Posts filed under “Cognitive Foibles”
Exactly six years ago today, the markets made their ultimate low following a 57% collapse of the S&P.
I was fortunate to have been on the right side of that trade in both directions. What is most fascinating to me about that was the pushback from traders and investors — in each direction. It is revealing as to how much recency bias infects people, especially with those who have hard earned money on the line, and are watching it slowly disappear.
Lets start with a little background. What began as an intellectual exercise bloomed into something else entirely. Cult of the Bear was a look at the individual stocks in the Dow, and what could possibly go wrong with them. The Dow 6800 call was not supposed to be a forecast; rather, it was an exercise in valuing what the Dow Jones Industrials might be worth in light of issues in housing, credit and consumer spending.
It was part of a series I was doing at TheStreet.com. The key analytical starting point was this 2006 thesis:
“It starts with the consumer, who after years of spending, finally tires. Soon, it infects corporate revenue and profits. Slowly, it cascades its way across different sectors: housing, durable goods, discretionary spending, entertainment. Eventually, the decay spooks the markets.”
That turned out to be rather prescient. The market topped the next year, and my rough, back of the envelope calculation that had pegged fair value of the Dow at about 9,800 (at the time when it was trading near 11,000) was dead on. I wrote of a continued Bull rally, especially in the Nasdaq, before the collapse. Why? Because that is how tops get made.
I also argued that any break of 10,000 at the same time as a Housing decline and retail sales slump (due to end of cash out refis) could lead to another 3000 point “panic drop.”
I ended by saying: “If and when that happens, it likely will be the best buying opportunity in the markets since the October 2002 cyclical lows.”
All told, that turned out to be more accurate than I ever imagined.
The media interviews I did around that time were defined mostly by the pushback from TV anchors. But especially noteworthy were the comments posted at Yahoo Finance. They were terribly revealing as to exactly how distorted investor psychology could become in light of any analysis with a very out of the mainstream conclusion.
It was as if no one could even imagine a market falling again.
Note that we just had a 35% drop in the S&P and a near 80% drop in the Nasdaq, a mere 5 years prior. Regardless, it served to prove the old saw that investors seemingly learn nothing from the past.
Of course, comments are where intelligence goes to die. Yahoo Finance comments were unusually inane those days – it was a pre-moderation free for all — filled with idiotic, anti-semitic, racist, full of anonymous cowards and other assorted creeps. It was so over the top that Yahoo had to revamp their comment system to screen out so many truly offensive, egregious racists.
It is a shame those comments are lost, as they were an incredibly instructive example of confirmation bias amongst investors.
Flash forward to 6 years ago today: I do a video shoot with Aaron Task of Yahoo Finance. Markets were as deeply oversold as I had ever seen them and every metric I tracked was pinned to an extreme.
We discussed investor psychology, the Fed, valuation, and other related issues. But the money quote, was simply this: “The mother of all bear market rallies is coming.”
That was recorded on the 9th. It was posted the morning of the 10th, and by the end of the day, the Dow had risen 5.8 percent. (the videos do not seem to be posted at Yahoo Finance).
The same fascinating pushback took place in the comments at Yahoo (including the racist/anti-semitic nonsense). The negative experience of the collapse had left investors so shell shocked, they simply could not imagine a market going higher. Whereas the last go round I was called a perma-bear, this time, I was a perma-bull (ignore the obvious conflict there). I was a hack, in the pay of Wall Street, working for the Fed, a White House plant, shorting into the rally, and worse.
Although the silliness was disappointing — you Humans serve to make me appreciate my dogs more — It was incredibly instructive. Investors are emotional, lack objectivity, and are filled with all manner of cognitive errors.
But it also taught me that looking at the world in an objective data-driven manner, with a defendable investment process. And, I am aware of exactly how much randomness went into nailing the low.
Today, my office runs a robust asset allocation model. We are not dependent upon nailing the exact top & bottom. Instead, we are focused on long term investing. We use rebalancing to take advantage of market dislocations. We also developed a tactical portfolio in house to take advantage of events like 2008-09 — but its an adjunct part of our holdings, and not the main focus. The lessons we learned from 2008-09 have made us better investors. Hopefully, you learned something constructive as well.
If you are interested in a more data-driven approach to financial planning and asset management, please contact us here.
When Barry Ritholtz Talks, People Listen (Freakonomics, March 11, 2009)
Five Years Ago, Dumb Luck Made Me a Genius (March 10, 2010)
Better Late than Never: Dow 6,800 (March 2nd, 2009)
Today’s discussion is aimed at the individual investor, though certainly the professionals might take something from our philosophical musings this morning. The bull market that dates to March 2009 is now entering one of its more interesting — and perhaps dangerous — phases. Not hazardous, mind you, from a market perspective, but from a behavioral…Read More
For investors, it’s a perfect time to go back to the basics Barry Ritholtz Washington Post, December 21, 2014 Look around you: This is the time of year when the pages of newspapers and magazines are filled with predictions and lists and all manner of money-losing nonsense. I have pushed back against much…Read More
Unbelievable jobs numbers..these Chicago guys will do anything..can’t debate so change numbers — Jack Welch (@jack_welch) October 5, 2012 Today’s column is about stupidity. Perhaps that’s overstating it; to be more precise, it is about the conspiracy-theorist combination of bias, innumeracy and laziness, with a pinch of arrogance thrown in for…Read More
Will they never learn? Yesterday, oil rallied 4.3 percent and gold gained 3.6 percent as commodities had an up day after a long and painful fall. The fascinating aspect of the trading wasn’t the $45 pop in gold, nor the even greater percentage rally in oil, but the accompanying narrative. (As of this writing, each…Read More
The quality of our discourse is decaying. This was once a standard complaint about the tone and depth of our national political debate. Now it has spilled into the financial realm. Shall we blame Twitter, trolls or bloggers? I am unsure of the underlying reason. But as we have seen far too, financial discussions seem…Read More
We have said a good deal in this space about the futility of trying to time short-term market moves (see e.g., this, this and this). No one has demonstrated the ability to do this consistently over time. While it is possible to avoid the very largest of collapses over long periods of time using a…Read More