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Monday, August 8, 2011

Fear vs. Greed

A popular way of viewing markets is in terms of a battle between fear and greed.  When greed has the upper hand and prices are rising sharply, it seems perfectly normal.  When fear gains the upper hand and prices plummet, like the correction we are now experiencing, not so much.

All kinds of advice comes out of the woodwork during times like the present.  After all, it's a chance to look like a genius.  Reputations are made in times like this.  Stay on the path, we are not lost, the road is straight ahead.  Coming out of the bush after listening to the advisor goes a long way towards inspiring confidence.

But the fact of the matter is that there is a bit of a moral hazzard issue here.  If the advisor is correct, then he or she is seen as a wise person.  On the other hand, if stocks are lower 10 years from now, the client is the one that loses.

It is notable that the advice to stay the course has always worked in the past.  On the basis of historical experience, it is the "safe" bet.  And, in fact, there are very good reasons why it should work this time - reasons that long-time market observers understand.  For example, stocks are getting cheap relative to the usual metrics of p/e ratios and dividend yield.  Also, actions are taking place behind the scenes to correct the problems.  One scenario (this should get a good laugh) is that the U.S. and the rest of the world actually begin to get their fiscal messes in order.

On the other hand, we are definitely in uncharted waters as usual.  Go back to late 2008 and early 2009. We know how markets turned out.  There was a massive rally ( which is firmly in investors' memories) from March 2009 on.  But what if the Fed and the Treasury hadn't stepped up at the last minute and guaranteed money fund assets?  What if TARP hadn't passed the second time around?

Today's situation is scary because we are depending on Europe to do the right thing policy wise.  In other words, we aren't driving the car.  Furthermore, we've got craziness in the U.S. political arena that can't be papered over easily by monetary and fiscal policy.

One observation I have made as an advisor is that many people are taking risks with their portfolios they don't have to.  In other words, they are set for a comfortable retirement even if they earn a modest 3% or so return on their assets.  They don't need 60% invested in equities.  They may want to think about reducing equity exposure.  The additional expected return doesn't compensate for the possibility of a big downdraft from here.  Others are well advised to stay the course, and younger people should start to put on their buying hat, IMHO.


  1. Time to be greedy when others are fearful.

  2. I was actually surprised on how the markets bounced back today.

    But a roller coaster is never a good sign. Good advice.