Fear and Greed – The Stock Market Drivers

Over the past year we have seen a great deal of volatility on the Australian and world share markets leaving investors battered and bruised and above all worried about the immediate future. Which direction will the market take next in the short term? Who knows? But one thing is for certain, the market will be controlled by the human emotions of Fear and Greed.

Have you ever noticed when the stock market crashes or corrects it does so quickly and sharply? This is fear at work. When the market is positive and moves up, this is greed at work. The market always moves down quicker than it moves up, therefore we can deduce that fear is a stronger emotion than greed, and it is fear that is a most useful “weapon” for the “savvy” investor, as long as you don’t become consumed by it as well.

With the American economy slowing and earnings estimates being reduced worldwide, we have seen markets, including our own, go into a type of “limbo”, not going up significantly or going down at any great rate of knots either. It would seem there are equal numbers of fearful and greedy people, and a whole lot of investors who have pretty much lost interest since the “Tech Wreck” early last year (when all the high tech stocks started slipping). So, who will win out? Will it be the pessimistic “Bears” and their Fear, or will it be the optimistic “Bulls” and their rampant Greed that will push the market higher and allow us all to breathe a sigh of relief that this uneasy “equilibrium” has come to an end.

I suspect, that in the next few months the markets will start to move higher again as investors and fund managers begin to conclude this may be the bottom of the current economic cycle. At the moment, we are seeing interest rates start to move lower as economic news tends to be poor with lower earnings estimates (Lend Lease), dropping business confidence, lower job vacancies and slowing retail sales (Coles Myer). Twenty years ago, this would have amounted to only one thing, a recession was looming. However, I think a lot has been learnt from the past and a recession is unlikely, but a slowing in economic growth is certainly on the agenda and this does tend to frighten investors and they exit the market and invest in cash and bonds until the worst is over. Most of the bad news is out now, investors are depressed, and the markets are a little “bearish”. Now, is not the time to sell shares, it is the time to buy them. As the year unfolds, confidence will return as lower interest rates take effect and the chance of a recession in the US recedes. As this occurs, we should see a re-emergence of the Bulls and a rising market.

With all this in mind what should the “smart” share investor be doing? In my opinion, I would be waiting for the “Fear” days, when the market plunges due to any number of reasons, real or imaginary. Buy up “blue chip” shares that have been punished unduly (like Lend Lease for example, around $ 16 at the time of writing) and wait for a “Greed” day to come along and lighten up your holdings (say 50%) taking some healthy profits with you. Don’t sell all your shares, keep the other 50% as a core holding that you have been able to secure at “fear” prices. This strategy is one that I have employed quite successfully in recent years and while it may not be the “boots and all” approach that some investors prefer, it does allow you to sleep at night and accumulate a very nice portfolio and a few cash profits for good measure. The secret to this approach is patience and the belief that the “end of the world” isn’t approaching.

While the last year hasn’t been a happy one for investors, it should improve, because it always has in the past and there is no evidence the world has changed, fear and greed will continue to dominate the markets. When the market is gripped by fear and investors are selling as if there is no tomorrow, you should consider buying, because this is when the market is having its “sales” and prices are “marked down”. Conversely, when investors are gripped by euphoria and they are paying silly prices for shares, as we saw with tech shares in early 2000, you should be willing to sell a few. This is when the market is totally consumed by greed. Always try to think a little anti-cyclical, ignore following the “herd mentality” and try not to get caught up in the emotion of it all, regardless of whether it is Fear or Greed.

For more information on this subject, read Trident Press title:

The Australian Share Market Guide