You Are Not as Dumb as the Bear Market Makes You Feel

I wrote an article in February 2007 in the Rocky Mountain News called - “You are not as smart as you think” . That article was written to address overconfidence that we get in bull markets.  Today I’ve slightly rewritten the same article to address underconfidence of bear markets.  

Lately I’ve been getting this nagging feeling that everything I touch turns to dirt. Every time I buy a stock that is already down a lot, the one that my analysis leads me to believe is cheaper than dirt, it declines more.  Did I completely lose my ability to value stocks?  Did I start ignoring Will Rogers’ advice - Buy stocks that go up, and if they don’t go up, don’t buy them?

No, I didn’t get much dumber, and my stock picking skills haven’t diminished that much over the past year. I was simply a willing participant in the latest (cyclical) bear market. Bear markets make you feel dumber than you are, the same way bull markets make you feel smarter than you are. Feeling dumb makes you do the opposite of what you should be doing. Fear and pain - yes, continued losses cause a lot of pain - are dangerous things because they can make you (and me) panic, lose confidence and do the opposite of what we should be doing.  

To alleviate pain, we sell, we react, we default to the only asset that made us money (so far) in the bear market – cash!  Cash is only a king when other assets are princes.  When you cannot find a stock with a long-term (a key word) superior risk reward profile, then cash is King (with capital “K”).  However, during a cyclical bear market, cash is slowly demoted to a prince as great companies are thrown out the window with the junky ones.  You have to actively make yourself aware of the eight-letter word T-O-M-O-R-R-O-W!  Yes, tomorrow.  Think of the lyrics from Annie: 

When I’m stuck with the day that’s gray and lonely
I just stick out my chin and grin and say, ohhh

The sun will come out, tomorrow
So you gotta hang on’ til tomorrow 

Of course, we don’t know if tomorrow is tomorrow or years from now.  But investing is a marathon, not a sprint, and do not let the bear market turn you into a sprinter.  

First of all, remind yourself that you are not as dumb as your portfolio makes you feel.  You have bought a stock (once or twice) that made you money.  This is what I do.  I pull out a chart of a stock on which I made a boatload of money or one I sold (for the right reasons) before it declined. I do this with pleasure, trying to relive my “smart days”. 

We all have these stocks, the ones we nailed. We tend to forget about them during the bear market phase. But I suggest you remember them now, when you feel lonely and miserable, so you’ll have more of these names to remember in the future as cash will not bring the pleasure of victory in the long run.  The cyclical bull market is still there; it is just hiding under the ugly sentiment of the cyclical bear market. Believe me, it will show its happy face.  It is just a matter of time. 

In a bear market, it is easy to forget about buying. Selling is a much easier decision to make. Every time you buy a stock you look dumb because it usually goes down afterward. I recently bought a couple of incredibly cheap stocks and, of course, they declined.  I don’t feel smart about these buys right now. However, awhile back I analyzed these companies, figured out what they are worth, determined an appropriate margin of safety and got my buy prices.  Stocks declined, fundamentals have not changed, so I bought these stocks.  

You cannot worry about marking the “bottom” in every buy. My objective is not to buy at the “bottom” and sell at the “top.” No, my objective is to buy a great company when it is cheap and to sell it when it is fairly valued! I suggest you do the same.  Will Roger’s advice is great, but unfortunately I have yet to meet a human being who has figured out how to apply it in real life.  No, you are not as dumb as bear markets make you feel.   

Comments

[css1971:]

1: Every reduction is a new bargain.
2: The stocks aren't changing value. It's money which is changing value. You can't value anything objectively because your measuring stick is changing size.

2008 Oct 30 04:15 PM

[sr9web:]

To: CSS1971 -

Stocks do indeed have value - but that value fluctuates greatly based on many factors beyond your control. They key is to buy and trade them sufficiently well that your cost basis stays below market price. This is very hard to do during a bear market. That's why it's good to own stocks which pay nice dividends. This way, when the market price drops below your costs basis, you are still receiving income from your positions.

2008 Oct 30 04:22 PM

[Larry House:]

No, I do feel pretty dumb. I trusted S&P and Moody's with their investment grade rating of LEH and AIG and bought the bonds of both several months back. LEH is gone, and AIG is just about gone. I feel dumb, but I feel like the rating agencies committed fraud. You live and learn, but sometimes the lessons are expensive. I used to feel corporate executives earned large salaries and bonuses, but I don't any more. The execs at LEH and AIG have been borderline criminals, and they may have crossed the line. Enron has happened again, and this time the damage is even more widespread.

2008 Oct 30 05:16 PM

[investor88:]

Will Roger's approach is to buy stocks that go up, and only those that go up. The more you think about it, the more logical and practical it is. Many hedge funds and momentum traders employ it to good effect.

Vitaliy's approach is more like Warren Buffet, ie value and buy and hold. Who can quarrel with Warren's success and the logic of his method?

For the average person, Will Roger's approach is perhaps simpler and more practical. To Will Roger's approach to buy only when a stock is going up, it may be practical to add that there should be a sell stop/cut loss Bill O'Neil style.

2008 Oct 30 07:06 PM

[2houndz:]

I don't know, based on this article maybe you are as dumb as you think. And css shows in his item 2 that he certainly is. That's the stupidest thing I have ever read. I feel dumber just having read it.

2008 Oct 30 09:18 PM

[Jackson Cash:]

@ 2houndz:

The reason a dog is a man's best friend is because his tail wags instead of his tongue.

.. way to contribute absolutely nothing.

2008 Oct 30 10:50 PM

[DC Housing ...:]

Sorry, but I think you should feel dumb. The past 5 years have been a mirage and anyone investing in equities should have really thought a little more about what they were doing and what was really going on. I haven't lost any money and I'm not any sort of financial guru at all. Don't think that makes any sense? You may want to start here:

www.hussmanfunds.com/w...

2008 Oct 31 01:51 AM

[BerkeleyBob:]

I take some comfort in the fact that some well run mutual funds with great long term results are showing a loss in the short term about the same as on my individual stock picks. In other words, I am not doing much worse than the professionals. However, reasonable diligence does not avail if you are relying on "objective" rating agencies or faced with an Enron-style conspiracy to defraud. I am no longer convinced that the market's behavior is explained by transparent transactions or is fairly and reasonably regulated by the likes of the SEC.

2008 Oct 31 02:29 PM

[Pessimistic...:]

2 houndz
we have all been hit by this.. if you haven't good but beat on somebody who has... what the hells the matter with you? I appreciate the man's pain as I am in it as well. most of us are and have been stumped by this market. I lament Steven's opinion. You have not contributed anything positive.

2008 Oct 31 10:57 PM

[Old Trader:]

Yeah...being "only" down 16%, YTD is cold comfort. I try to console myself with the knowledge I'm doing better than a lot of Harvard MBAs, and former "Masters of the Universe", but it doesn't help all that much..

2008 Nov 01 01:10 AM

[OctoberFaith:]

Now it get what your talking about.

2008 Nov 01 10:12 PM