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There is no observed improvement in the emotional stability of the average investor, notwithstanding dramatic advances in financial literacy or in the sophistication of computer software.The investor of the 1990s is probably no less prone to excitability and self-delusion than the investor of the 1920s.
Paul McRae Montgomery... has made a lifelong study of the role of perception in the financial markets. There is the logical and calculating part of the human mind, Montgomery has observed , but there is also the emotional and impulsive region. Each plays its role in the supposedly cold-blooded calculations of buying and selling stocks and bonds.
To suppose that the value of a common stock is determined purely by a corporation's earnings discounted by the relevant interest rate and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed.
Investors are prone to be bullish at the top of the market when prices are high, and bearish at the bottom when prices are low.
Like war, speculation is a social activity. It is carried on by groups.
-- James Grant, Minding Mr. Market: Ten Years on Wall Street With Grant's Interest Rate Observer
On Oct. 30, 1938, Orson Welles directed and narrated an episode for the CBS radio network as part of the anthology series "The Mercury Theatre on the Air"; it was an adaption of H.G. Wells' The War of the Worlds.
Ladies and gentlemen, we interrupt our program of dance music to bring you a special bulletin from the Intercontinental Radio News. At 20 minutes before eight, central time, Professor Farrell of the Mount Jennings Observatory, Chicago, Illinois, reports observing several explosions of incandescent gas, occurring at regular intervals on the planet Mars. The spectroscope indicates the gas to be hydrogen and moving towards the earth with enormous velocity. Professor Pierson of the Observatory at Princeton confirms Farrell's observation, and describes the phenomenon as (quote) "like a jet of blue flame shot from a gun" (unquote). We now return you to the music of Ramón Raquello, playing for you in the Meridian Room of the Park Plaza Hotel, situated in downtown New York.-- The War of the Worlds (as adapted by Orson Welles and The Mercury Theatre)
The first two-thirds of the 60-minute broadcast ran without a commercial break and was presented as a series of simulated news bulletin, which suggested to many listeners, especially during the anxiety and stress leading up to World War II, that an actual Martian alien invasion was currently in progress. Some panicked in response to the broadcast and, in the days following the adaptation, there was public outrage against the news bulletin format of the radio show.
The broadcast became a textbook example of mass hysteria.
Of course, the Martians were not invading Earth!
As I have written repeatedly, all is not rosy -- far from it! My intention is not to be a Pollyanna; I recognize the current soft patch in domestic economic activity. Housing, in particular, remains sluggish and confidence subdued. Moreover, there exists numerous P/E multiple deflators and nontraditional headwinds to growth. The following factors don't necessarily prevent an extended bull market, but they most certainly have deflated P/E multiples -- the S&P 500 now trades at only 11.5x 2011 forecasts -- and have put a cap on the market's upside potential:
While there are headwinds aplenty (some gale-force), they are now mostly well-known and arguably have been incorporated in more measured market and economic expectations, as the notion that "it's different this time" has become an accepted view.
With benign inflation and near-historic lows in interest rates and with most measures of business activity still signaling moderate growth ahead (as Jim Grant wrote in Minding Mr. Market), to some degree, it can now be argued that the equity market is traveling the path of fear rather than the path of fundamentals, as emotions and a crisis in confidence have overwhelmed good corporate profits growth, strong productivity gains and rock-solid corporate balance sheets.
Importantly, the S&P now provides an 8.7% earnings yield (the inverse of the P/E ratio), which seems very attractive against a 2.95% return on the 10-year U.S. note and no return on cash. That differential between the S&P's earnings yield and other interest rates is among the widest in decades.
Jim Grant reminds us that investors are typically greedy when they should be fearful (e.g., spring 2008 and two months ago in late April 2010), and perhaps now, as was the case at the generational low in March 2009, they should consider being more greedy when others are growing more fearful.
In "Free at Last," I opined that the market's descent was creating more long investment opportunities than seen in six to eight 8 months, and I suggested that any further retreat in stock prices should be bought.
Over the past few days, many individual equities have approached or are approaching increasingly attractive entry points as fear has overcome many market participants.
As one of my most savvy acquaintances in the hedge fund community suggested to me last night, Mr. Market himself is looking cheap. According to this friend, the market, in the aggregate, is currently discounting a double-dip and is pricing in 2011 S&P earnings at about 25% less than consensus.
And now, the famous astronomer, Professor Richard Pierson, from the Princeton Observatory at Princeton University, will explain the disturbances on the planet Mars....Professor, would you please tell our radio audience exactly what you see as you observe the planet Mars through your telescope?
-- The War of the Worlds (as adapted by Orson Welles and The Mercury Theatre)
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