. . . and Our Halting, Ambivalent Recovery

Wall Street wants stocks to recover their lost values, yet it appears to understand that such a recovery is dangerous: it might not happen without another bubble.

Last Saturday, “The Intelligent Investor” in the Wall Street Journal wrote that while stocks have dramatically risen in value since March, this was a cause for worry. “In the entire 113-year history of the Dow, only six rebounds have been bigger and faster. But the swiftness and magnitude of this bounce-back aren’t reasons to be cheerful; they are reasons to be cautious.”

Noting that corporate insiders are selling their stock at a far greater rate than they are buying it, Jason Zwieg suggests: “it is at times like these, when a rising market sweeps our spirits up with it, that investors need to evaluate their emotions and consider whether their beliefs and actions are justified. . . . The market’s light has turned yellow. Don’t try to run it.” (See “Why Investors Need to See the Light and Slow Down.”)

Yesterday, Mark Gongloff, wrote in the Journal from a different angle: “Stocks fell so far from their prerecession, October 2007, highs, that — despite a 47.5% rally since March — the Standard & Poor’s 500-stock index is still missing $4.8 trillion in market value.” He adds, “It still needs a 57% gain to return to its October 2007 high.” (See, “Bubbleless, Stocks Still Playing Catch-Up.”)

Looking around for sources of potential growth to make up the difference, he notes, “it would likely take frothy energy markets or a new credit binge to push stocks immediately back to their previous highs.” But then he adds, at the end, “Neither would be sustainable, nor desirable.”

It may not be entirely clear that we are recovering from the recession, but it does seem unmistakable that we are recovering from misplaced faith in the rational market. Worry, impatience, evaluating emotions – a new language of investment is making its appearance in our financial journals. The books on “behavioral finance” have been coming for some time now, but now mainstream financial journalists are catching up.

Two weeks ago, indeed, the Journal published a report by Meir Statman, Professor of Finance at Santa Clara University, stressing the impulsive and irrational factors at work in typical investment decisions. Statman cites the work of Daniel Kahneman and Amos Tversky, for example, demonstrating how gains or losses in wealth register emotionally far more than absolute levels of wealth, a point that could be useful to remember when you are suffering an acute loss and need to regain balance and perspective before making any further investment decisions. (See “The Mistakes We Make—and Why We Make Them.”)

Statmen offers other bits of advice, no doubt drawing on the work of other researchers into behavioral finance. He could have referred to many, many more. The field is growing rapidly, and the list of experts and advisors is lengthening, along with the bits counsel they have to offer.

This is a welcome change from the dominance the quants have enjoyed among investors – and least it is a useful addition. But it still falls short of what is actually needed. New sets of rules and new mottoes help only up to certain point.

Psychologists have known the limitations of behavioral approaches for some time. Useful when struggling against strong entrenched and destructive behaviors, such as addictions and phobias, they turn out to be not so useful with familiar problems that continually recur. Like new years’ resolutions and self-help books, they get quickly discarded as we automatically repeat what we are used to doing. It’s like any other set of rules: we forget that we decided to change.

Actually nothing takes the place of an awareness of self-knowledge and insight – but that is not so easy to accomplish. What we don’t know we know about ourselves is how hard it is to change even the behaviors we don’t want to engage in.