In March, the S&P 500 Index reached an important inflection point.
It wasnt the new all-time high you may have been hearing about, because the all-time high wasnt the major inflection point, and the major inflection point wasnt hit in March of this year. It was hit in March 2009.
It was then that the S&P 500 (and most other major U.S. stock indices) closed at dramatic lows. For the S&P, the closing low of on March 9, 2009 represented a 57% decline from its previous high in October 2007.
Many investors were shocked at the magnitude of the losses, and for some the urge to give up on stocks became irresistible. Even as the S&P 500 clawed and bounced its way higher, investors relentlessly pulled money out of stocks. According to the Investment Company Institute (ICI), investors took net redemptions from equity mutual funds in 19 of the 20 months through December of last year, totaling more than $320 billion.
Now that the S&P 500 is back in the news for hitting a new high, investors appear to be ready to start putting money back into stocks again. The ICIs latest reports show net inflows to equity funds in each of the first three months of this year totaling nearly $65 billion. We believe it is a good idea to include stocks as part of a long-term investment strategy, so were pleased to see investors warming up to them again. Still, we wonder if the timing of this new-found enthusiasm isnt a bit instructive.
We have found that most people understand and accept that one of the keys to successful investing is to buy low and sell high. The idea seems straightforward and logical enough at least in theory. But real life investor behavior does not seem to suggest that this understanding is making its way into actual practice. As humans, we come equipped with more than logic. We also have emotions.
Lets take a look at hypothetical reactions to the market hitting new lows and new highs. On the one hand well look at what a purely logical reaction might be; on the other, a possible emotional response:
Which set of responses looks like buy low and sell high, and which looks like what people tend to actually do?
In a logical world, what would you expect to see happening around the time markets are hitting all time highs:
- Investors happily taking profits on any holdings that are faltering after a long run higher; raising the cash they intend to put to work when the next value opportunity comes along, or
- Finally getting off the sidelines and buying stocks after years of waiting for conditions to improve.
When stock prices have taken a tumble, would you expect to see?:
- Investors putting their cash to work by buying solid companies at bargain levels, or
- Finally giving up on the stocks theyve held all the way down because this investing thing doesnt seem to be working anymore?
Emotional responses to market movements can result in decisions that run counter to logic and our own best interests. We have seen it during market panics, when fear clouds an objective assessment of an assets value. We have seen it during market manias, when index envy causes investors to chase returns often after the conditions that brought those returns have already passed.
A major market index like the S&P 500 can be a useful shorthand for getting the sense of how the stocks of some big U.S. companies are doing, but comparing your personal progress toward your goals to its movement comes with its own set of risks. It is possible to invest in products that track the movement of an index if you are prepared to risk the investment experience that comes with it.
As we have seen, that experience can include regular declines of 10% to 20%, occasional losses of 57%, and, as in the case of the S&P 500, 14 years of waiting to get back to a 0% return. In our experience, few investors will be able to withstand the onslaught of emotion that market index style volatility brings with it. Instead, they will compare their portfolios performance to that of a market index in a Bull Market, but in a Bear Market they will regretfully compare it to what they could have gotten in the bank.
After more than 25 years of watching investor behavior, we have concluded that the more urgency an investor feels about taking action whether its selling or buying the more likely that action is to be a huge and costly mistake.
The effects of emotional investing are not restricted to investing in stocks. The recent Real Estate bubble was largely fueled by the fear of missing out on run-away house prices. How many investors jumped on the housing bandwagon, confident they could jump back off with a hefty gain whenever they wanted? Housing has only recently begun to recover from the devastation that resulted from that emotion-based bout of decision-making. In retrospect, does highest price ever really sound like an argument for a great time to be a buyer?
What should be the reason to invest in an asset, whether in a stock or a bond or in an investment of any kind? We think the best reason to buy is value; the opportunity to acquire something thats worth more than its current price. The second best reason to buy? We dont think there is one.
Does this mean investors should wait until market indices are hitting new lows before buying any stocks? Fortunately, no. According to the NYSE, there are over 8,000 listed stocks trading in the United States. Developed and emerging countries around the world offer stock markets of their own. As its name suggests, the S&P 500 contains only 500 names, and they are the stocks of the 500 largest U.S. publicly traded companies. The Dow Jones Industrial Average tracks the movement of just 30 stocks. Security prices dont always move in lockstep, even among stocks within a single index, and attractive values may be cropping up (in the U.S. or abroad) no matter what popular indices like the S&P 500 or Dow Jones Industrials happen to be doing.
Just as importantly, prices can and do pause while fundamental value catches up. The same price that seemed too expensive yesterday can look like a bargain again tomorrow as conditions improve.
We are optimistic about the future, and we will continue to hunt for value and opportunity wherever we can find it, take profits (and cut our losses) as conditions change, and follow a disciplined process to manage our investors money. What we wont do is allow our emotions to carry us along, running from or chasing after the movements of the market. It just wouldnt be logical.
Gary Stroik, CFP is Vice President and Chief Investment Officer for WBI Investments, Inc., and lead manager of WBI Funds, with combined AUM of $2 billion for advisors and their clients. He can be reached through www.wbifunds.com
Register or login for access to this item and much more
All On Wall Street content is archived after seven days.
Community members receive:
- All recent and archived articles
- Conference offers and updates
- A full menu of enewsletter options
- Web seminars, white papers, ebooks
Already have an account? Log In
Don't have an account? Register for Free Unlimited Access