Archive for the ‘Investor Behavior’ Category
Greek Hair Cut
This morning, I woke up to news that the Europeans, Germans mostly, have finally hammered out a deal with Greece, which now only needs to pay 50% of what it owes to private lenders (mostly German banks). German Chancellor Angela Merkel called this a 50% “haircut.”
World markets cheered the news by rallying 2% to 6%. But wait a minute, how is it different from a Greek default? Is the market dumb or not?
There are lessons for investors in this.
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What happened to the market in August and September?
Between July and the end of September, markets lost between 13.5% (Dow) and 27% (Emerging markets) depending on which market you are looking at.
I pored through economic data and could not see any marked deterioration in the economy. In fact, on balance, I see continued slow improvements.
Pundits attribute the market tumble to 1) political gridlock in Washington and 2) the European debt crisis. I don’t buy either of these explanations.
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Fear
On March 6, 2009, about lunch time, I got a call from Mrs. C. Apparently she was in some sort of a panic; she asked me when the market would stop falling. I couldn’t predict the future, all I could tell her: the market will eventually turn around, and when it does, it will stage a huge rally and we won’t know it in advance.
I felt I was making some progress in comforting Mrs. C and convincing her to stay the course. Then, I heard a roaring voice: “Get out! Get out! Tell him to get the hell out of stocks!!!” I knew it was Mr. C in the background. Mrs. C broke down in tears on the other end of the phone call. She said, “Michael, I can’t take it anymore, just get out of stocks.” I meekly replied: “OK, but you should never try stocks again.”
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Imagine your house has a ticker symbol, and it scrolls along the bottom of CNBC together with other ticker symbols. The price of your house, like a stock price, is set by a bunch of people you’ve never met making apparently random bets based on a combination of intuition, general economic statistics, output of an automatic-trading program, and, a couple of times a year, the real price achieved by one of your neighbors actually selling a house.
Minute by minute, the price of your home would gyrate wildly. If you are a nervous type, you might lie awake at night wondering if its value would cover your mortgage in the morning.
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US Credit Downgrade: Stock Market Panics, Bond Market Thumbs Its Nose at S&P
Posted on: August 9, 2011
On the first trading day after the US credit rating was downgraded, the markets seemed to suffer from bipolar disorder.
The stock market was a bloody mess: the Dow Jones was off 634.76, its worst ever decline since the credit crisis in 2008!
The bond market, especially the treasuries market, which was supposed to take the brunt of S&P’s downgrade, responded positively. In fact, the 10-year treasuries yield dropped to a record 2.38%. The yields on long-term municipal bonds also dropped, to below 4%. This actually makes government borrowing costs lower, not higher. In a way, the bond market just thumbed its nose at S&P: to hell with your downgrade, we like US bonds even more.
Why the bond market reaction is important
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If the recent headlines make you feel like the international financial order is heading toward a cliff, I would not blame you. Apparently, the Europeans have managed to spread their sovereign debt crisis from Greece to Italy, a far more significant country for the world economy. Here in the US, politicians are engaged in high-stakes political brinksmanship regarding raising the debt ceiling, without which the US will go into default for the first time in its history.
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This list is taken from an Irish Times article on behavioral economics.
1. LOSS AVERSION
People are more motivated by fear of a loss than hope of a gain, hence are more likely to seek to avoid a penalty than seek to gain bonus, even if both amount to the same thing.
2. ILLUSION OF CONTROL
For example, people feel an illusion of control when they’re allowed pick their own lottery numbers, even though they are no more likely to win by being given this choice.
3. DENOMINATION EFFECT
The tendency to spend more money when it’s denominated in small amounts (like coins) as opposed to large amounts (like large notes).
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A Simple Investment Principle
Posted on: December 5, 2010
MZ Capital 40/60 model vs S&P 500
Just like two sides of a coin, the capital market is made up of capital demanders (businesses) and capital suppliers (investors). What for businesses are costs of acquiring capital are for investors rewards of supplying it. It is a simple truth that
Costs of Capital = Expected Returns
Looking through this lens, many capital market phenomena can be explained.
Why small stocks tend to have higher returns than large stocks?
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Taking Investment Risks
Posted on: September 30, 2010
Investment Risks
Risk taking is an integral part of investing, yet most investors are blissfully unaware of the risks they are taking, let alone managing them well. In this post, you will quickly learn the good, the bad, and the ugly of investment risks.
Nine Types of Risks
Idiosyncratic risk is defined as risk that is specific to a particular company. This type of risk can be eliminated simply by holding a well-diversified portfolio; therefore, taking this kind of risk is not compensated by the capital market. Examples of taking idiosyncratic risk include investing in individual stocks and buying annuities as investment.
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Will Greece sink your portfolio?
Posted on: May 6, 2010
In the last few days, news of Greece’s bankruptcy has rattled the markets. Pundits are predicting a spiraling debt crisis spreading to other PIIGS (Portugal, Ireland, Italy, Greece, and Spain) countries. Investors are worrying out loud that the crisis is going to sink their portfolios, again.
Not if they have a balanced portfolio. Here is why …
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Living with uncertainty
Posted on: April 15, 2010
[Guest post by Tom Warburton] Last week a buddy walked into my office distressed over unemployment, the economic malaise, gold prices, the prospect of inflation, government debt, currency fluctuations, trade imbalance and future prospects for the stock market. He basically covered the waterfront of issues we see on the front page of financial magazines and issues we hear talked about on CNBC.
When my buddy left my office (somewhat soothed – I believe – in the knowledge that his portfolio was positioned to achieve his financial goals without regard to the speculations of Jim Cramer), I found myself thinking about the many obstacles that humans have overcome and the unlikelihood that ‘conditions will last’.
In the words of John Allen Paulos, Professor of Mathematics at Temple University and versatile author with books on a wide range of philosophical topics:
“Uncertainty Is The Only Certainty There Is, And Knowing How To Live With Insecurity Is The Only Security”
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When talking to a prospect about my advisor services, I would ask him his philosophy about risk. The conversation would usually go like this:
Prospect: “I don’t like losing money.”
Me: “What do you mean? Can you be more specific?”
Prospect: “I don’t mind giving up a little upside; I just don’t want to lose too much on the downside.”
Me: “So you are concerned about volatility risk?”
Prospect: “That’s it.”
Me: “Other than that, are there risks you are concerned about?”
.. (long pause)
Prospect: “Not that I can think of.”
It is not surprising that most investors equate investment risk to volatility; they see assets prices (and their portfolio values) fluctuate every day. But there is much more to investment risk than what meets the eye. And what investors don’t see usually is far more insidious. For example:
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“Stir-Frying” Chinese Stocks
Posted on: January 26, 2010
Is it how you treat you stocks?
At the end of last October, the Chinese stock market index was up 70% for the year. One would expect Chinese investors to be making money hand over fist. Not so, the Chinese Securities Investor Protection Agency, the equivalent of SIPC, did a survey of investors in November that garnered 2,791 valid responses. The result was shocking.
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This is a story shared with me by Larry Swedroe …
In 1959 Harry Roberts, of the University of Chicago, had a computer generate a series of random numbers that would have a distribution matching the average weekly price change of the average stock (about 2 percent). Since the numbers were randomly generated, there was no pattern and therefore no knowledge that could be obtained by studying a chart of this nature. In order to create the illusion that his charts were those of particular stocks, Roberts placed a starting price of $40 on each chart. He then took a group of these charts to the leading technical analysts of his day. He asked for their advice on whether to buy or sell these unnamed hypothetical stocks. He told them that he did not want them to know the name of the stock since this knowledge might bias them. Each technical analyst had very strong advice on what Roberts should do but since the numbers were randomly generated the patterns were only in the minds of the observers. I am sure that you will never hear about this story from a technical analyst.
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Can experts predict the future?
Posted on: October 28, 2009
“When the blind lead the blind, both shall fall into a ditch.” – Old Proverb.
In July 2007, I went to an event where the keynote speaker was a former Federal Reserve Board governor who had worked with Alan Greenspan for many years.
I had had a hunch since early 2006 that the housing bubble would end badly. However, the market had proven me wrong month after month. Bewildered, I felt an expert of that caliber could help prove or disprove my hunch once and for all.
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The Significance of Dow 10,000
Posted on: October 15, 2009
“It is a tale told by an idiot, full of sound and fury, signifying nothing.” – Shakespeare
Yesterday, the Dow passed 10,000 again. Predictably, the press kicked up a big storm about it.
Even a relatively unknown like me got a call from a major newspaper asking me to comment whether this was a sign that the market would keep going up. I really struggled to answer. I knew that if I could spin a good story, the reporter would come back to me for more and more comments. Pretty soon, I would look like a stock market guru to my clients and prospects. This would surely be a win-win for me and the newspaper – if only I could bring myself to pretend.
The Investment Scientist 