Behavioural finance offers path to market recovery.

Investors could be willing to take on more risk to recoup their losses.

Behavioural finance theories are gaining prominence and could plausibly explain the wild market volatility of recent months, according to Jan Mahrt-Smith, an associate professor of finance at the University of Toronto’s Rotman School of Management.

Speaking at the University of Toronto on Tuesday, Mahrt-Smith pointed out that behavioural finance has recently gained much more attention as financial experts and commentators seek to explain the dramatic market activity of recent months.

“Behavioural finance is everywhere these days,” said Mahrt-Smith, who is also co-director of the Rotman Master of Finance Program.

One of the roles of behavioural finance, which is the study of non-rational decision-making and the ways such decisions impact financial markets, is to fill in the gaps of rational finance theories, Mahrt-Smith explained. For instance, behavioural finance acknowledges that investors have different expectations about investments, and that changes in investor confidence levels can impact the markets. In addition, the theory shows that emotions can play a role in investing.

Certain irrational investment behaviours could have played a role in adding to the market volatility of recent months. For instance, Mahrt-Smith pointed to studies showing that investors tend to focus more on gains and losses than their overall level of wealth.

“It should be only wealth matters,” he said. “But it turns out we care about gaining money or losing money much more.”

Whether a loss is big or small, it can have a significant impact on a person’s happiness, he added.

“One dollar gain is a gain, it’s fantastic. One dollar loss is a loss and it’s horrible,” Mahrt-Smith said.

The losses incurred by investors early in the downturn, therefore, could have helped trigger an irrational panicked reaction that led to a more severe selloff and added momentum to the downturn.

Some of the investment losses of recent months could also have been worsened by the tendency for investors to hold on to losing stocks longer than winning stocks -- a reality of investment behaviour, according to Mahrt-Smith.

“We’re willing to gamble that it will come back up, but we don’t want to take the loss,” he said.

He added that the recent crash could change investors’ behaviour going forward.

“We’re all poorer now, so we have to recalibrate how we think going forward,” he said. “Maybe using historical statistics isn’t going to be the same when you’re going through a period of a crash or a bubble.”

In particular, Mahrt-Smith said that even though nearly all investors have lost money in recent months, behavioural finance theory shows that they could be willing to take on more risk to recoup their losses.

“We’re going to behave quite differently from these risk-averse, rational investors,” he said. “People are going to gamble for a resurrection.”

Mahrt-Smith noted that there are some considerable arguments against using behavioural finance theories to explain the current market events. For instance, some argue that since all investors tend to behave differently, it is difficult to draw generalized conclusions about this behaviour.

Still, Mahrt-Smith said the theories represent a promising starting point for justifying some of the ways investor behaviour has played into the widespread market volatility of recent months.

(-Courtesy of: "Investment Executive - 03/18/09 Article by Megan Harman.)

What amazing times these are...

“Be careful what you water your dreams with. Water them with worry and fear and you produce weeds that choke the life from your dreams… Always be on the lookout for ways to turn a problem in to an opportunity for success.” -Lao Tzu

"Bear-Market... Shmear-Market..."

The near term will likely remain volatile, but I continue to believe periods like these create long-term opportunity... We must however navigate wisely.

We will look back on this period as one that provided fantastic entry points for long-term oriented investors.

If you are a value investor- you are a long-term investor. If you are a long-term investor- you accept in advance that you are making no effort whatsoever to keep up with your benchmark or peers on a short-term basis.

Reasons to consider investing today:

-Contrarian Sentiment: Buy when there is blood in the streets. While the current crisis has created mass fear and panic, it has also created opportune entry points for long-term investors.

-Cheap Stocks: Current S&P 500 valuations imply an extended period of extraordinarily- and unlikely- weak long-term earnings growth.

-Government Action: The U.S. Government- and others- is making an extraordinarily proactive effort to address current problems.

-Growth on Tap: While the economic global engines of growth (e.g. China, Brazil, India) have slowed, they are not broken.

-Parked Wealth: Nearly $4 trillion are currently sitting in money market funds.

-Historical Precedent: Equities have delivered 9% to 11% annualized returns in the more than eight decades through 2007... decades that include the Great Depression, World War 2, the Long-Term Capital Debacle, the Asian Contagion, Iraq Wars 1 and 2 and September 11Th.

Addition To The Corporate Bond Post... (From Warren Buffett's Recent Release)

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.

Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier.

Beware the investment activity that produces applause; the great moves are usually greeted by yawns.

Bonds... Corporate Bonds. (Sexy no?)

Safety and security is a pressing issue now-a-days; when we see even the most rational investors of our life time acting in irrational ways. But where does one focus his investments and still guarantee a great degree of protection while beating the eroding effects of inflation? If your stomach (IE. risk tolerance) is not up to the swings of high-yielding equities (IE. companies that pay handsome dividends, etc...), then bonds are the most logical place to look... or one could simply hide under a rock until the sky is done falling... Unfortunately, most of us don't have that kind of luxury, as time is something we don't have alot of. So now more than ever, investment returns are vastly important to achieve some semblance of our former retirement dreams and aspirations.

Quick Background:
Bond prices and bond yields move in opposite directions. Prices are quoted relative to a par value of 100 - a bonds value at issue. If the bond has a 5% interest coupon, the annual yield is 5%. But if investors bid down the price of the bond in the market, and you buy at say 90, the effective yield is greater than 5%. And if you hold the bond to maturity, you'll get the 100 in principal, on top of the coupon income you've received.

If you read that bond yields have increased, it means that bond prices have declined(and vice-versa). Prices for long-term corporate bonds tend to move alot, since these prices are based on Government bonds plus a spread for greater risk. A company's sales, earnings and other financials also have a big impact. Rating agencies grade bond issuers on their ability to repay (AAA, AA, B, Etc..).

In the current market one sees great opportunities, especially in midterm corporate bonds. In 2006 and 2007 spreads were very tight. Even riskier corporate bonds weren't yielding much more than Government issues. But last fall, corporate bond prices plummeted as the credit crisis worsened. Today, spreads are more rational - they're wider.

Overall it is important to hold on to the bond until maturity to be certain to make money. Even without the glamour of stocks, there's still risk - and excitement in bonds these days.

(PLEASE CLICK ON THE LINK TO MY TEAM'S WEBSITE ON THE RIGHT SIDE OF THIS BLOG-PAGE TO FIND OUT MORE ON SOME OF THE GREAT DEALS ON CORPORATE BONDS. UNDER THE HEADING "PUBLICATIONS: CABA NEWSLETTERS"... CHEERS)

(Some information sourced from The Globe and Mail - R.O.B. 03/2009)

Thoughts Going Into The Weekend...

The Chinese word for crisis, Wei Ji, is a compound of the characters for Danger (Wei), and Opportunity (Ji). There is probably no better word for describing the mindset of successful investors.

Where we're at... (Brief comment from Don Coxe)

What we know from the 70s is that if you have a recession at a time of fast money supply growth that what happens is that the stock groups that tend to do best during the recession and to lead you out of the recession tend to be commodities. So the commodities stocks of course, were just hammered after the ‘midnight massacre’ of July 13, 2008 which is what really launched deflation in the world. But what’s interesting is what’s happened to them since then in relative strength. We come back to my old faithful of the IBD’s 197 industry subgroup rankings and what changes there are in that from week to week. This week, if we take the top 21 stock groups, we see that 7 of them, that is one-third of them are commodity groups led, of course, once again, by metals, ores, gold and silver; they’ve been at the top for some time. But we’ve got food flour and grain; we’ve got oil and gas transport pipeline, we’ve got oil and gas refining and marketing, I feel very good about the fact that pure refiners have done so well, I can tell you. Food, miscellaneous preparation, retail, wholesale food; and Oil and Gas, International Exploration and Production interestingly enough.

So, what that tells me is that this is the kind of swing at a time when everything looked bad, back in 1974, and by the way, things looked much worse then than they do now, in 1974. We were down to a 6 mulitple on the Dow. And the belief in equities as an asset class was being abandoned on all sides and unemployment was double digit levels and governments were falling; things were much much worse then. But, what you could see was the relative strength of the commodity groups, including, by the way, the supermarkets back then, which is interesting, because the supermarkets are doing well now. So, I would therefore like to take the view that what signals we’re getting for the market are that the market like all the pundits, isn’t sure that this $2-trillion that’s being thrown at the system is going to work. But the belief is if it does work, we’re going to have a greater demand for scarce assets, and that everybody recognizes that the huge selloff that we’ve had in commodities and commodities stocks means that scarcities could come back pretty quickly. And that’s exactly what happened in the 70s.

Now, I’m quite sure there’s a lot of you out there saying ‘you keep talking about the 70s, and its a different world.’ It is in many respects, but only in one, I think, that’s really crucial, and that is on the real estate side. Because back then what we had was the baby boomers were university graduates having to live with their parents or grandparents because there were no houses available for them. There was a housing shortage because of course, there was no way they could expand the housing market fast enough to take cognizance of the huge number of baby boomers coming out of high schools, community colleges, and universities; well we havn;t anything like that this time, because of the birth dearth that began back then. What we have is a situation where the housing supply was built on the assumption that things would be the same as they had been every other cycle and of course they aren’t the same, and they will never be the same the next 50 years. So that’s the big difference. We have demographic deflation across the industrial world and in that sense, what it means is that there is one asset class which cannot behave as it did back then. And back then, house prices, although it took them a while to start moving up, even though we had inflation, they did. In any case, you didn’t lose money on housing back then.

I think that the fact that the oil stocks, despite the fact that spot WTI has gone to a new low, the oil stocks are actually starting to perform better, is people’s recognition that with the cutbacks that OPEC has already delivered and then the evidence that US consumption hasn’t fallen by 5%, 6%, or 7% as people thought; those statistics were clouded by what the retail gasoline sales were; and of course, what they did, because retail gasoline was down by 50%, was in trying to adjust for this after you took out state taxes and all these things, people got wrong what the actual volumes there were. So what we see is that the actual demand for oil in the world has not fallen off a cliff. Yes, the demand for industrial goods and consumer goods and ? and things like that has fallen of a cliff. But certainly not for most commodities, and particularly, not for oil. And with the move that we’re getting in the fertilizers, and I’d just like to mention once again, the value of the IBD survey, because way down, you get way down the list, number 56 on the list, and you see chemicals and fertilzers [12:23] but that this week and three weeks ago they were down in the depths at 154 and the charts show you that there has been a huge change in attitude towards the fertilizers and indeed towards the agricultural stocks generally.

Now, that’s not because I think the world has embraced our view of the strong possibility that the two centuries of global warming have come to an end, and that we might be entering a period of global cooling which would dramatically affect the outlook for crops in the northern hemisphere. No, I think its simply once again the recognition that although demand is reduced somewhat for key grains and feedgrains as a result of the economic slowdown, that it has not collapsed and the carry overs even though they’re bigger than they were a year ago, are not so great as to suggest that the prices farmers are going to get for their grain are going to be profitable. Yes, spot corn is $3.66, but the new corn that hasn’t been planted yet, which will be delivered in December is $4.07, and corn for the next year after that is $4.25. These are prices, that if you’re a farmer who does a good job producing it, could make a lot of money on it, despite the collapse in demand for ethanol. So, what I’m basically saying is that we already have two commodity groups which in the last few weeks have been moving up strongly, and they’re basically saying that you don’t have to take a bet on how the Obama program works out, as to whether or not this recession is going to drag out a couple more years. You can make money here.

Nick Murray... Words of Wisdom

Stocks Vs. Bonds:

The most important thing is: did you invest relentlessly in any stock funds as opposed to any bond funds, individual bonds or CD’s. The Megatruth is: real wealth come to, and abides with, the owners of great companies, not to the lenders to great companies. I’m not suggesting that an owner can’t lose; I’m declaring as an article of faith that a loaner can’t win.

If you steadily accumulate even mundane stocks month after month and year after year, if you patiently remain true to your tortoise disciplines even when hares go whizzing past you left and right, and above all if you regard “bear markets” as opportunities to buy more of your stocks at sale prices rather than as the onset of Armageddon – you’ll not only achieve wealth, you’ll probably “outperform” 90% of your fellow investors without even trying.

Thus, a huge percentage of your total lifetime return is attributable to the simple decision to be an owner and not a loaner. And most of the rest of your return depends not on how your stocks perform vs. their peers, but on how you behave. Wealth isn’t primarily determined by investment performance, but by investor behaviour.

Equities neither make you wealthy nor keep you wealthy. You have to do those things yourself. You can’t, as we’ve seen, build and hold wealth without equities. But the converse is even more importantly true: equities can’t do it without you. Your appropriate behaviour with respect to equity investments – and not the relative “performance” of those investments – is the variable that will govern your financial success. (And in the end, your behaviour is the only thing you can ever really control.)
The single most important variable in the quest for equity investment success is also the only variable you ultimately control: you own behaviour.

Four Behavioural Tactics to Success:
1. Setting goals in dollar-specific, date- specific terms.
2. Establishing a plan for achieving those goals, assuming a specific rate (or rates) of return.
3. Investing the same dollar amounts at regular intervals, so as to harness the power of dollar-cost averaging.
4. Meeting your retirement income needs via systematic withdrawal from your equity portfolio.