Bear Market Logic Part 2: There's 'Blood in the Street'.... Now What?

"Courage is knowing what not to fear." ~ Plato

It's times like these -- when emotions lead market direction -- that the use of logic is arguably most useful and the use of emotion is least useful...

In this market environment, or any market environment for that matter, the prudent question is not, "What should I do?" but it is "What should I not do?"

Let's extend upon our discussion from a previous and related post, Bear Market Logic:

• Between 80% and 90% of the returns realized on stocks occurs in less than 10% of trading days. So, if you're out of the market when stocks resume their march upward, your long-term returns may suffer significantly.
• From 1990 to 2005 a $10,000 investment would have grown to $51,354 had you just sat tight from beginning to end. However, if you had missed the best 10 days in that 15-year period, your returns would have dwindled to $31,994; if you had missed the best 30 days, you'd be looking at a mere $15,730.
• Nobel laureate William Sharpe found that market timers must be right an incredible 82% of the time just to match the returns realized by buy-and-hold investors. While long-term investors were sitting tight, the market timer was fretting over when was the best time to get in or out of the market and not necessarily earning greater rewards.
• Between 1986 and 2005, the S&P 500 compounded at an annual rate of return of 11.9% -- even in the face of the market crash in 1987, two recessions, two wars, 9/11, the 2000's "tech-wreck," accounting scandals (i.e. Enron), and more. Due to market timing, the average investor's return during that time was only 3.9%.
• In absence of information, coupled with blinding emotions, herd mentality typically (and mistakenly) overwhelms logic in financial markets.  This behavior often marks the highest points and lowest points of each market cycle. 
• Uncertainty and emotion in investors, as measured by extreme market volatility, and illustrated by the CBOE index (aka "The Vix"), are at levels (above 40) typically indicative of market bottoms in recent history. 

"The world is so constructed, that if you wish to enjoy its pleasures, you also must endure its pains." ~ Swami Brahmananda

So what logical conclusions may we draw from our observations of history?  Timing the market, which would include this week's panic-induced sell-off of stocks, is not a winning strategy.   In other words, time in the market is almost always favorable to timing the market.  This rhyme of history is especially important when the fear of others, and of our own, will test our reason.

These observations would also indicate that, if you are a long-term investor (more than 10 years) and your stock exposure is limited to money that you do not need for more than three years, history will tell you that the correct response to the current market panic is... nothing.

"All know the way, few actually walk it." ~ Bodhidharma

Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when "there is blood in the streets" and Warren Buffet, arguably the greatest investor of our time, implies that his success is founded upon the idea that, if an investor insists on timing the market, the investor "should try to be fearful when others are greedy and greedy when others are fearful."

I believe it is reasonable to assume that there is blood in the streets and that others are certainly fearful in financial markets today.  While many would attest to this wisdom, or at least admit knowledge of its sensibilities, very few are willing to separate themselves from the herd... but those few who have applied this courage, or as Plato said, "knowing what not to fear," in the past, have been significantly rewarded more times than not...

Source:  Profit From Market Timing, by Rich Duprey, The Motley Fool, January 23, 2007

Comments

[donna]

Thanks for reassuring me on my current market strategy, even if I do feel like a fool for it. ;^)

[The Financial Philosopher]

You are welcome Donna... I must say that doing these kinds of posts are theraputic for my self as well!

"Patience and fortitude conquer all things." ~ Ralph Waldo Emerson

[Ari Koinuma]

It's hard not to get all the hoopla in our heads, isn't it? Thanks for being a voice of reason.

ari

[Jack O]

is this just a website of cliches and popular knowledge? imo the title of "financial philosopher" is a little presumptuous for this kind of content isn't it?

[The Financial Philosopher]

Jack O:

In the spirit of philosophy, I will answer your second question by asking a few of my own:

Why do you believe the blog title, "The Financial Philosopher" to be presumptuous?

Is the blog not aptly titled in your opinion? Explain your answer, if you feel so inclined...

What is your definition of "financial?"

What is your definition of "philosopher?"

Now put the two words together. Is the title still presumptuous in your opinion?

In my mind, a "philosopher" is one who seeks and loves wisdom. I believe we may agree on the definition of "financial."

As for your first question, read my "About" page and you may understand my intentions for this blog a bit better. Here's the link:

http://financialphilosopher.typepad.com/about.html

Please join in the conversation again. I enjoy answering questions because questions are the essence of philosophy...

Cheers...

Kent, the presumptuous philosopher

Kent @ The Financial Philosopher