Unfortunately I've just gone through another birthday. Anybody else notice that as you get older the year passes more quickly? And what a great year it's been for equity investors.
But it was oh so different 12 months or so ago. World stockmarkets plummeted from the previous autumn and bottomed on 6 March 2009. A few days earlier, in late February, I think I was the only adviser The Telegraph could find who was positive about equities for the coming year. And it seemed many Telegraph readers were of the same opinion as an old neighbour of mine who informed me, in no uncertain terms, I needed my head examined for being so optimistic.
One of the problems is we listen too much to experts who are constantly pessimistic and usually wrong. Previously they were of the opinion that property prices would keep heading up into the stratosphere. They are the same people who confidently predicted the US Dollar would plummet while Gold would double by now.
As oil was hitting $145 a barrel they are the same folks that were predicting it was heading to over $200 bringing with it a global meltdown. Every prediction ended up wide of the mark.
Last year I simply reminded readers history tells us when experts and headlines are aligned it's time for a sharp exit. And it tells us to be afraid when things look too good and be optimistic when things look too bad.
The problem it seems is with our brains. Neuroeconomic experts including Jason Zweig and James Montier have written books on investor behaviour telling us our brains get in the road of good decisions when it comes to investment. But they don't exactly tell us why our brains make bad decisions when it comes to investment.
I recently read the fascinating book by American biologist Joe Quirk which goes into great detail as to why men and women don't think the same. Have you ever noticed that? But what's fascinating is he explains the reason human beings, or Homo Sapiens to give us our technical name, have become the dominant species on the planet is because our brains evolved over millions of years only to see problems. We're hooked on them.
Take that and link it to the fact that the modern brain is in three parts. The outer part is in information overload sucking in numbers and filing them away whereas right at the core of the brain is the hypothalamus. Some folks refer to it as the reptilian brain.
It's the emotional brain. It's also the survival one. Back in the days of the dinosaurs that quick reactive reptilian brain saved our lives. It acts much faster than logical thought. And that's why we are such bad investors.
In fact it's so bad, private investor sentiment extremes are great contrarian buy and sell signals. In the 10 years preceding the beginning of March last year there were 66 occasions when US private investors were measured at the extremes of pessimism and optimism. How many times did they get their buying decision or selling decision right? Yes that's right, none.
And by the end of February last year the measure of extreme investor pessimism in the US was at its highest since the early 1970s just before the dramatic bull market rises of 1975.
I have found over the years that a very good question to ask when listening to all these experts is what do you believe to be true that is actually false? There are many examples but I will give you just one.
It is generally believed, thanks to the continual pontification by experts, that deficits of any kind are bad for a stockmarket. The corollary of course is surpluses are good. Since 1947 there have been 9 peaks in US deficits. There has also been 9 surpluses and in the 3 years following surpluses the stockmarket rose in total terms, with reinvested income, at only 2.8% per annum. Following deficits the equivalent number was 12% per annum.
Stockmarkets are leading indicators. They fall before the economic crisis and rise before economic recovery. Every single time.
And there lies the message. Experienced investors don't listen to the news every day. They don’t care whether the FT 100 Index is up or down and whatever excuse experts come up to explain why. They look for businesses, sectors and economies with great business models and prospects. And it's even better for them if public opinion makes these great investments available at discount prices. Do you think Tom Dobell, the manager of M&G Recovery Fund cares what's happened to the price of an equity he likes because it's just gone down for the last half hour?
I attach an emotional cycle showing points of maximum financial risk and maximum financial opportunity and the various emotional bits in between. I suggest investors keep it to remind them that kneejerk reactions cut no ice when it comes to making good long term investment decisions.
But after such a sharp recovery we're likely to get a bit of sideways movement and some volatility. Experts and headlines will still pump out the bad news and your problem focus brain will tend to believe them. So it might be a bumpy summer but all the non emotional factors point to a very positive autumn and winter.
An edited version of this article was published in The Telegraph, Saturday 13 March 2010
