Meditation on Why We Buy

“I wish to have certainty in my life,
and outcomes in the timeframe of my choice,” She said.
Too bad 

Had the stock market been rib eye steak in 1974, grocery shoppers would have been all over it. It was selling for half the price of twelve years prior, and investors were not only not buying, they were dumping stocks at wholesale. Now, forty years later, with the market up big, extremely expensive, and far outrunning the growth in the underlying company earnings, they can’t get enough of the stuff.

A cursory look at the chart below should make the reader want answers to two questions:

1) Why is it that investors never buy cheap and always buy expensive?

2) Why must there be a bear market that erases all the gains of the last forty years.

Fed Fed

The Investor Behavior Problem

Shopping for stocks is different from shopping for socks. Socks are utilitarian, we get them at the best price we can–preferably on sale. Stocks are a bet on the future, which is uncertain, so we need to feel confident that the future is good. Without knowledge of the future, we default to the past. When stocks have been falling, we feel bad, so we hold off. When stocks have been going up, we feel good, so we are willing to buy.

At the end of a long decline, the mood is very negative and most are unwilling, at the optimal time, to bet on the future. As the market rises in a new bull phase, it gets easier to make a move. At tops, people who have not been involved at all will buy without even investigating. They are the ones who drive valuations to excess. They are the ones most vulnerable.

Buying at the bottom, or soon thereafter, requires retraining our brains to want to buy in the midst of fear. Very difficult.

Why Stocks Crash

 The stock market is driven by the regret of the naïve investor, who buys from the savvy investor at tops, regretting that he didn’t get in years ago, and finally sells out at the bottom (to the savvy investor), regretting that he held on, instead of selling out a lot sooner. If we didn’t have naïve investors, we wouldn’t have bull and bear markets. Savvy investors do not account for foolish rallies.

This process is in play at all degrees of trend, from day trading up to multi-year moves. The bear phases, or corrections, are always occurring because the emotions of the regrettors are hard wired. Can’t change our feelings.

Then we have epic advances–bull markets that last for decades. The naiveté simply expands and induces ever greater disregard for reality. Plus, and this is a biggie, a lot of it is done with borrowed money. Never in the history of markets has there been so little equity and so much debt in the stock market as there is now:

NYSE-investor-credit-SPX-since-1980

There is even more borrowing than during the Tech Bubble. Not only that, but the underlying economy, supposedly the reason we buy stocks, is also more highly leveraged than ever:

US debt worse than 1929

Debt is an essential element in economic development–until servicing the borrowings stymies growth. And every fifty years or so we realize that an ordinary advance morphed into a mania. That is when we need to read Leviticus, and Tacitus, and De La Vega, and Mackay: All of the investment manias in recorded history have been fully retraced.

So, are we closer to the top or the bottom? You decide.

Cheers,

Rod

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