Fear and Greed

Jim Steffen |

Warren Buffett made the following quote famous, “Be greedy when others are fearful and fearful when others are greedy.” Invest by this adage and you likely will do very well over time.

Buffett’s quote also implicitly describes the investor sentiment continuum, fear being opposite of greed. These human emotions are what drive financial markets. They also lead the majority of investors to make very poor investment decisions.

Looking back to late 2008 and early 2009 when we were at the height of the financial crisis, many of the world’s largest businesses had been brought to their knees, some being bailed out by the United States Treasury. During this time, the S&P500 had dropped over 50% from its previous high reached in 2007. I witnessed many individuals get so overwhelmed with fear that they sold all of their positions at or near the bottom of the market, locking in huge losses. Clearly, we were at the far end of the “fear-side” of the investor sentiment continuum.

Fast forward about 5 years to today. The Dow Jones Industrial Average is up about 150% and close to its all-time high. Unfortunately, many of the same investors I described in the previous paragraph either never got back into the market or have been sitting largely in cash and bonds. Thus, they’ve missed all or most of the significant gains of recent years. Though this is unfortunate, the thing making me most nervous in recent months is that these same people are starting to move back into the stock market.

Over the past 6 months, I am of the view that there has been a substantial shift in investor sentiment toward the greed side of the continuum. Without question, the large run-up in US stocks in 2013, the strongest year since 1997, added fuel to the fire. We are seeing this play out in a variety of ways such as new money pouring into equity mutual funds from bonds, increased trading activity amongst retail investors and changes in attitude amongst our own clients and those of our colleagues.

So what does all this mean? The first thing I want to point out is it does not mean that the stock market has to decline this month or this year. In fact, as we move further down the greed side of the continuum, the crowd effect gets stronger and very well could push asset prices even higher as new money pours in. Therefore, trying to predict when we’ve reached the top is a fool’s game.

So what should one do? This leads me to another timeless Buffett quote:

“The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.”

Another way to think about this is, as markets get hot, it becomes increasingly important for investors to second guess their gut feelings. More specifically, if after witnessing the strong returns posted by US stocks in 2013, you’re feeling the desire to have more exposure to stocks generally, this decision must be extremely carefully considered.

To bring this discussion to a conclusion I think it is most important for the average investor to simply be aware of the fear-greed continuum. Consider how rising stock prices impact your own thinking about investing. If you’ve considered yourself to be a “conservative” investor in recent years, opting to own more bonds and cash products, now is probably not an ideal time to start being more aggressive. The vast majority of investors are best off choosing a mix of assets that they are comfortable owning through both up and down markets because the reality is, we will experience both (up and down markets) and no one can predict in what order they will occur.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.