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A Behavioral Approach to Investing

Using Scientifically Engineered Models

Time to ring the bell?

Nobody rings the bell at the top of a bull market telling us the fun times are over and to prepare for the bear market. Markets can go up far longer than most of us can imagine, which is what makes them so dangerous to investors. The seemingly resiliency of the market causes the vast majority of market participants to believe we’ve entered a “new era” where risk management does not matter.

 

Yesterday I heard from two different advisors who had clients  request to move their account from their risk management programs into something where they could buy & sell individual stocks in their accounts. Both are retired women with risk scores that would allow at most 30% exposure to stocks. Instead both are now going to be playing the market with their retirement funds because they do not see any reason the market would go down. One claimed she would know when it was time to get out. As one advisor put it, “this makes me want to sell everything and go short the market right now.” 

 

Stories like this among our 100+ advisors across the country seem to be increasing. While these types of indicators are not useful for trying to call the top, I think it is adding to the evidence we are near it. No matter what era you look at, the market always follows the same cycle. No amount of technology has been able to make investors “smarter”. Why? Because our human brains continue to get in our way of making wise decisions when it comes to our investments. Since the market is still controlled by humans (and even in the era of robo-advisors and computerized algorithms running money) this means there are still emotional swings where tons of money pours into the market and will eventually be pulled out of the market when the losses become too steep.

I’m not sure exactly where we are in this cycle, but I know we are much closer to the top than the bottom, which makes me quite comfortable with our risk management programs at SEM.  This week John Mauldin had a thought provoking article discussing where we are in the market cycle. He included a list of 10 Rules of Investing. I only wish the two retired ladies that are now trading their own accounts would read this list:

1. Markets tend to return to the mean over time.

2. Excesses in one direction will lead to an opposite excess in the other direction.

3. There are no new eras – excesses are never permanent.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.

5. The public buys most at the top and the least at the bottom.

6. Fear and greed are stronger than long-term resolve.

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. (Sound familiar? Can you say FAANGs? Facebook, Apple, Amazon, Netflix, & Google)

8. Bear markets have three stages: sharp down, reflexive rebound, and a drawn-out fundamental downtrend.

9. When all the experts and forecasts agree, something else is going to happen.

10. Bull markets are more fun than bear markets.

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New Kent, VA
Jeff joined SEM in October 1998. Outside of SEM, Jeff is part of the worship team at LifePointe Community Church where he plays the keyboard and bass guitar. He also leads a small group Bible study.