture."

Here's the thing to remember: A portfolio is like a Monet. If you get too close to a Monet, all you see is a bunch of dots (a phenomenon comically illustrated in the movie Ferris Bueller's Day Off when he goes to the art museum). The same is true with our portfolios. When we get too close, we see nothing but a bunch of dots. It's data devoid of context. The picture makes no sense, and when it comes to our investments, that's scary.

The key to appreciating a Monet or a portfolio is viewing it from the right distance.


This means resisting the constant pull to look at our investments from a weekly... daily... (minutely?) framework. If you look at a chart of the past month, it will provide a frighteningly volatile picture of big ups and bigger downs that may induce a feeling of motion sickness. If you look at a chart of the past 20 years, it is much more likely to produce what Glenn Frey would call a "peaceful, easy feeling". Volatility is not the same thing as risk, if you have the right time horizon. Perspective is everything.

I'm speaking of course not only about the distance of time, but of emotional distance as well. When we get "too close" emotionally to our portfolios the result is the same. This is one reason why working with a financial advisor (or failing that, an investing confidante) can be so valuable. Sometimes we need someone to tell us, "Take a step back".

Like Sisyfus rolling his stone up the hill in Hades or me organizing my desk, it is a neverending battle because, as humans, we are constantly, unconsciously and inexorably and being drawn into a short-term focus. (It's happening right now. Seriously. It is.) That's the side effect of paying attention to our world and we can't help it. But if we can make ourselves aware of it, and that gives us a fighting chance.

How do you keep yourself aware?: Reminders. Whatever works best for you. One option would be to get yourself a Monet print to hang in your office. They're cheap, they're easy to find, and they make a nice reminder of how we can't appreciate our portfolios if we don't have the proper distance.

Plus people at work will think you're "classy". Which is nice.

Sunday, August 12, 2007

One Risk and One Opportunity

In my weekend readings - trying to figure out what is going on in the markets - I came across two interesting comments in Barron's. One is a frightening, and lingering risk, and one is a stunning and immediate opportunity.

The risk is this: If the credit crunch continues, the Fed will be compelled to lower the discount rate to return liquidity to the system. A rate cut will hurt the dollar, and foreign capital may flee if the dollar begins to fall. As a result, credit could tighten even as the Fed eases.

The opportunity is this: many long-short quant hedge funds buy value (i.e. low P/E, low price/cash flow, etc...) stocks and short high priced stocks. As these funds have been hit by paradoxical market action in early August, and because many of these funds use leverage, they have been bailing out of value stocks with a vengeance. I've been affected by the deepening of value myself, as a value portfolio I have been holding since January 2007 was up 35% in early July, but is now up only 15% (losing 10% alone in the past week). The stocks that value-seeking hedge funds are bailing out of have actually become very cheap -- presenting great opportunities for value investors (and I have a feeling that many will become even cheaper). Later I'll post some of these bargain stocks' names, when the coast is clear. I don't think this is a good time to buy.


Thursday, August 09, 2007

CNBC INTERVIEW and Waiting 'till the Fat Lady Sings

NEWS FLASH: Marketpsych Managing Director Frank Murtha on CNBC today!!! See the video here.

Market fear is spreading, and that's a good thing.

This afternoon a stranger sitting next to me on the subway asked me how the market was doing today (someone who didn't know I work in finance). When anonymous strangers stop staring straight ahead, and start nervously inquiring after the health of the stock market, then it's about time to search for bargains. I figured that experience was the opposite of knowing it's time to sell when you shoeshine boy (or cab driver, or doorman) is offering you stock tips.

As predicted in my last blog post - shameless self-congratulation :) - the market would drop, bounce, and then drop again on greater fear. Below is this morning's market fear chart. Notice how investor pain has risen well above March's pain levels (this is a 7 month chart).

The sell-off will continue, in fits and starts, until the full depth of the (1) subprime mortgage defaults and (more importantly) (2) Credit (and thus liquidity) squeeze on borrowers is comprehended. As long as there is uncertainty, the markets will not rest, and the relief rallies will be only brief and tentative.

If the extent of overextended borrowers (and subsequent defaults) turns out to be as bad as the Chicken Little's are claiming (unlikely), then the market may not rally until congressional legislation is passed and it's ramifications are fully understood (not a good thing in the short-term). Such legislation would be intended to prevent further profligate borrowing by debt-weary consumers. And better credit monitoring and preparation for liquidity crunches (higher reserves) by financial institutions. As long as interest rates remain low, the expansion should continue with only minor economic consequences. It's just a waiting game now -- to see what the fallout will be, and then it will be time to buy.

Ah, but that's idle speculation of a nervous mind. We have had a pattern of profitable buying on dips recently (past 4+ years), and it's possible that many have become seduced by the ease with which they made money -- letting their guards down. That could end badly, or it could keep on. In any case, it will be safe to buy dips when the cards have all fallen and the hands are turned. We need capitulation, panic, and consequences. Then the liabilities of the losers will be known, and the mess can be cleaned up.

Happy Investing,