Two decisions: the right time to buy stocks and the motivation to do so. Two more decisions: the right time to sell stocks and the motivation to do so. Like the moon and the stars, it is very unusual for these events to line up at same hour, same day, same week….compromise is always necessary. Buys and sells tend to be quantitative while motivation is born of emotion. A good mathematician can reduce both sides of these transactions to quant theorems. It’s always nice to reduce emotions but as we all know, if you become good with a hammer, pretty soon everything looks like a nail….gotta be careful about that.
The right time to sell is not the polar opposite of the right time to buy. So if you’re good at buying you’re not necessarily good at selling. Once you own something you put down a tent stake that the accountants call basis…..the date and price at which you purchased shares. Buying is not influenced by basis until you add to a position. Basis is always a consideration when selling. The relationship between date and price can be very significant. The investor that owns a hot stock, appreciating rapidly, can fall into the “too far, too fast” club pretty quickly…pure quant after you eliminate greed. The same investor enduring a 15-20% drop in price over almost any period of time, might consider adding to the position, loss trading it or getting out while the getting is still good….pure quant if you can eliminate fear. Any way you cut it, basis is a factor and upside volatility tends to be less emotional than downside volatility.
Some Say Today’s Market Seems Overvalued….
It might be. We are currently flirting with Dow 20,000, riding a 7-year old bull, P/E’s on the high side of their historical range, while interest rates continue to be held artificially low….cowabunga Buffalo Bob, how do you figure all that stuff out?
Some say not selling is the same as buying. Does that mean if you maintain long positions you’re actually buying the market? What does it say about the investor reluctant to invest new dollars but willing to hold appreciated positions? There’s that basis issue again.
This stuff gets pretty complicated pretty quickly, doesn’t it? Many are afraid of stumbling into the next financial bubble….a surge in asset prices unwarranted by fundamentals and fueled by exuberant behavior. Behavioral finance helps us understand how investors make irrational financial decisions. These concepts include anchoring, hindsight bias, confirmation bias, and decision paralysis. Check out Behavioral finance impacts money decisions for a more detailed discussion….it’s pretty interesting. The dot-com bubble at the turn of the century is the classic overvaluation that investors seek to avoid. During that event, the NASDAQ Composite soared from 2,192 on 12/31/98 to a high of 5,048 on 3/1/00. That’s a 15-month surge of 130% for an index that had been averaging about 15% annually. Looks like a bubble, talks like a bubble and walks like a bubble….that was a bubble. There were very few of our clients that didn’t know more about the NASDAQ than we did during that period. That phenomenon has ended.
On 7/19/2007 the Dow Industrials topped out at 14,000. Prior to that date it had “surged” from 10,667 on 01/20/2006….a 31% increase that spanned 18 months. Although this is a little higher than the historic 11% average posted by the Dow, it is hardly the stuff that bubbles are made of. However, July of 2007 was about as close to the beginning of the financial recession as any of us would care to get. Unfortunately, the onset of this swoon in financial prices was due to a mortgage collapse which caused the stock market to sell off in sympathy, Dow 14,000 to Dow 6,547. It didn’t fit the definition of a bubble and investors could not expect to predict this event by reading stock market tea leaves. This sure is a tough business…isn’t it?
I fully expect to see Dow 40,000 in my lifetime and I won’t profit from it if I am not fully invested. In 1970 I started my first salaried job at the First National Bank of Lincoln in their Investment Division. My job was to sell municipal bonds to banks. At the time the Dow was around 825 and today it weighs in at 19,799, that’s a compound accreted rate of return of 7.10%….not counting dividends. At that same rate the Dow doubles in 10.2 years…..presto change-o…40,000. If Donald Trump doesn’t measure up and the Dow grows at a meager 6.00% it will take 12 years….I’ll just have to live longer.
I also fully expect to see 15-20% corrections during the next 10-15 years. They won’t be any fun because 15% of a 20,000 Dow is 3,000 Dow points and 20% of a 40,000 Dow is 8,000 Dow points. Behavioral finance also teaches us that people don’t get cozy with big figures too quickly. The tendency is to expect the same type of volatility experienced in the last correction…that doesn’t always work. P&A was born in a 7-8 figure multi comma world, so no one around here is surprised or intimidated by these kinds of numbers. As your assets grow so will your liabilities. In a similar fashion, equity performance and volatility are joined at the hip. If you are unable to deal with these issues expect to drive a small car well into retirement.
Knowing what’s going to happen doesn’t always make it easier. The long-term is the only term, hang in there and succeed. Happy Holidays!