Exactly six years ago today, the markets made their ultimate low following a 57% collapse of the S&P.
I was fortunate to have been on the right side of that trade in both directions. What is most fascinating to me about that was the pushback from traders and investors — in each direction. It is revealing as to how much recency bias infects people, especially with those who have hard earned money on the line, and are watching it slowly disappear.
Lets start with a little background. What began as an intellectual exercise bloomed into something else entirely. Cult of the Bear was a look at the individual stocks in the Dow, and what could possibly go wrong with them. The Dow 6800 call was not supposed to be a forecast; rather, it was an exercise in valuing what the Dow Jones Industrials might be worth in light of issues in housing, credit and consumer spending.
It was part of a series I was doing at TheStreet.com. The key analytical starting point was this 2006 thesis:
“It starts with the consumer, who after years of spending, finally tires. Soon, it infects corporate revenue and profits. Slowly, it cascades its way across different sectors: housing, durable goods, discretionary spending, entertainment. Eventually, the decay spooks the markets.”
That turned out to be rather prescient. The market topped the next year, and my rough, back of the envelope calculation that had pegged fair value of the Dow at about 9,800 (at the time when it was trading near 11,000) was dead on. I wrote of a continued Bull rally, especially in the Nasdaq, before the collapse. Why? Because that is how tops get made.
I also argued that any break of 10,000 at the same time as a Housing decline and retail sales slump (due to end of cash out refis) could lead to another 3000 point “panic drop.”
I ended by saying: “If and when that happens, it likely will be the best buying opportunity in the markets since the October 2002 cyclical lows.”
All told, that turned out to be more accurate than I ever imagined.
The media interviews I did around that time were defined mostly by the pushback from TV anchors. But especially noteworthy were the comments posted at Yahoo Finance. They were terribly revealing as to exactly how distorted investor psychology could become in light of any analysis with a very out of the mainstream conclusion.
It was as if no one could even imagine a market falling again.
Note that we just had a 35% drop in the S&P and a near 80% drop in the Nasdaq, a mere 5 years prior. Regardless, it served to prove the old saw that investors seemingly learn nothing from the past.
Of course, comments are where intelligence goes to die. Yahoo Finance comments were unusually inane those days – it was a pre-moderation free for all — filled with idiotic, anti-semitic, racist, full of anonymous cowards and other assorted creeps. It was so over the top that Yahoo had to revamp their comment system to screen out so many truly offensive, egregious racists.
It is a shame those comments are lost, as they were an incredibly instructive example of confirmation bias amongst investors.
Flash forward to 6 years ago today: I do a video shoot with Aaron Task of Yahoo Finance. Markets were as deeply oversold as I had ever seen them and every metric I tracked was pinned to an extreme.
We discussed investor psychology, the Fed, valuation, and other related issues. But the money quote, was simply this: “The mother of all bear market rallies is coming.”
That was recorded on the 9th. It was posted the morning of the 10th, and by the end of the day, the Dow had risen 5.8 percent. (the videos do not seem to be posted at Yahoo Finance).
The same fascinating pushback took place in the comments at Yahoo (including the racist/anti-semitic nonsense). The negative experience of the collapse had left investors so shell shocked, they simply could not imagine a market going higher. Whereas the last go round I was called a perma-bear, this time, I was a perma-bull (ignore the obvious conflict there). I was a hack, in the pay of Wall Street, working for the Fed, a White House plant, shorting into the rally, and worse.
Although the silliness was disappointing — you Humans serve to make me appreciate my dogs more — It was incredibly instructive. Investors are emotional, lack objectivity, and are filled with all manner of cognitive errors.
But it also taught me that looking at the world in an objective data-driven manner, with a defendable investment process. And, I am aware of exactly how much randomness went into nailing the low.
Today, my office runs a robust asset allocation model. We are not dependent upon nailing the exact top & bottom. Instead, we are focused on long term investing. We use rebalancing to take advantage of market dislocations. We also developed a tactical portfolio in house to take advantage of events like 2008-09 — but its an adjunct part of our holdings, and not the main focus. The lessons we learned from 2008-09 have made us better investors. Hopefully, you learned something constructive as well.
If you are interested in a more data-driven approach to financial planning and asset management, please contact us here.
When Barry Ritholtz Talks, People Listen (Freakonomics, March 11, 2009)
Five Years Ago, Dumb Luck Made Me a Genius (March 10, 2010)
Better Late than Never: Dow 6,800 (March 2nd, 2009)