Markets moved by mass hysteria

People learn from their mistakes. Only a fool makes the same mistake twice, right?

If this is the case, why is it that we have been witness to a process that has occurred, on average, every five years over the past 60 and yet we are still surprised when it happens again?

Let’s get one thing absolutely clear: bear markets will keep happening, whether we like it or not. They will happen for the same reason that bull markets occur. Human nature causes us to fear missing out on a good thing. As a result, the share market always gets pushed beyond the point of fair value. Invariably, this continues until a point where the predominant sentiment switches from fear of missing out (or greed, if you like) to fear of getting burned. Thus commences the bear market.

Something else that is not up for debate is that the only sure way to profit long term from investing in the share market is to buy and hold.

Note the use of the terms ‘investing’ and ‘long term’. People occasionally make money at the casino or the track, but rarely in the long term and you definitely can’t call it investing.

Since the peak before the bear market that commenced on May 30, 1946, to the recent low point of the current bear market, the S&P 500 rose a staggering 6,000 per cent. Not a bad rate of return by any measure and that for just owning the index. Everyone has heard the expression, ‘Buy in the gloom and sell in the boom’. Knowing this and armed with the historical returns of share markets at our fingertips, why is it the majority do the opposite of what makes sense?

Late in 2007, punters were buying with their ears pinned back. Up until a few weeks ago, share markets were languishing at a level almost 50 per cent below their November 2007 peak.

So, the million-dollar question is this: what mental process is in play that sees buyers gobble up shares at $1, but nowhere to be found when these same assets are selling at 50 cents? It just shows there is nothing common about commonsense. Little wonder the great Warren Buffet is quoted as saying “share markets are efficient at transferring wealth from the impatient to the patient”.

Are we forever doomed to be locked into a perennial cycle of herd mentality that sees us follow each other into the market way beyond the point of acquiring any value, only to follow each other back out of the market, taking our losses with us, well after the values have fallen through the floor? Is there no escaping this continual and perpetual mass hysteria?

We financial advisers have a great deal to answer for. We know this stuff. We talk about it all the time. So, where are we when the clients are pondering their options and looking for guidance and reassurance? Judging by a substantial proportion of what you read in the financial as well as mainstream media these days, we are acting bewildered and concerned right alongside our clients.

I was recently asked by a much younger adviser what I was doing to fix my clients’ portfolios. He was visibly stunned by my response of “nothing”. I asked him: “Was there anything wrong with your recommendations in the first place?” His response to this, of course, was “No”. So I asked him: “Then what is there that you need to fix?” How come, when we know from the outset what is going to happen, with the only question marks being the timing and, perhaps, the quantum, do we act surprised when it does happen?

When a client asks: “What are you/we going to do about my current situation?”, they are really asking for our assurance that everything will be okay. The moment we attempt to ‘remedy’ the situation, we give proof to their suspicions that our advice was inappropriate in the first instance.

The reality, of course, is that in most instances (Storm Financial et al excluded), there was nothing wrong with the advice in the first place.

Financial planning, as a discipline, has come ahead in leaps and bounds since its origins a little over a quarter of a century ago.

Yet, just when our clients need us the most and we have a real chance to prove our worth, the evidence suggests very few of us have the courage of our convictions.

Our clients may expect a great deal from us, and, perhaps, some of us have been guilty of promising the world and delivering the proverbial atlas. But no one with a sound understanding of the role of a financial planner would have consciously created an expectation in their clients’ minds of possessing a crystal ball that would enable them to anticipate market cycles.

So, think back over the contents of the statements of advice you presented prior to late 2007. If the advice was appropriate at the time, taking into account both what you know of financial markets and your clients’ circumstances, chances are you need do nothing, except to reassure your clients that they are on the right track, then sit back and await the inevitable recovery. And, with markets having rebounded almost 20 per cent in the past three weeks, that recovery just may already be here.

Wayne Leggett is co-principal of Paramount Wealth Management.