"Chiggity Check Yourself"

Sage advice from Pepper Brooks, color dodgeball commentator for ESPN8, The Ocho (second reference this week).

I wrote up an article for RealMoney that drew a lot of what I would characterize as emotional responses. We have had a couple of clients have emotional responses to the current market volatility and some emotional comments on the blog.

A big picture way of thinking of this is that we have had a bad month. There might be more bad months to deal with or not but that is what we have had. I went to page 155 of the 2007 Stock Trader’s Almanac, the one with month by month changes in the S&P 500 going back to 1950, and I counted 53 bad months with a bad month defined as a 5% drop or more. So almost one a year. The one a year is less common than the 2-3 per year every few years and there were a couple of instances where there were more than three in a year.

So 53 times in 56 1/2 years (it only goes half way through 2006) means, to me, that this is very very normal. Emotional responses to very very normal will likely result in a bad decision.

This is what behavioral finance is all about, emotional responses to financial events where emotion is the last thing you need. There have been white papers and the like on this subject.

How many of the 53 bad months have you endured in your investing career so far? How many more do you think you will endure in the future. Now replace bear market with bad month in that last sentence.

I prattle on about having something in place to try to take defensive action if a bear market looks like it is coming. The entire point is to remove emotion from the equation. Look at a long term chart. If you first invested 20 years ago to the day (so right before the crash) with a long term time horizon and literally never sold anything (assumes index funds) you have endured wars, bubbles, terror, various financial crises and you have made a fortune–way ahead of inflation.

So if you can actually smooth out your ride all the better, but it isn’t even necessary for success.

I can think of no reason why the next 20 years should be any different so worrying about a bad month becomes incredibly unproductive and depending on the person even physically harmful.

10 Comments

  1. Roger

    I absolutely agree with your message, and second your big picture, long term perspective.

    I do have one small quibble with your last statement. An argument can be made that starting valuation is very different today than 1987 (or any point in history really except late 1990s).

    There are a lot of ways to measure this (P/B, normalized P/E, P/S, etc.) but we are clearly in a different and much higher valuation regime than in the past. It seem to me that either it’s different this time so valuations can stay higher, or valuations will mean-revert. If you believe the latter, it would be prudent to subtract from return assumption over whatever time frame you think is reasonable (e.g. at least 5 years) it will take.

    None of this invalidates your point that short term volatility is irrelevant, but I think long term return assumptions should properly account for one’s views on current valuation. And if mean reversion happens in next 12 months, downside could be significant. Investors should be mentally prepared for at least that possibility.

    Michael

    Reply
  2. I get tired of anyone who uses the 20 year story. Sure if you have 20-30 years. What about 5-10 years? Do what you have to protect your principal. Don’t listen to investment advisors or the media. Be your own manager and learn to make the decisions for youer money.

    Reply
  3. Ron,

    I have touched on this before–time horizon is what it is and then it comes down to proper asset allocation.

    5-10 years though? are you 90? if you are 70 and healthy you have a longer time horizon than you think. Same with 80 for that matter.

    Reply
  4. “I can think of no reason why the next 20 years should be any different…”

    You have got to be kidding. Please relook at household debt from the Fed. It has roughly doubled relative to income.

    All bubbles are debt bubbles. Remember Nasdaq 5000? Expect to see that anytime soon?

    The Fed solved the Nasdaq bubble by creating a housing bubble (look how debt increase at an increasing rate since 2000).

    The Fed has tough choices here and it is not yet clear what they will do . But trust me you can not have an ever increasing debt bubble without consequences.

    Easy Al left the Fed. The last 20 years was the best 20 years for the markets ever. The next 20 years will be different.

    How different? I do not know. I do not know if the Fed will switch from using the Fed funds rate to the discount rate. If they stick with the Fed funds rate will they be as easy as easy Al (I doubt that).

    The story is currently unfolding. It is difficult to read the tea leaves right now. But I expect things to be different.

    If they continue with the policies of easy Al the house hold debt bubble will eventually pop. Trust me it will be different.

    That does not mean the sky will fall.

    BTW, maybe you should read Hussman again for some near term understanding.

    Also, COMPLACENCY proved again by such a statement.

    Reply
  5. I went and saw the movie Superbad yesterday. What a hoot. It’s perfect for this kind of market. Funny & Profane. Tom in Indy

    Reply
  6. John writing this. To the reader who said to read Hussman for a reality-check. Here is a passage from Hussman’s 27 August article:

    “Still, my impression is that investors are easily worried by the possibility that “this time it’s different,” and by the belief that normalized P/E ratios and the like haven’t “worked” in the past few years. On that issue, it’s essential to recognize that valuation is not a short-tem timing tool, but has its primary effect on market returns over periods of 7-10 years and beyond.

    “As Will Rogers once said, “it ain’t what people don’t know that hurts ‘em – it’s what they do know that ain’t true.” The fact is that many “new era” arguments have no provable basis even in the data of the past decade, much less in long-term historical data.

    Reply
  7. Futures are shooting up based on the news Bush will bail out homeowners in trouble. Our republican government is coming to the rescue of the risky borrowers to get more votes in 08. Bush is ready to spend more on the mortgage mess.

    Reply

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“Chiggity Check Yourself”

Sage advice from Pepper Brooks, color dodgeball commentator for ESPN8, The Ocho (second reference this week).

I wrote up an article for RealMoney that drew a lot of what I would characterize as emotional responses. We have had a couple of clients have emotional responses to the current market volatility and some emotional comments on the blog.

A big picture way of thinking of this is that we have had a bad month. There might be more bad months to deal with or not but that is what we have had. I went to page 155 of the 2007 Stock Trader’s Almanac, the one with month by month changes in the S&P 500 going back to 1950, and I counted 53 bad months with a bad month defined as a 5% drop or more. So almost one a year. The one a year is less common than the 2-3 per year every few years and there were a couple of instances where there were more than three in a year.

So 53 times in 56 1/2 years (it only goes half way through 2006) means, to me, that this is very very normal. Emotional responses to very very normal will likely result in a bad decision.

This is what behavioral finance is all about, emotional responses to financial events where emotion is the last thing you need. There have been white papers and the like on this subject.

How many of the 53 bad months have you endured in your investing career so far? How many more do you think you will endure in the future. Now replace bear market with bad month in that last sentence.

I prattle on about having something in place to try to take defensive action if a bear market looks like it is coming. The entire point is to remove emotion from the equation. Look at a long term chart. If you first invested 20 years ago to the day (so right before the crash) with a long term time horizon and literally never sold anything (assumes index funds) you have endured wars, bubbles, terror, various financial crises and you have made a fortune–way ahead of inflation.

So if you can actually smooth out your ride all the better, but it isn’t even necessary for success.

I can think of no reason why the next 20 years should be any different so worrying about a bad month becomes incredibly unproductive and depending on the person even physically harmful.

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