Wall & Main

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My perspectives as an investor and consumer

As the pendulum swings…

the_pendulumThrough my experience as an investor, I’ve learned to look at the market as a collective expression of fear or greed. Webster’s dictionary defines greed as a selfish and excessive desire for more of something than is needed.  Fear, on the other hand, is an unpleasant often strong emotion caused by anticipation or awareness of danger.

The market tends to swing between these extremes in reaction to various factors.  What’s peculiar to me is the timing of these emotions.  We are most fearful when we should be aggressive and most greedy when we should be cautious.  I use the words “aggressive” and “cautious” purposefully because I don’t think we should ever be making decisions based on fear or greed.

Part of the reason for collective emotion is due to the human tendency for groupthink.  Groupthink is an exhibition of consensus without critical thought or analysis.  It requires minimal effort, is not caustic, and appeals to our desire for a comfortable buffer.  If an idea fails, at least we’re not the only ones failing.  There is a certain level of comfort in failing or being mediocre as a group.  Unfortunately a successful idea under groupthink does not bear a lot of fruit because the participants, by design, are too late to the game.

Independent thought, on the other hand, requires maximal effort.  You find yourself having to do most of the research and analysis, and drawing your own conclusions.  These ideas differ from the “group;” so criticism is inevitable, which over time, can wear emotions down.  Besides, there is always the danger of failing miserably with no one to fall along with you. Once we take these factors into account it’s no surprise that many of us unintentionally pursue the path of least resistance.

The emotional pendulum had swung to the side of greed during the historic housing boom:

  • as home values appreciated, the idea of quick and large profits gained momentum
  • our wrongful association of material wealth with happiness found new life
  • homes inappropriately became ATM’s due to easy access to home equity loans
  • financiers saw an opportunity to take advantage of groupthink participants to juice up their bottom lines
  • as our perceived “ATM’s” got bigger, we allowed ourselves to suspend the simple, yet profound, notion of spending less than we earn

Kyle Bass serves as an example of a person who resisted groupthink during the greed phase.  Mr. Bass runs a hedge fund out of Dallas, Texas.  In 2005 he started doing his own research into the mortgage-related securities that were being packaged by Wall Street and sold worldwide.  He asked the tough questions.  According to him, Wall Street was putting lipstick on a pig and selling it to people who did not understand what they were buying.  The lynchpin to the groupthink assumption was that home values would never come down.  Bass came to the conclusion that the trend was unsustainable and the unraveling would be vicious.  He and his partners predicted early on that the amount of troubled loans would hit $1 trillion.  He even shared his concerns with risk managers on Wall Street.  No one wanted to listen.  He then made the tough decision of putting a substantial portion of his own capital and that of his investors behind his conclusions even as the herd was thundering the other way.  His fund reported a return of 400 percent in 2007.

The pendulum now finds itself swinging to the other extreme — that of fear:

  • people are pulling out of the stock market after seeing half the value of their portfolios vanish into thin air
  • those nearing retirement are worried that they will have to work much longer to make up for the lost value in their retirement accounts
  • the housing-led recession is fully afoot
  • those who have lost jobs are wondering if they’ll find one soon
  • those who still have their jobs are fearful of losing it any day
  • the decline in home values hasn’t abated yet (remember the lynchpin?)
  • the foundations of many banks are crumbling leaving people wondering if their money will be safe
  • ……….

Fear seems to control our decisions these days.  Unfortunately, the economy will not see an improvement until this emotion subsides.  One thing I know for sure…this too shall pass.  As Solomon, the wise man, once said, “To every thing there is a season, and a time to every purpose under the heaven.”   There are enormous opportunities for people who recognize this, resist groupthink, make tough decisions, and take some risks.  As sure as Kyle Bass earned his profits working against the market’s greed, there will be those who reap great rewards working against the market’s fear.  Sadly, most of us will only hear about it after the fact.

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Filed under: Business, Economy, Psychology, , , ,

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