Image Credit: Heath Hinegardner
By Jason Zweig | April 3, 2010 12:01 a.m. ET
Has spring ever sprung quite so gloriously across the financial markets?
In the first quarter, just about everything went up: U.S. stocks large and small; foreign stocks; gold; the dollar; corporate, high-yield and municipal bonds; even most Treasury bonds. Over the past year, every major stock index in the U.S., and many abroad, went up at least 45%. Real-estate investment trusts more than doubled. If you are alive, you made money.
It is hardly the second coming of irrational exuberance. Investors added an estimated $5.4 billion to U.S. stock funds last month, barely outweighing the $5 billion they withdrew in February. That is peanuts compared with the $33 billion that investors poured into U.S. stock funds in March 2000.
Nor does the market look wildly overextended. The Standard & Poor’s 500-stock index is trading at 23 times its earnings over the past 12 months and 15 times the coming year’s estimated profits — hardly a bargain, but no bubble.
Says Theodore Aronson, who oversees $20 billion at Aronson Johnson Ortiz in Philadelphia: “We would love to observe an indication that would enable us to tell our clients that some part of the market has gotten unsustainably ridiculous like the Internet bubble.” But, he adds, “valuations aren’t really out of whack; they’re in whack.”
So there is no obvious cause for alarm. After all, the latest advance leaves the stock market 23% below its high in October 2007.
But there isn’t any cause for complacency, either. This springtime of performance is an ideal opportunity to reflect on four rules.
First, distrust your emotions.
Yes, it feels good to gain back some of what the market gods stole from you over the past few years. But how you feel about your portfolio today tends to be inversely related to how it makes you feel tomorrow.
Weren’t you euphoric back in 1999 and the beginning of 2000, when your tech stocks were soaring? (Then they crashed.) And didn’t you feel flush a few years back, when the Dow was hitting 14,000 or you could make the price of your home go up just by sitting in the living room watching TV? (Then they crashed.)
More important, didn’t you absolutely hate your stocks in the miserable days of March 2009 — at the very moment when they were about to enjoy their biggest gains in years?
Second, emotions are as contagious as pathogens. In experiments on group performance of routine tasks at Yale University, the “cheerful enthusiasm” of one member jumped to others, reducing the diversity of opinion within the group and leading the average participant to conclude that the group was performing better. Recent research even shows that positive emotion is at least as likely to spread over the Internet as it is face-to-face. Bear in mind, then, that an online thread of bullish investing posts can skew your feelings more than you might ever realize.
Third, investments don’t become more attractive after prices go up. What you get out is always a function of what you pay to get in. In a speech in 1963, the great value investor Benjamin Graham warned that “a large advance in the stock market is basically a sign for caution and not a reason for confidence.”
Finally, hold fast to your independence. When the investing crowd stampedes into bonds and emerging markets, as it is now, you should move with extreme caution until the herd moves on.
Yale economist Robert Shiller, who warned investors away from both the Internet mania and the real-estate bubble, recently told me, “People who insulate themselves from the collective consciousness are not very numerous, probably because it’s hard to do.”
Added Prof. Shiller: “I don’t follow the crowd as naturally as other people do. I’m kind of ‘off’ there. When I watch a sporting event, I’m always amazed at how intensely people care who wins. As a child, I read [Aldous Huxley’s novel] Brave New World, and I never wanted to get socialized like that into a caste or clique whose beliefs are reinforced by other people’s thinking.”
“What’s the personality of the most successful investors?” asks William Bernstein, a neurologist who co-manages $156 million at Efficient Frontier Advisors in Portland, Ore. “They aren’t affected by other people’s feelings. In fact, the most empathetic people I know are the worst investors.”
So it is fine to bask a little in the market’s luxuriant spring. Just don’t let anyone whip you up into a frenzy.
Source: The Wall Street Journal, https://www.wsj.com/articles/SB10001424052702304871704575160190948059722
For further reading:
Definitions of BULL MARKET, HERDING, IRRATIONAL, RISK in The Devil’s Financial Dictionary
Chapter Eight, “The Investor and Market Fluctuations,” in The Intelligent Investor
Robert J. Shiller, Irrational Exuberance
If You Think the Worst Is Over, Take Benjamin Graham’s Advice