Over the past few weeks, we’ve been debating the state of the economic recovery. The posts that have emphasized the shift in data towards the positive have generated a lot of pushback.

This is something that I want to discuss in general terms — I want readers to not only understand my perspective, but to grasp what typically occurs heading into recessions and recoveries, into new bull and bear markets. (Note I am speaking generally, and not referring tot he details of this cycle).

Over the next week, I will put together a broad overview of the positives and negatives of the economy, looking at the risks and opportunities presented. For now, let’s discuss the sentiment that typically accompanies oscillating phenomena,  such as markets or the economic cycle.

Today, I want to look at the big overview. Historically, the sentiment that occurs at inflection points are extremes. The are the result of the prior few years of economic/market activity. They lag the cycle — often quite significantly.


• Humans have an unfortunate tendency of to overemphasize our most recent experiences. We draw from what has just happened, rather than deduce based on what is occurring right now.

• Following that idea, the analyst community is typically too bullish at tops, too bearish at bottoms. They extrapolate from the most recent data to infinity or zero. Hence, they miss the inflection points.

• Sentiment is a justification of recent actions. Very often, equity buyers describe themselves as bullish after their purchase. The comments they make can are often an attempt to reassure themselves.

• Changing viewpoints is a gradual process. Flipping from bullish to bearish and vice versa is difficult. We remember what most recently rewarded us, and internalize that. After a period of economic expansion, we are slow to grasp the change for the worse. At the tail end of an ugly recession, we find it hard to imagine an imminent improvement.

• Investors develop the equivalent of Muscle memory. During a bull market, every dip that was bought made us money. When the cycle changes, we are slow to perceive it. Bulls become out of phase with what is taking place, buying on the way down in a bear market.

• The reverse takes place after a long Bear market. Selling rallies made us money, preserved capital during the downturn. When the sell off ends and a new bull cycle begins, the bears have a similar hard time getting back into sync with the market. Since it was so rewarding to sell into prior rallies, it becomes difficult to flip towards the positive perspective.

• Excuse making rationalizing the missed turn becomes endemic. We get conspiracy theories (the Fed is buying SPX minis!), complaints about the artifice of the market, Fed bashing, etc. They all have their roots in the missed turn. I even suspect some of the Goldman bashing (deserved tho it may be) is also partly rooted in this issue.

Consider this chart, which I first showed back in 2005 — but its worth reviewing again:



If you like these sorts of things, there are more psychology visualizations after the jump . . .










Category: Apprenticed Investor, Cycles, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

36 Responses to “Lagging Psychology at Turning Points”

  1. wunsacon says:

    Well, Barry, you’re right. But, some of us expected all that free Fed money to be used for additional writedowns, instead of being used to report phantom profits. I kept — keep — waiting for those shoes to drop. However, so long as we’re using mark-to-model and so long as the DC-NYC establishment continues its no-prosecutions-and-here’s-more-money policies, those shoes are not dropping.

    I still do not believe that the major banks are solvent or that nominal GDP would grow absent continued significant government stimulus. However, none of that matters until it does. And, as I’m learning, it now seems to me that perhaps “the only time it[, insolvency,] matters” is when it’s accompanied by illiquidity (e.g., bank runs).

  2. investorinpa says:

    Barry, the first chart you put up (Point of Maximum Financial Opportunity) is by far the best chart and one that I continue to use. I was exposed to it on your blog several years ago and another blog that I follow regularly (HousingPanic/Soot&Ashes) has touted it to a tee. I believe we are in between Relief & Optimism at this point in time. I think the roller coaster diagram will be a lot quicker this time but we will exhibit enthusiasm shortly. Thanks for putting this up again- it truly is the easiest way to make “dumb” money.

  3. wunsacon says:

    Remember that book that ends with the kid pointing out that the emperor has no clothes? What happens after the last page?

    The sequel is being written as we speak. The emperor’s courtiers proclaim the emperor is indeed wearing clothes. With their confidence renewed, the parade continues.

  4. [...] I do without The Big Picture?  The articles there are always so very timely.  Barry has a new post up detailing the cognitive biases that prevent us from shifting our perspectives when there’s [...]

  5. Robespierre says:

    • Excuse making rationalizing the missed turn becomes endemic. We get conspiracy theories (the Fed is buying SPX minis!), complaints about the artifice of the market, Fed bashing, etc. They all have their roots in the missed turn. I even suspect some of the Goldman bashing (deserved tho it may be) is also partly rooted in this issue.

    This bullet is misleading. All the sentiments you are expressing there where being discuss in multiple blogs BEFORE the inflection point. “Their roots” started long before the inflection point. You are beginning to sound like a revisionist.

  6. Lots of excuse making existed prior, but the quantity and volume of the rationales (ie, Biderman) turned way up after +40 or 50%!

  7. mister_x says:

    Not all markets go straight down and then up like this one. This time the charts look like the work of a genuius but what if are stuck in an extended range for a few years?

  8. tagyoureit says:

    The emotions tend to recognize most in myself: exhiliration, unease, pessimism and relief. It’s no wonder my success in investing has been marginal at best! I feel unease today.

    Based on these charts, ideally, I would be aware of market euphoria or dispair regardless of my own feelings, then act.

    How do you keep your own feelings from coloring your view of the market?
    What evidence do you prefer to use to gauge the general feeling?

  9. Lamont says:

    Japanese investors celebrated after 1990 every time they had a 60-85% upside rally too, but then the market tumbled right back down again because the market went up in the first place not because the fundamentals of the economy improved, but rather because of money printing.

  10. Patrick Neid says:

    Great collection. In the right hands, priceless.

  11. number2son says:

    Ah, but the rub is to recognize where you are in those cycles. Are we at this moment at hope, optimism, thrill or euphoria?

  12. IvoZ says:

    @ Lamont: obviously there is a difference b/w “the big picture” over the mid/short term and the longer term. Short term -> liquidity-driven cyclical rally / long-term -> who knows (cares), flat as in a secular bear?

  13. catman says:

    Posted by Barry Ritholtz on November 1, 2009 @ 9:00 am in Trading… Lesson #4 Let profits ride until the price action dictates otherwise. Money quote – “It was never my thinking that made the big money for me. It was always my sitting.”

  14. Arequipa01 says:

    Too many are ogling the peaks when the good stuff is found in the valleys. To wit, here is a post on the ACAS yahoo message board (ACAS traded between .65 and .77):

    Turning Point 10-Mar-09 09:56 am
    IMHO ACAS’ pps has reached its turning point and the risk-reward balance is extremely favorable.

    If one thinks in terms of proportions, the possible percentual loss in a 10,000 share position (modest to be sure) of 20-25% [1675 max]seems an acceptable level in relation to upside gains as the macro reality improves. ACAS’ results are now less a function of its own actions and execution and more governed by the attendant reality in which it operates. If the gears come unstuck, ACAS goes parabolic.


  15. HEHEHE says:

    I agree with the charts but I do not agree that what is currently going on in the stock market reflects the macro economic realities. One could say that the market has entered the optimistic phase of the spectrum. The problem is the real economy is so mired in despair that the market would appear to be a decades ahead of economic reality. Plus there’s so many shoes waiting to drop (CRE, Sovereign Debt Problems, Unfunded Pensions) independent of the problems DC/NYC have papered over that it would seem that this orgy of liquidity is just waiting to pop.

  16. DD123 says:

    This is just another way of saying that linear algebra is the little bitch of the human mind. We own straight lines.

    y=2x+1, where x=3

    7, bitch! Is that all you got?!

    We tend to lose our F*ing minds, however, when that tame little line starts to curve.

    “WTF, I said 7, not 6.5…what are you doing?”

    We’re not alarmed at this point. Just annoyed. We’ll just come up with another linear equation…until our line goes all the way to 5! New equation.

    “C’mon, I got better things to do then come up with stupid ass equations!”

    And so on…and so on…until a genius cuts through the madness and derives one single continuous function to explain those G-Damned curves.

    We sing to the heavens…all our problems are solved!

    Until we are asked to solve for the turning point of that smooth, curved line…

    “Come again? Turning point of what? Paraba who? Parabola? Is that like one of those African viruses? Vertex? Complete the square?…

    “Yeah…um…I think I’ll just stick with my straight lines.”

    And so…when the line is sloped upward…we are happy. And even though we know know better, we’re just going to assume it will keep heading upward…forever.

    And when it’s sloped downward, we’ll do the same.

    Easier to be locked into the cycle of Euphoria/Desperation than to find the F*ing X-component of a vertex.

  17. 4horsemen says:

    This is great stuff, but I have one question:

    Do these emotional states refer to retail/general public investors, the media, the buy side, or the sell side (or maybe an assessment of all of them together)?

    We all know that sell-siders tend to be relentlessly bullish more often than not, but during & immediately after the crisis, many were bearish for quite some time until the ‘mo’ turned them otherwise. Now what I see appears to be a fever-pitch of bullishness, with nary a single analyst to be seen having a model that doesn’t factor in a full economic recovery. Brokers are unilaterally bullish.

    The media – well, they are basically a lagging puppet of the sell-side machine, so of course they are very bullish. The cheesy CNBC headlines like “Road to Recovery” and “The Coming Wall of Money” etc etc do their part to ensure (as much as possible) that main street takes the bait.

    The Buy side has been more reluctant with many believing they are more savvy than the hype machine, ignoring the ‘mo’, then ignoring the data shift, until they finally put money to work, albeit reluctantly. This is what I see (and have done, unfortunately). It began as tentative buying and fear of selling – leading to markets rallying right through some horrible news – Greece, Chinese tightening, etc. Now, in part, I think some are tapping the ‘mo’.

    This leaves the general public. Main Street. While they should be relentlessly bullish given the source of most of their research (The media and sell-side analysts), this source of capital has been sidelined, continuing to prefer income products to straight equities. With so many unemployed, I am not surprised of the tentativeness. But some are wading back in, afraid to “miss out.” My fear is that this largely naive group will be back just in time for the next crack – something I view as cataclysmic to longer-term equity market sentiment, not to mention the health of American nest eggs.

    Barry uses his Board as one tool (of many) to assess market optimism, and lately has talked about the “pushback” being a clear sign that the market has further to go. I think this makes sense, on the assumption that some bears here ultimately capitulate. The difference is that, while pros “can’t afford to miss the rally” a retail investor has nothing to lose sitting out a rally, but everything to lose participating in a crash. So frankly, I’m not surprised to see them hesitate.

    With respect to this board as a gauge of market sentiment…I am not sure. There are many bears here, but the bears are not driving this bus. try some Yahoo or other boards with a more short-term, day-trading base and you’ll get a completely different view. All I am saying is, from my “view from 100 feet” there seems to be a pervasive bullishness. Euphoric? Who knows. Certainly sometimes.

  18. 4horsemen says:

    I cant see my post. Have I been blacklisted or something? When I re-post, I get a message that I already posted this message…

  19. 4horsemen says:

    oops! duh…there it is. A fool, I am.

  20. Ted Kavadas says:

    This is a very good collection of charts…

    The pivotal question is where in the cycle are we?

    There are many aspects of the overly optimistic market sentiment right now…

  21. Remember that book that ends with the kid pointing out that the emperor has no clothes? What happens after the last page?

    That’s easy. The secret service come out and beat the kid senseless. Then they taser him until he’s comatose

  22. Transor Z says:

    Barry, I really liked your line in the recent Forbes interview: “You can’t fight ZIRP.”

    But there’s something about that line that makes me think of a white blood cell saying to his buddies, “I told you guys not to bail on this gangrenous body — you can’t fight amputation! The government isn’t going to let this guy die!”

    I’ll believe the patient is disease-free and on the way to recovery when the banks aren’t using smoke and mirrors to value MBS. Until then, the patient is unstable and liable to relapse/crash again without much notice.

  23. [...] Barry Ritholtz has an excellent post analyzing why investors’ sentiment is always slow to change at turning points of the business [...]

  24. mathman says:

    Add this list of unfixed problems to your great post. Recovery?


  25. carlwied says:

    BR: Good topic. Look forward to the discussion. Here’s another good chart to include:


  26. Niskyboy says:

    “. . .the sentiment that typically accompanies oscillating phenomena,. . .”

    Barry — “oscillating phenomena”?? I hate to be impolite to the host of this wonderful site, but you’re getting a bit carried away here by your fascination with physics and math. Dial it back a bit, Mr. Wizard. You can’t discern a resonance frequency in the market as you can with a bell. To think you can is reminiscent of the thinking at Long Term Capital Management.

  27. [...] psychology lags at turning points.  (Big Picture, ibid also [...]

  28. mkkby says:

    Ritholtz, I’ve never actually seen you take a stand on anything. Is the market topping or bottoming? All you ever do is equivocate. I guess you “gurus” never actually make a call. It’s always up, or maybe down… then, see I told you so!

  29. Exactly! I never make any bullish or bearish calls. I hHardly even have any opinions. I am all about equivocating!

  30. IvoZ says:

    @ mkkby: BR was spot on to turning bullish in Mar-2009 on the blog; he still remains in the bull camp. He has tried to find some fundamental arguments as well for being bullish, except for technical / psychological, but they have only recently been convincing .

  31. wally says:

    “Historically, the sentiment that occurs at inflection points are extremes. ”

    The key word there is ‘Historically”… you can only know the turning point by looking backward and you can never know that an extreme will not be followed by an even greater extreme until it does not happen.

    You can guess and you might be right or wrong, but you cannot “know’.

  32. Dennis the menace says:


    Seriously? Never made any calls?

    Did you miss:

    Short AIG
    Short Fannie Mae
    Short Lehman Brothers
    Sell Banks
    Sell the market
    Sell Housing

    Those were before the bottom call last year

  33. Mike C says:

    Ritholtz, I’ve never actually seen you take a stand on anything. Is the market topping or bottoming?

    LOL. Top and bottom calling are for people who either want to lose money or get their 15 minutes of fame on CNBC. People who want to consistently take money out of the market identify trends, and stick with the trends, and continually reassess and stay mentally flexible.

  34. Scott F says:


    I am glad to see our host has FINALLY figured out he doesn’t have to waste time responding to every newbie and troll.

  35. jac says:


    Great post.

    I thought 1000 is fair value for SnP based on economic fundamentals, revenue, normalized profit margins and such. Markets can overshoot and people are good at extrapolating a quarterly gain into multi-year gain.

    If economy indeed gets better, don’t you think this excess money will indeed be inflationary and if it is not sustainable, the profit growth won’t be there and PE’s have to contract. Inflation or slow growth – PEs will contract – isn’t it? How do we justify 1200-1350 on SnP 500?

    It is very difficult to accept this is a genuine rebound, when there is so much leverage in the system and we only postponed the day of reckoning.

  36. Simply-Put says:

    I would have to say based on the charts above:

    Economic Cycle – Early to Middle Expansion (More toward middle)

    Market Emotional Cycle – Somewhere between Thrill and Excitement

    The Clock – Just about 10

    The Chart – Drat’ i’ll buy it again. Its Cheaper than the last time anyhow!

    Sentiment Cycle – Returning Confidence -everyone else enters the market

    Speculator Emotional Cycle – GREEN – Greed, want more, pleasure, buy! buy! buy!

    So in conclusion – I say the SP500 should reach 1250 shortly and top somewhere around 1350 1380 and then it starts to get dangerous….

    BR – I hope this is what you were looking for…..