Managing greed in bull markets is the second most important psychological task in investing. Only coping with fear in a bear market is more important.
At this moment, fear still predominates among investors, but there are increasing signs of growing greed in the investment community. Some of the telltale signs are statements such as, “I know the economy is going in the tank, but I know I have plenty of time to get out.” Or, a statement is heard like, “There are no worries because the market is not overpriced.”
It is well to think about greed because greed becomes infectious in a bull market as people begin to think of large gains and the accompanying growing greed as normal occurrences. As greed grows, the psychology of the crowd tends to sweep away the ordinary investor, creating a subtle hypomania alluded to in the Wall Street aphorism, “Never confuse a bull market with genius.”
Crowd mentality seduces its members into feeling safe. To avoid crowd thinking during episodes of greed, the goal is to think independently. To achieve this, especially when it comes to greed, you need to know that our unconscious works to conceal greedy behavior from us. This is what makes greed so powerful as a mental force.
From early childhood, we are told by our parents that greed is bad. This becomes quickly incorporated into our super-egos, i.e., our conscience. It is then quite usual to rationalize any greedy thoughts or behaviors as they occur. In the realm of investing, this sometimes takes the form of saying, “ABC Corporation has gone up consistently. Buying more is obviously sensible.”
The neuropsychological correlate to this is that our frontal lobes release more serotonin with such thoughts, making us feel even better. If you feel this way when making profits, remind yourself that this is a potential danger signal. In this regard, here are nine of the most common warning signs:
Experiencing wonderful feelings of control.
Growing expectations of unrealistic returns.
Speculative investments no longer seem speculative.
Managing greed in bull markets is the second most important psychological task in investing.
Your stock choices favor overpriced stocks. (You can measure this with simple math by applying valuation ratios such as performance/earning (P/E) ratios, price/book value (P/B) ratios, performance earning/growth (PEG) ratios, price (P)/free cash flow ratios.
When you hear cocktail conversation about new stock ideas, you feel left out unless you buy, too.
Stock tips excite you.
Investing becomes a competitive activity for you.
You stop thinking about having a diversified portfolio and instead concentrate on whatever are the hot areas of the moment, such as Internet gaming companies.
You know for certain that “It's different this time.”
When I discussed this article with a colleague, his response was, “Boy, I wish I had to cope with greed again. I am sick of this sideways market.” I understand his point. Even though the market is near its all-time high, no one is feeling rich. Everyone still feels traumatized by the 2008-09 collapse. We will not know until time elapses whether or not my warning is premature, but, with that in mind, I offer you the following market signals to watch that may alert you to greed again becoming rampant:
A sharp increase in initial public offerings (IPOs). Although not yet at levels associated with dangerously heated markets, there has been an increase in recent months.
Ratios of prices to companies' earnings, sales, and book values approach record heights.
Dividend yields are low, perhaps at record lows. (Currently these yields are quite low.)
John W. Schott, M.D., is a member of the Boston Psychoanalytic Society. He is director and portfolio manager at Steinberg Global Asset Management. He also publishes a monthly newsletter on investment psychology, The Schott Letter.
Volume is low on market up days and high on down days. This indicates the professionals are selling.
The advance-decline line (i.e., the ratio of the number of stocks that have advanced to the number that have declined) points downward over several weeks.
There is market divergence. This means that one segment of the market is advancing while another is not. Presently this is so because while the DJIA and the S&P 500 have been advancing on new highs, the DJ Transports are lagging.
Time Magazine and other important periodicals place a bull or bear on their cover. This signals a market turn.
When 60 percent or more of market newsletter writers are bullish.
All this begs the question as to what investors should do today. There are enough danger signals that investors should be increasingly defensive by decreasing the percentage of their portfolio invested in equities. The problem is where to go because bond yields are pitifully low. There is no really good answer to this. Most professionals have fled to solid dividend-paying blue chips. This is the safe haven of the moment, but the danger exists that this sector is becoming overpriced to the point of becoming a new speculative bubble.
Whatever you choose to do with the non-equity portion of your portfolio now, it should over-emphasize safety.