Friday, October 10, 2008

The Value of the Time Out

In the words of Dick Vitale... "Get a T.O., Baby!!"

The value of the time out to the investor and investors plural (i.e., "the market") is hard to exaggerate.

Whether it's FDR's famous "Bank Holidays," or suspended trading, or simply going for a long walk when you're tempted to make an impulsive trade, the "time out" is a major weapon in an investor's fear-fighting aresenal.

Why? Because fear FORCES us to think short term. It's simply the way our brains are wired. There is a sound biological/evolutionary reason behind this reaction.

When you're out gathering firewood for the cave and lock eyes with a large male Smilodon (read Sabretooth Tiger) who has just emerged from the glade, your brain simply CANNOT LET you indulge in thoughts like "what to wear to Zog's birthday party?" or "should I redo the cave paintings for the harvest season (antelopes are so "early pleistocene")?"

The Sabretooth has gone the way of the Dodo, but the evolutionary function remains. Intense fear still draws our focus on the here and now. As well it should.

This is where the time out can help. The ablility to take a break and regain our bearings (to "step out of the box" as Crash Davis would say) gives our amydalas a chance to stop firing. When that happens we can engage other parts of our brain. That's when we can pull up and out of the tailspin of panic. It's neurobiology. See Rich's critically acclained tome for more information.
This is, of course, the eternal struggle for investors: To pull out of the short-term focus and think big picture.

When we do calm our brains and revisit the situation, it doesn't mean our outlook becomes rosy. It just means we've given our brains the ability to reintroduce reason to our thinking processes - and perhaps a chance to spot the fantastic opportunities such crises produce.

A few days off may be just what the doctor ordered.

In the meantime, good luck out there, everyone.


Thursday, October 09, 2008

The Psychological Prescription

This crisis is now fundamentally about psychology.

Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won't move.

Trust is gone: there is no longer trust between counterparties in the financial system. Furthemore, confidence is at a low. Investors have lost their confidence in the ability of shares to provide decent returns (since they haven't).

This is now a PSYCHOLOGICAL problem. That's what Frank and I do - manage psychology, so here is my prescription:

1. A show of financial force is needed. Confidence has been lost in the ability of any one institution or government to solve this crisis. Now, to restore order, EVERY major central bank in the world needs to stand shoulder-to-shoulder and say: "We won't let this system fail." What? I didn't hear you... "WE WON'T LET THIS SYSTEM FAIL!!!" That's what the business community in the world needs to hear. That's how confidence is restored. It has to be a HUGE intervention and very credible.
2. I've said for a while that if the bailout plan had passed the first time, it may not have needed to be spent. Sometimes just the idea of a price floor is enough. That requires action to demonstrate that there is a buyer of last resort who will establish that floor. Sadly, we've seen the weakness and pettiness of U.S. political leadership, which has terrified investors. And so the credit crunch continues.... Only coordinated action by governments with their hands on the money spigot can pour enough financial oil into the engine now.
3. We need to believe that a BIG entity or institution or consortium is in control, or plans to take control of sorting out the crisis. Otherwise the fear and credit contraction will continue.

That means that when the coordinated action happens, it can't be watered down, and it needs to include the sentiment EVERYTHING will be done to fix this. Less than urgent STRONG action is not enough. Everyday huge amounts of wealth and growth potential are being eroded. It doesn't have to be this bad, but it will if no one steps up to the plate.

Unfortunately, I'm concerned (as is the market), that no one with the power has the leadership drive or political will to get this done. There are huge political risks to this, and sometimes explaining the psychology of what you're doing is enough to undermine it. For that reason, the final solution will need to sound very mechanistic, but the fundamental effect will be psychological.

The implications of a huge coordinated bailout/buyout will be hard to swallow for many people, on philosophical grounds. They might say, "but how can you advocate what is essentially a worldwide regulator or central banking system?" To which I say, "would you prefer a worldwide depression?" This credit crunch and the current market panic is THAT serious. And it needs the appearance of such an entity, for restoration of global confidence.

We need a coordinated, BIG, credible, active, and absolutely forceful response that demonstrates who is in control (and it has to be a unity of governments and central banks with a strong leader). Maybe the IMF and Worldbank will come up with something at their annual meetings this weekend? Maybe...


DISCLOSURE: I'm net short equities.

Wednesday, October 08, 2008

Pressure Valve: Letting off Steam

Have you ever seen a steam pipe explode?

I did. I was in Boston driving down Boylston. I heard an explosion, checked the rear view mirror and what I saw looked amazingly close to the above photograph.
Market crises can create the investing equivalent of steam pipe explosions. Investors get caught between two competing pyschological forces that build up pressure:

On one hand, uncertainty causes indecision.

But on the other hand, when we are anxious, we naturally feel a need to do SOMETHING.

The result of these two psychological forces work against each other until -- Kaboom! -- the pressure becomes too much.

It's a vicious cycle and it goes something like this: Do nothing (and suffer), do nothing (suffer some more), continue to do nothing (suffer to the breaking point) then PANIC!!! (do something rash).

It's a wealth killer.

We need a way to let off steam, so that the pressure doesn't build to the point of explosion.

Now, let it be said that we don't give specific advice to investors here at MarketPsych.

Nonetheless, there are some tricks that people often employ to relieve the pressure.

One of the best pressure valves we have is to sell a small percentage of certain positions to free up some cash.

This works on a financial level, but more importantly it works on an emotional level.

Why does it work?

1) It fulfills a deep-seated psychological need to do something, to take back control of our lives.

2) It creates something safe. It lets us know that at least part of the money that was at risk, is now safe. We have less exposure to pain.

3) It gives us freedom. We now have money that we can put to work on our terms. Emotional forces can no longer compel us to sell what will we have already willingly sold.

4) It's a hedge against regret. We all have the same nausea-inducing fears of regret: E.g. "The moment I sell, the market will bottom out" or "It's going to keep going down, and I'm going to hate myself for riding it to the bottom." Selling a small percentage mitigates this crippling fear.

5) It allows us to reframe crises as opportunities. We know that market panics create opportunities. The problem for so many people is they simply don't have the cash available to take advantage of those opportunities. The ability to engage other parts of our brain is another fear-fighting tool that helps put investors back on a healthy investing track.

How much is enough? 1%? 5%?... 20%? Only you can decide. Sit down with your advisor and see where you stand.

If you would like more information on our trainings, please feel free to contact us.

In the meantime... good luck out there.


Monday, October 06, 2008

Keeping Your Cool in a Panicking Market

The market appears to be crashing (in an orderly way) as I write this.

On the NYSE, New Highs = 1, New Lows = 1000. The VIX is over 55. Our MarketPsych Fear index is the highest ever.

If you're an active investor, what should you do?

Here's an NPR Marketplace interview with me about this.

1. First take a deep breath.
2. If you can't think clearly: go exercise, change your pace, play with your dog.
2. Now orient to where prices currently are. Forget about where you bought a position, or how much it is down. Right now, prices are what they are. And the first source of mistakes is being unable to come to terms with where things are right now.
3. Now, if your holdings are still hurting you, then take some action. You can't think clealy until you stop the bleeding. That doesn't mean sell everything. That means consider selling a small portion of a very painful position to relieve the pressure.
4. But now come back and consider that this is a historic time to find bargains in the market.

For example, if you believe that financial catastrophe is coming (and you have logical reasons for believing this), then gold is usually a good bet. Recently gold mining stocks have fallen in tandem with other stocks (yet their profits will be greater in an inflationary environment).

If you believe deflation is coming, consider this statement: "During deflationary environments, equities have performed poorly; however, high-quality fixed income has performed well." This powerpoint is a primer on managing investments during deflationary and inflationary environments.

Keep in mind that the best investments going forward will often be in stocks that you probably haven't heard of. And corporate bonds may perform better than stocks.

A stock screen looking for companies with high cash levels (and little debt) is sure to find some great opportunities in both stocks and bonds.

Distressed debt and preferred stocks currently have high yields, and you are likely to be very happy about owning these going forward. Also consider convertible bonds. A bond screener (such as at Yahoo Finance), can help you locate these.

If you've ever considered buying Google shares, it's cheaper now than in the past 2 years: $371/share. And they have $12 billion in cash to use to buy cheap and washed out companies.


Tune in to your internal sense of balance first. Stabilize your mind first, and only then begin the process of sorting through the rubble.

In general, you don't NEED to do anything. However, sometimes inertia can cost you if you're not well-positioned.

And keep in mind that it's always good to keep cash available for bargain shopping.


Disclosure: I own several gold mining stocks as a short-term trade (but I don't believe financial catastrophe is coming).