Fear is a Four Letter Word

In polite society, if such a forum exists today, a “four letter word” refers to a description which is not to be used. While both love and hate are four letter words, one is viewed positively, and the other as unfortunate. I use the word fear as descriptive as
to what is driving investors and also as unfortunate.

As a professional investment advisor and an investment committee and/or board member of a number of non-profit organizations, I spent this last week strengthening relationships. Some callers “just couldn’t take it any more.” Some wanted to reduce equities by 50% from today’s levels. Others reported they had sold all of their domestic stocks and bonds. Not only did they want to temporarily reduce their anxiety, but they were reaffirming their belief as to how smart they finally were. Yet they all believed the stock market would rise again eventually.

Unfortunately the sellers did not have the advantage of attending my first place of analytical instruction, the race track. Any serious handicapper would doubt the ability to place three winning bets in a row. Those driven by temporary fear almost by definition commit themselves to a program of sell, switch, and buy. Very few can do all three successfully. From my study of money managers, and particularly mutual fund managers, those with much larger-than-their normal cash positions miss the relatively easy winnings in the early stages of recovery. During the uncertainty surrounding turns to the upside, cash becomes too comfortable. They do not want to risk the relative performance rank they achieved on the downside.

What will be the best stocks to own once the recovery begins? Those with cash will continue to look backwards and buy the stocks that went down the least or the ones that went down the most. In each case there is an equilibrium price the stock will return to, as if stock prices have memories. While both approaches have worked occasionally, they do not consistently work. (They are fighting the odds of the three bet parley.) If the investor did not raise an inordinate amount of cash relative to his past patterns, he/she can improve their odds significantly. First their focus can be on owning the best stocks for the future. They can fund these purchases by using some of their cash or switching out of their pre-decline holdings. For most managers it is easier to switch than commit the cash that had recently made them a winner.

What Should Be Done Now

First, remember what you have paid for the following advice = zero, which could be exactly its worth. Second, observe what happened on Friday, the 10th of October. Third, focus on the odds of a continuing trend. On Friday, the Dow Jones Industrial Average moved over 1000 points, changing direction 18 times in the last trading hour alone. While the average did finish lower, the intraday price action is suggestive of capitulation. Those who have been driven by fears of a greater collapse have sold at almost any price.

Finally, in a world where traders believe the trend is their friend, one should start to bet on a trend reversal. On the basis of this market analysis and using the individual portfolio segments as suggested in Money Wise, my recently published book, start to add to your buying program of specific stocks that have an above-average future and/or a group of mutual funds that have diversified strategies.

Let me know how you are feeling and doing as you find more positive four letter words.