The Financial Philosopher

Reasons Not to Sell Stocks Now

"The investor's chief problem -- and even his worst enemy -- is likely to be him self." ~ Benjamin Graham

I'm going to do something completely out of my character today.  No, I'm not selling all of my stocks (in fact, I will be buying stocks today and selling none) -- I'm going to make a prediction!  I'll get to that prediction after we walk through a brief logical exercise to keep our sanity in tact...

Here are some reasons NOT to sell stocks now...

You do not "lose money" until you SELL:  The value of your investment assets has declined.  This does not mean that you lost money -- it means the value of your account has declined!  There's a difference...

Losses or gains are not realized until the asset that was purchased is sold. 

Everyone else is selling:  If you do not have at least 10 years' experience as an investor or money manager, then think about anything you've ever read or heard about stocks and the nature of financial markets:  Have you ever heard "buy low and sell high?"  Have you ever heard "be greedy when others are fearful?"

It's interesting how many investors do not get equally nervous when prices are hitting all-time highs.  Imagine this scenario:  "Oh my gosh, honey!  Did you see my 401(k) statement?  It's worth twice as much as it was five years ago!  Call our advisor and tell her to sell immediately!  I want to lock in my gains!"

You will increase the odds of poor performance:  Selling (or buying) based solely on market conditions, and not your own investment objectives, can cut your returns in half or worse.  Timing the market loses to time in the market more than 80% of the time.

"...the greatest danger is not to take the risk." ~ Soren Kierkegaard

Real risk has an inverse relationship with perceived risk:  For every panic-selling day we have in the market, the closer we come to an equally powerful rise in stock prices.  When risk is perceived to be highest, history will reflect that "real risk" is lowest.  Was it "safer" to fly on a commercial jet one week before 9/11 or one week after 9/11?

Similarly, real risk is highest when perceived risk is lowest.  When the Dow hit an all-time high above 14,000 this time last year, how many people were saying to sell stocks? 

You are a long-term investor:  Any money you do not need for three to five years should absolutely stay in stocks!  Of course, it is possible you are improperly allocated or poorly diversified, but that would be another story.  Ask yourself if you think stocks will be higher in three years or lower in three years.  What do you think?  If you're still nervous, what about five years from now?

Here's my prediction (actually, I like to think of it as a logical and rational deduction based upon history):  Stocks, as measured by the S&P 500, will be higher at the close of trading on October 5, 2009 than the close of trading today, October 6, 2008.  In fact, I will take this prediction one small step farther:  Stocks will also outperform the average money market fund during that same time frame.

What do you think?  Do you think stocks will be higher one year from now?  If not, what makes you believe that?  What are you listening to today?  Emotion or reason?  Cramer or logic?   Is this capitulation?  

Of course, no one will absolutely know the answers to these questions until this bear market is history.  Let me know what you think...

Related Posts:

Bear Market Logic

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

Bear Market Logic

"Histories make men wise; poets, witty; mathematics, subtile; natural philosophy, deep; moral, grave; logic and rhetoric, able to contend." ~ Francis Bacon

Where are stocks headed?  To answer this question, there are certainly many methods that are employed by investors, traders and analysts, such as fundamental analysis, technical analysis, economic indicators, and market sentiment.  But what about logic? 

I believe the line that intersects science, mathematics and philosophy is logic:  Scientific theories, algebraic equations, and philosophical reasoning are all structured arguments and inferences to draw a conclusion based upon what we already know...

Using logic correctly, we will review data-points or factual information available to us, use them to form our logical assumptions, then make conclusions based upon our assumptions...

"Bad reasoning as well as good reasoning is possible; and this fact is the foundation of the practical side of logic." ~ Charles Sanders Peirce

Let's apply logic to draw some conclusions with regard to the projected depth and duration of the current bear market for stocks.  Here's what we already know: 

• Since 1926, the average bear market -- typically defined as a drop of 20% or more -- has lasted 1.3 years. 
• As measured by Standard & Poor's 500-stock index, stocks have plummeted an average of 33.5% during those bear markets and that includes the three "once in a generation" declines:  1) The Great Depression-induced drop of 86%, from 1929 to 1932, 2)The 1973-74 decline of 47%, and 3) The "tech-wreck" fall of 44%, from 2000 to 2002.
• Since the 1930's, all but two bear markets have been significantly milder than average -- with losses generally averaging between 20% and 30%.
• The current bear market decline from the October 9, 2007 peak to the most recent low on July 15, 2008, is approximately 22% and the duration is just over 8 months.

Now for some logical conclusions supported by our data:

• This bear market is not a "once in a generation" decline:  The most recent generational occurrence (2000 - 2002) ended only six years ago, which is much less than a "generation" ago.  We may further logically deduce that a generational decline would follow a generational appreciation in stock prices, which most would agree that the 2002 - 2007 bull market was not a generational climb for stocks. 
• This bear market decline will not be far from average: The generational declines of a few historical bear markets account for a great portion or weight of the average decline, which is why all but two bear markets have been milder than "average."  For an average decline in this current bear market, stocks have approximately 10% more to fall from the most recent lows.
• This bear market duration will not be far from average:  This conclusion is more of a stretch to make but it follows the logic of the previous two conclusions and, for the sake of observation, does provide perspective:  Based on the average bear market duration, this current decline would end (and the next bull market would begin) around January 2009.

Of course, our logic here is not intended to be presented as fact or truth and it certainly is not the basis for prediction or investment decisions -- it is intended as perspective amidst perception -- as logical observations based upon what we already know -- not upon what we do not know.

"The emotions aren't always immediately subject to reason, but they are always immediately subject to action." ~ William James

The perspective, based upon our logic, is that the worst of the bear market may be behind us -- not ahead of us, as our perception would have us believe.  As emotions become more extreme, stock movements reflect those extremes in the form of market volatility, which always punctuate the latter stages of a bear market.  Fear and panic manifest much quicker than that of complacency and greed.

"It is the mark of an educated mind to rest satisfied with the degree of precision which the nature of the subject admits and not to seek exactness where only an approximation is possible." ~ Aristotle

What we do not know is that our logical conclusions will become a reality, for this assumption would be illogical, especially when emotion and perception are factors.  For this reason, I have argued that scientific methods cannot consistently forecast stock prices accurately because it is illogical, if not impossible, to quantify something that is influenced by emotion.  Risk is quantifiable but emotions and uncertainty are not... 

Emotion cannot be measured -- just as love cannot be explained by reason or logic, which is why the prudent investor's methods and strategies will fall short of prediction and market timing, in the absolute sense, and will reflect contentment in the absence of precision and "exactness where only an approximation is possible..."

Related Posts:

Uncertainty, Volatility & the 'Vix'

Going Through the Emotions

Source: Kiplinger.com, Make Money in a Bear Market, Dec. 4, 2007

Delusion, 'Non-Bottom Callers' & The Afflictions of the Investor's Mind

"The ignorant mind, with its infinite afflictions, passions, and evils, is rooted in the three poisons.  Greed, anger, and delusion." ~ Bodhidharma

We certainly have observed a wide range of emotions in financial markets over the past several months and we have analyzed them at length here at TFP.  Today, we will not necessarily analyze emotion but the delusion of making attempts to accurately recognize emotion as it occurs, and thereby making the mistake of investing according to this delusion... 

It seems the currently favored pastime in the world of financial news punditry is "bottom calling."  There are two primary camps in this prediction game:  Those who say we are at (or near) a bottom for broad market stock prices and, as you would expect, those who say we are not at a bottom and prices will fall farther...

"Until a man has expressed his emotion, he does not yet know what emotion it is..." ~ R.G. Collingwood

What I find especially interesting to observe is not the foolishness of the bottom callers, but the foolishness of the non-bottom callers, if you will, who believe that they are being wise in saying we are not at a bottom.  They appear quite confident and proud in their self-professed virtues of patience, experience and foresight.  They believe that it is the bottom-callers who are acting as fools and it is they, the non-bottom callers, who are acting prudently.

The preferred basis for which the non-bottom callers refuse to call a bottom is their self-professed ability to recognize market sentiment (emotion) as it occurs, specifically in current market conditions, the absence of panic and capitulation -- the primary emotions present when stock market prices hit a cyclical bottom. 

This is where the delusion takes place... 

While it is historically evident that bear market bottoms have been marked by the emotions of panic and capitulation, the non-bottom-callers fail to realize that these emotions come in different shapes, sizes and forms in each unique market cycle.  Put simply, it is widely known what will occur and what emotions will accompany the occurrence but it is virtually unknown how and when the emotions will appear.  Furthermore, once the emotion occurs, it is already in the past; therefore, it is impossible to accurately "call a bottom" in real time, with the exception of happenstance.

"Those who have knowledge, don't predict.  Those who predict, don't have knowledge." ~ Lau tzu

I've read this quote from Lau-tzu many times and have not fully applied its meaning or quite appreciated its profundity until now:  There are those who are aware of their own ignorance and those who are not.  Those who are aware of their own ignorance, do not predict.  Those who predict, are not aware of their own ignorance..

To say that we are (or are not) at a market bottom, are both forms of prediction (and foolishness), which is precisely my point:  While an investor may know that the next market bottom, if it has not already occurred, will be marked by panic and capitulation, that same investor will not be able to recognize the emotions as such until after they have come and gone.

Perhaps the lesson we may derive from this analysis of delusion is that we should not fool ourselves into believing that, just because we are taking the opposing side of an opinion we believe to be foolish, that our side must be the wise one.  We should remember that it is quite possible that both sides of a prediction have equal potential to be incorrect and that we would be better off not taking either position but to be a passive observer.

Here are more examples of two-sided opinions where there are beliefs or ideas on both sides that may be equally as foolish as the other:

• The market has hit a bottom. -- OR -- The market has not hit a bottom.
• It's different this time. -- OR -- It's the same this time.
• Tomorrow it will rain. -- OR -- Tomorrow it will not rain.
• If this happens, I will be happy. -- OR -- If this happens, I will be unhappy.
• This will make me money. -- OR -- This will not make me money.
• Stocks are risky. -- OR -- Stocks are not risky.
• Debt is good. -- OR -- Debt is bad.

Can you think of others? 

If we simply admit (and submit) to the wisdom that there is much that we do not know, and be contented with the certainty of uncertainty, we may guide our decisions (or indecision) accordingly, and our lives will be the better for it...

Related Posts:

Bull vs. Bear vs. 'Right' 

Weekend Wisdom: The Certainty of Doubt