Guest Post: Reality Vs Belief
Submitted by Lance Roberts of StreetTalkLive blog,
In this past weekend's missive I showed, in rather excruciating detail in multiple charts, that complacency in the financial markets is at extremely elevated levels. I equated this "complacency" to the danger of driving down an isolated freeway very late at night:
“The sky is clear, the music is on, you become a bit hypnotized as the road stripes regularly tick by...and then - WHAM! A deer runs out in front of you.”
It is much the same with the markets. As prices steadily rise - investors become lulled into a false sense of security. Since bull markets tend to grind their way higher – investors began to believe that the rise will be unending as the mainstream analysts encourage continued risk taking. Each time investor's fall victim to the belief that somehow, or for some reason, this time will be different. However, it is in this moment of extreme complacency that **** happens - “WHAM!”
The chart below shows you what I mean.
The reason that investor's perform so poorly over long periods of time is that investors continually extrapolate current trends (reality) indefinitely into the future (belief). It is in that moment, when "contrarian investment views" are regularly disregarded as irrational fears, that a new "reality" presents itself.
In 1999 - it was the age of technology that justified lofty valuations. Old valuation metrics no longer mattered...until they did.
In 2003 it was believed that the market would continue going down as the internet bubble collapsed from its own weight. It didn't.
In 2007-08 it was the "Goldilocks" economy and "subprime" issues were contained while banks and hedge funds had eliminated market risks. They weren't and they didn't.
In late February of 2009, as I wrote the article entitled "8 Reasons For A Bull Market," it was believed that the markets had nowhere to go but further down. The unwinding of the financial crisis and destruction of the real estate market was far from over.
Each time as "belief" separated from "reality" investors repeatedly made the same emotional mistakes either selling at bottoms or buying at tops. Today is no different. With mainstream analysts goading them forward - investors who have remained cautious, until now, are throwing in the towel. The "belief" has now become that global liquidity injections, from the Fed to Japan to Europe, have changed the game offsetting any risks of being invested in equity related investments. However, just as we have seen repeatedly in the past, that "belief" may be flawed and it is possible that a new "reality" may be set to form sooner rather than later.
This past week I posted a piece by Mebane Faber entitled "You Are Not A Good Investor" which goes to much the same point. Mebane Faber stated:
“So why do most people think they are great investors? Likely the same reason most people think they are better drivers than average, and are certainly better looking than average. It is a built in behavioral bias floating around in our genetics passed down from our ancestors many years ago.
Don't be too downtrodden; stock picking is hard, really, really, hard. The basic odds are stacked against you. My friends at Longboard Asset Management completed a study called The Capitalism Distribution that examined stock returns from the top 3000 stocks from 1983-2007. They found that:
- 39% of stocks were unprofitable investments.
- 19% of stocks lost at least 75% of their value.
- 64% of stocks underperformed the index.
- 25% of stocks were responsible for all the market's gains.
Simply picking a stock out of a hat means you have a 64% chance of underperforming a basic index fund, and roughly a 40% chance of losing money!
Not only is it hard to pick stocks, you are also up against the most talented investors in the world.
There is a famous saying in poker, 'If you sit down at the table and don't know who the fish is – you're the fish.' Most people who sit down at a poker table with a professional player will quickly lost all of their money. While luck can have an influence in the short term, eventually the outcome is near certain. Most individual investors do not know that they are the fish in the game known as Wall Street...”
Investors behave much the same way as individuals who addicted to gambling. When they are winning they believe that their success is based on their skill. However, when they began to lose, they keep gambling thinking the next “hand” will be the one that gets them back on track. Eventually - they leave the table broke.
It is true that bull markets are more fun than bear markets. Bull markets elicit euphoria and feelings of psychological superiority. Bear markets bring fear, panic and depression.
What is interesting is that no matter how many times we continually repeat these “cycles” – as emotional human beings we always “hope” that somehow this “time will be different.”
Unfortunately, it never is, and this time won’t be either.