FOMO and Market Dips

Guest post by Michael Wagner

“Buy the dip.” Even those who are only somewhat familiar with the stock market have likely come across this advice. The logic is simple. Over long periods of time, the stock market tends to “go up”; over shorter periods of time it can and frequently does “go down”; and the lower one’s entry price, the greater the gains experienced when the market goes up. Everyone likes a deal, and “the dip” is the stock market equivalent of a discount sale. Or so the wisdom goes.

In all the talk about “the market”, from blogs like this one to the Wall Street Journal to Fox Business channel, it is sometimes easy to lose sight of what the market really is. In short, it is a group of investors, some individuals and some working on behalf of others, buying and selling securities (stocks, bonds, mutual funds, ETFs, etc.) amongst themselves. That’s it, just a group of humans trading with each other, each trying to secure the right investments for the best price. As with any group of humans, then, there are mistakes, failings, and frailties in the midst of all this activity. The study of these shortcomings is the subject of behavioral finance.

One of the most well-documented investor phenomena in the behavioral finance literature is a concept known as herding, which is the tendency of investors to follow the trend, whatever it is, due to lack of knowledge or perhaps due to “FOMO”—the fear of missing out on the latest rally. When inserted into this crowd mentality, a concept such as “buy the dip” can initially have a somewhat counter-intuitive effect. The more investors conditioned to buy the dip, the more buyers there are to step into even fairly minor selloffs, keeping the “bulls” fat and happy. Not a bad thing, right?

Before you buy the dip, though, you might want to consider this: why is “the market” (specifically the stock, bond, mutual fund, ETF or other financial instrument of interest) on sale in the first place? It could be that the seller has incorrectly decided his piece of the market has become overvalued or perhaps he just needs some cash. On the other hand, he could be right in his assessment that the risk of holding the security outweighs the benefit of continuing to hold it.

In today’s world, there are a number of significant risks of which to be mindful. Yes, North Korea has a history of crying wolf, but if you remember the story, the wolf does eventually come. How about the “Trump bump” that sent markets soaring after the election on expectations of significant healthcare and tax reform and increased investment in infrastructure? President Trump unexpectedly cut a deal with the Democrats this month to fund the government for a short while longer, but at some point investors are likely to give up on their hopes for and promises from an Administration that seems unable to whip its Congressional majority into working order. This week the Federal Reserve tipped its hand that interest rates might rise before year end. Central banks around the world, including the Fed, are indicating that they may start soon to gradually tighten their easy money policies after a decade of flooding global financial markets with liquidity. We all know what this liquidity has done for markets. While there continues to be a notion in the popular financial press of growing economies, soft economic data both in the United States and abroad leaves room to contemplate less optimistic assessments of global economic strength.

These are but a few of the many complex dynamics that investors must grapple with, and while they are varied in the type of risks they present, they each share a common element: they are incredibly complex issues and are extremely difficult to measure accurately as they relate to the stock market. Circling back around to behavioral finance, research has found that because such risks are difficult to isolate and measure, investors ignore the risks in favor of, you guessed it, the prevailing trend, simply because it’s easier and it supports their comfortable worldview. Unfortunately, ignoring risk because it’s easier is not a strategy that is likely to end well. Just ask anyone who bought a house in ’05-’06.

Buying the dip can result in picking up a good bargain, but before you do, make sure you’ve considered the following questions:

  1. Besides “the dip”, why do I think this is a good time to buy?
  2. What kind of risk exists in my portfolio right now?
  3. How much risk will I be adding to my portfolio by buying this dip?
  4. How will I respond to new developments in the stock market, economy, or geopolitical landscape that will significantly impact my portfolio? In other words, do I have an exit strategy as well as an entry point?

After doing so, you might find that you haven’t discovered such a great deal after all.

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September 21, 2017


Thinking about the stock market

Time does matter

How’s your algebra?  You know . . .  x + y = z.  If you know one factor, you know a bit but cannot solve the equation.  If you know two, you can probably figure out everything about it. Apparently, the news media and many investors believe that this is all there is to figuring out the stock or bond market. Pundits are prone to reduce their explanation of the markets in just such simple terms.  I probably should just let it go, but I continue to be confounded by the way, at the end of the day, the media explains how that day’s events have shaped the market. I understand that we human beings have a strong and undeniable desire to establish a cause-and-effect relationship between two things especially when we perceive that one affects our life. For example, we truly want to believe that what goes on in Washington or somewhere else around the world will help make sense of the daily gyrations of the financial markets. True news flash: the markets are much more random than that. The truth is that in the short-term, certainly in a period of less than a year, political, fundamental, and even economic data have very little to say about what goes on in the market from one day to the next.  There are exceptions, but they are rare.

Part of this conundrum is grounded in our perception of time, or perhaps the lack of a clear perception of market time. Dr. Alexander Elder cautions that the we need to first become aware that market time is much slower than our own.  When they hear the daily news, I fear that few people stop to consider that the market moves in multiple time-frames.  It moves simultaneously over years, months, weeks, days, and even hours and minutes–often in contradictory directions from one time frame to another.  The trend of the market may be up on a monthly and weekly basis, but down today. Or vice-versa.

What the news commentators miss is the context of the daily moves as they play out in longer time frames.  I believe that one should start with a longer view to gain strategic perspective, and then analyze a shorter time frame to figure out what you are going to do within it.

Many advisors will coach their clients toward becoming a long term investor–with a view toward years. One has to ask what “long term” really means.  Usually to the advisor it is an admonition to be patient with what can become severe drawdowns. The chief advantage of the long term view is that it eliminates the need to pay attention to the daily news. Because the markets have a bias to increase over long time periods, you could see rather large gains over long periods of time–but not always.

At the other end of the time spectrum is the day-trader.  Actually the title is a misnomer because a true day-trader has an expected duration of holding an investment measured in minutes or hours, not even an entire day.  Most day-traders end the trading day in cash. The folks who do this see many opportunities, because the market can move up and down very quickly. However, trading costs can mount up and eat away at return. It also requires a vigilance and dedication to investing that few people can maintain.

A middle ground is what the investing industry calls swing-trading.  The expected duration of a holding using this time perspective is usually days or weeks.  There are lots of opportunities offered to the swing trader, and he or she can match the opportunities with reasonable risk controls. The downside to this type of trading is that you can easily miss big trends by getting in too late and / or out too soon. It is possible to produce outstanding returns using a trading strategy, but that depends on the quality of  your trading system.

One step in goal-setting is to have a proper time dimension for each of your goals. Consider the goals of your investing and match the time-frame of your investing with the goal. For most people, this will mean tuning out the daily market report. But if you do listen to it, be sure to stop and place it in the proper context. It is also vitally important to consider the time-frame when you look at quarterly reports or monthly statements from the custodian of your funds.  Too many investors tend to make knee-jerk reactions based on a time-frame that is totally disconnected from their true investing goals.

Leave me a comment or question. I would love to know your thoughts on this.

News or noise?

Time to focus on what matters

The steady diet of headlines pouring out of Washington has been unsettling for many Americans, regardless of where they sit on the political spectrum.  Even Lloyd Blankfein, CEO of Goldman Sachs, jumped into the fray and wrote his first ever tweet criticizing President Donald Trump’s move to withdraw the U.S. from the Paris climate change agreement.  One has to ask whether he is truly interested in the environment, just wants to compete with Trump, or if GS holds a lot of Twitter stock, beaten down lately.

We all know that equity markets (stocks) hate heightened uncertainty. What is happening in Washington is generating an enormous amount of political uncertainty.  Even the word “impeachment” has been bandied about in conventional circles. Some pointed to that “news” to explain the one-day sell-off that caused the DOW to drop 373 points, last month.

But, political as well as international uncertainty has yet to translate into Main Street economic risk. It is here that you and I live.  To assess Main Street economic risk, we look at GDP (both nominal and real), household income, consumption, and nonresidential fixed investment. The standard deviation of those elements is a measure of economic risk.

According to Dr. Woody Brock, economic risk has decreased by well over 80% during the eight decades since 1930. Indeed, there was a spike in the ’00 decade, 2000-09. But so far each of the metrics, with the exception of household income, has shown a decrease in volatility (a standard measurement of risk) this decade. The economy has improved, from a riskiness standpoint.

Many will posit that the fundamentals of the economy, extrapolated from the news, drive the market. If that were the case, one could reasonably expect that the risk of the market would have also declined by more than 80% over those same decades. That simply hasn’t been the case. In that same period there has been only a 20% decline in market volatility (a standard measurement of risk).

Much will be said about the economy improving and that will likely be given as the reason for this or that happening in the market.  In reality, it is very difficult for anyone, including professionals, to make correct investment calls based on the news. That’s because mistakes in interpreting the news are rampant.

Remember when nearly everyone believed that house prices almost always go up and almost never drop. Furthermore, the price paid for a house didn’t really matter.  That led to overshoot of the price and the ultimate bursting of the bubble. We all now know that that belief, so widely held by investors, was a mistake. The news, in my opinion, represents mere noise.  Today, we must concern ourselves with the prevailing stories that may turn out to be wrong.

So what should we be concerned about today?  A possible list includes:

  1. Excessive debt levels. Margin debt is at a record high and student loan debt now exceeds other forms of debt.
  2. Increasing levels of pricing model uncertainty.  Discerning the true value of an investment today is quite different than it was a few years ago before the advent of today’s large, hi-tech companies.

Despite the frequent distractions from the popular press, we are keeping a firm eye on the market fundamentals, as well as the technical signals to navigate through these uncertain times. You might want to turn off the TV and enjoy your weekend and summer.

June 2, 2017