The stock market is crazy and you are not a psychologist

Don’t believe everything you read on the internet.

For example, over a million Google search results, thousands of articles, and dozens of investment books and letters will tell you, without proof, that the great economist John Maynard Keynes said “the market can stay irrational longer than you can stay solvent”.

The man who said it 36 ​​years ago, Wall Street veteran Gary Shilling, is no slouch himself to dismal science and, unlike Lord Keynes, is still with us at 85. year. He has opinions on the rationality of the recent stock market rebound. is: After the mildest of bear markets, the hardest hit companies, many of which are still unprofitable, have led a recovery over the past eight weeks. Dr Shilling is skeptical, saying stocks never reached their “vomiting point” – a stage of desperation that serves as the basis for a sustained rebound.

However, the more these one-time retail favorites bounce back, the more individuals and experts seem confident that bottom has already been reached. Citigroup strategists note that analyst optimism levels, based on the number of stock recommendations, are back. to the market peaks of 2000 and 2007. And longtime newsletter fan Mark Hulbert maintains a metric called the Hulbert Nasdaq Newsletter Sentiment Index that tracks the average stock allocation recommended by short-term market timers. He’s back to “extreme levels of bullish optimism.”

It’s hard to fathom, but some individual investors are even more optimistic than that. Last week, the theater chain AMC Entertainment announced that it would distribute preferred stock to shareholders with the unsubtle ticker symbol APE, a reference to what enthusiastic AMC shareholders call themselves. But the issue is a possible backdoor maneuver to sell them dilutive common stock. AMC shares first fell on Friday after the news, which makes sense, but then rebounded, trading nearly 50% above Friday’s intraday low on Monday afternoon.

Granted, many 2020 and 2021 darlings, from futuristic tech companies to pandemic stars to meme stocks like AMC, remain at or below half their highs. Their rebounds, however, were notable. Electric car company Rivian Automotive is up 102%, exercise bike maker Peloton Interactive is up 45% and GameStop,

the original meme stock, more than doubled from its 52-week low.

Actively betting that the spring slump would continue might well have left a bearish speculator insolvent, but market behavior is actually quite typical, even rational, says Dr. Shilling. As the 2.5 years it took for the tech bubble to bottom out show, the unraveling of a retail-led mania doesn’t happen all at once, but rather is punctuated by a chase. to premature bargains. He sees the S&P 500 eventually bottoming out 40% below its peak, necessitating another 30% selloff from today’s level. For what it’s worth, it almost accurately predicted the bottom of the 2007-2009 bear market.

Of course, anything is possible. The recent rebound may well have been the start of a serious and sustained rise in equities. Some technical analysts argue that retracing half of the S&P 500’s decline in value – not far off – would mean escape velocity for stocks.

But Dr. Shilling’s observation that investors never capitulated seems to be backed up by their actions, if not their words. While various measures of pessimism, such as the American Association of Individual Investors’ Bull-Bear Sentiment Survey, reached near historic depths this spring, the only month this year when investors withdrew a significant amount from domestic stock mutual funds was April, according to the Institute of Investment Companies.

A likely explanation for the apparent bargain-hunting in beaten stocks is a costly psychological bias called anchoring. The same trigger that causes us to buy something from a store when a much higher price is crossed out in red causes us to focus on a stock falling from its best days.

“There’s a pretty consistent long-term feeling that a stock is worth the highest price it’s traded at, or the highest price I’ve paid for it – it’s pretty ingrained in the human psyche. “, says Dr. Shilling.

However, much like an assumed initial sale price, investors need to consider whether peak valuations ever made sense. Peloton, which didn’t make a profit even at its pandemic peak, was worth $50 billion at its peak. Rivian, which sold fewer than 8,000 cars in its entire existence and is unprofitable, was valued at $155 billion, three times what General Motors is worth today. And GameStop, which continues to lose money, is ordering about 40 times what it was worth two years ago.

Timing the change in sentiment and jumping on the spring sale losers could have been very profitable, but was it repeatable? Lord Keynes, who was as good at investing as he was at economics, defined the former as “an activity of forecasting return over the life of the asset” while “speculation is the activity of forecasting of market psychology.

Good luck getting it right.

Write to Spencer Jakab at spencer.jakab@wsj.com

Copyright ©2022 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8

Leave a Comment

Your email address will not be published.