Holding onto Beaten Stocks: The Boiling Frog Story
A very non-scientific survey of friends and colleagues indicates that many, if not most, are holding on to their stock portfolios. While the values of their portfolios are down 35-50% from their peak, even after last week’s recession rally, they must think that things are more likely to get better than to get worse in the future. Why else would they be holding on to their stocks?
When I ask my friends for their rationale for holding on to their stocks, the answers, as well as their beholders, can be grouped as follows:
- The eternal optimist: things will surely get better tomorrow!
- The worrywart: I cannot bear the though of missing the eventual upswing, especially since I have already lost so much.
- Those in denial: if I just put my head down, focus on my work, ignore the news and do not even look at my investment performance, one day I will wake up and things will have fixed themselves.
Outside my group of friends, the economists are starting to converge on the view that the current recession is the worst since the Great Depression. Forecasters’ views about when we hit the bottom are still diverse, but most do not expect a turn-around until some time in 2010, at the earliest. Group 1 hence appears to have a unique definition of “tomorrow”.
Digging deeper into how the stock market has typically behaved before and after a recession, it appears that stock markets tend to be a pre-cursor to both the up and down swings of the broader economy. So, the stock market has typically started recovering before Main Street bottoms out. Group 2 is surely using this line of argumentation. The problem is, we do not know how much further the stock market will decline before it starts going up…
Also, group 2 has another troubling psychological hurdle to clear: the fact that you have already lost so much is irrelevant to the decision you are facing today: you should only be concerned about potential future gains and losses, not past ones.
On that note, I just read a commentary by a respected mind, Richard Russell, who has been analyzing and living through the markets for the past 60 years or so. Here is what Russell had to say: “I know that great bull markets and great bear market tend to overrun at the extremes. Let me leave you with one thought — prepare for the extremes. Just as the bull market that ended in 2007 rose to the extremes, I believe this bear market will go to the extremes. At the end, the market and the economy will be worse than even the bears envision. The worst thing you can do now is to be complacent.”
I have yet to find a good economic foundation for group 3, but I bet it has more to do with the psychology of survival than investment logic. Perhaps they just have a much more long-term approach to investing than the rest of us can afford to have.
All this reminds me a little bit of the boiling frog story. If you put a frog into a pot of boiling water, it will jump out. But, if you put it into a pot of cold water and heat it slowly, it will never jump out. The poor frog surely feels the water getting warmer, and warmer, and warmer. Perhaps he is thinking that the water must get cooler tomorrow? But, before he finally gets the smarts to jump out, he is one boiled frog.
This article was prepared by SustainableWealth.org and reflects the current opinion of the author. It is based upon sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute investment advise nor a solicitation or an offer to buy or sell any products or services. SustainableWealth.org is a trademark of Merk Investments, LLC.
