A Message About Fear and Greed

An Important Message About Fear and Greed
The Future (for the Market) is Bright!
It’s Different This Time?

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One of the great characteristics of the sciences, from astronomy to psychology, from anatomy to zoology, is that every generation builds on the work of those that preceded it.
As Isaac Newton put it in 1676, “If I have seen a little further it is by standing on the shoulders of Giants.”
This regular knowledge transfer happens—most commonly—because of schools.
It begins with reading, writing and arithmetic in the earliest grades, and it continues all the way through our formal college education, where students with the right combination of talent, interest and funding can enroll in courses on neuroscience, vector analysis, marine mammal cognition, psychopharmacology and much more.
Sadly, the same opportunities do not exist for investors.
Sure, you can get a degree in economics, finance or business.
You can become a Chartered Financial Analyst (CFA), which doesn’t necessarily mean that you’re a good investor, but at least means you might get a job in the industry.
You can even take courses in trading, which at least means that you’ll know how to move money around fast.
But none of those will necessarily make you a good investor.
Sure, you’ll know more, but you may not have a clue how to surmount the biggest obstacle to your investing success.
And what is that obstacle?
It’s the tendency to be swayed by emotions—both yours and the crowds’— and at the extremes to allow logic and reason to be trampled by the powers of fear and greed.
Yes, fear and greed.
In short, when people feel very optimistic about the future, as they did in early 2000, when the Millennium Bug had been averted and Internet stocks promised to bring a bright new future, the power of greed dominates and investors tend to award stocks higher prices.
Contrarily, when people feel particularly pessimistic about the future, as they did at the end of 2008, when our leaders told us our banking system was approaching a “crisis” stage, fear gains the upper hand and investors tend to award stocks lower prices.
Obviously, the best way to invest is to Buy at the point of peak pessimism, and Sell at the point of peak optimism.
Unfortunately, the system for detecting those points has yet to be discovered, and I doubt that it ever will.
But we can work toward it, first by learning more about the powerful role of sentiment, and second by measuring the emotions of investors—and potential investors—today.
To learn more, I tend to read books.  (I just re-read “Psychology of the Stock Market” by G. C. Selden, which includes this beautiful line: “Public opinion is becoming more volatile and changeable year by year, owing to the quicker spread of information and the rapid multiplication of the reading public.” The book was published in 1912!)
And to measure the current emotions of investors or would-be investors, I read the news, talk to friends, and consult a handful of experts.
Today, obviously, sentiment is quite negative, not only because very few investors have any profits to brag about, but because the economic news that dominates our headlines is so persistently gloomy.
But how negative is it?
Consider the following from Jason Goepfert of SentimenTrader.com.
“The latest survey from the American Association of Individual Investors (AAII), where the percentage of those looking for the market to rise plummeted to nearly a five-year low.”
“When you consider what we’ve been through during the past few years, this kind of give-up is astounding.
“Since the inception of this survey in 1987, there have been 48 other weeks where investors were this non-bullish.  The table below shows the performance of the S&P 500 going forward”

                      1 Week Later         2 Weeks Later    1 Month Later     3 Months Later
Avg Return            0.5%                  1.0%                  2.3%                       5.9%
% Positive              58%                    60%                  79%                        98%
Max Loss             -0.6%                  -0.8%                -1.0%                     -1.6%
Max Gain              1.0%                    1.9%                3.1%                       7.3%
“Looking out three months later, the S&P was positive 47 out of 48 weeks, a pretty impressive record.  The skew between the risk and reward was clearly tilted to the upside as well.
“What’s even more notable is that this is one of only seven weeks in total when the bullish percentage dropped this low, and the S&P wasn’t trading at a multi-month low at the time.  Of the other six instances, the S&P was higher three months later each time by an average of +9.1%, an average maximum loss of only -1.5% and an average maximum gain of +11.4%.”
The interesting aspect of the present, in short, is that sentiment is so low even though the market’s performance has been that bad.
I think sentiment is poor not just because of recent losses, and not just because of the rotten economy, but also because it’s been more than 10 years since that 2000 top!
Ten years without progress is a long time, but it is not unprecedented.  The Dow first hit 1,000 at the start of 1966, but was soon constrained by the rampant inflation of the 1970s, as well as the need to “digest” the excesses of the 1960s.
The Dow didn’t succeed in breaking away from 1,000 until late 1982, nearly 17 years after it first touched that level.
Now, I don’t know if it will take 7 more years before we break free from Dow 10,000 and I really don’t care.  I know there will be plenty of bull and bear periods in the years ahead, because there always are, and if you can use sentiment studies to be an early buyer—and an early seller—you’ll be able to take home your share of the profits.
So today I suggest you lean toward optimism, precisely because so many people are pessimistic.
One final point: Some people will tell you, “It’s different this time,” and they will cite various fundamental facts—our huge national debt, Social Security, Congress, demographics, China, terrorism, peak oil, immigration, global warming—as reasons that investing in the future will not pay.
To which I say, “Baloney!”
Throughout history, there have always been people saying “it’s different this time,” but bull markets and bear markets have repeatedly proved the naysayers wrong.  And why?  Because bull and bear markets are driven by changes in perception that drive human emotions from the depths of despair to the heights of euphoria and than back down again, over and over.
Over the decades and the centuries, the economic facts change and the technologies change (note the comment of G.C. Selden about the quicker spread of information), but human nature is ever dependable in its variability.
And THAT is why I am confident that the market’s next major move will be up.
Yours in pursuit of wisdom and wealth,
Timothy Lutts
Cabot Wealth Advisory
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