New Ways
to Understand
the Stock Market
By James Fraser, editor
The Contrary Investor
"A growing number of psychologist
and behavioral economists are finding evidence that our brains
just aren't wired for the markets we've created.
"It has to do with our evolution and the lack of it.
The human mind is an innovative hybrid. Built on top of the older,
'emotional' parts of our mammalian circuitry, there is a 'rational'
cerebral cortex."
Brian O'Keefe in Fortune, May 14, 2001.
We
are all aware of the human element in making stock market decisions
and yet, especially in our computer-oriented age, the average
investor seems incapable of calm reasoning. In March, some $15
billion was taken out of stock mutual funds, the largest monthly
outflow in history, though surely to be topped at some future
date. In early April, there was a 27% two week Nasdaq rally.
Investors are estimated to have eagerly bought $5 billion into
stock mutual funds during that rally. Brian O'Keefe says the
newer part of the brain, which is the analytical cerebral cortex,
is responsible in supposedly rational-thinking moves.
Over time, humans developed
rational thinking since our survival depended on our brains.
The mental characteristics of the gregarious animal lead to classic
herd behavior.
Stock market problems
are newly human, being rational on top of older circuitry, which
is herd-oriented. Indeed, we like to support desired outcomes,
follow the bull or bear, believe investment research that tends
to support our natural ability to convince others. O'Keefe puts
it this way "Bet long on solid fundamentals and try
not to think about it. And when you lose, take comfort: Your
fellow animals are going through the same growing pains. The
human brain just isn't as evolved as the markets."
What dose this mean,
that markets are more evolved? Individual investors have growing
pains and should be careful how brains are used. I know this
has been said before but you should use solid fundamentals and
try not to think too much about it. Take the recent example of
the Mensa investment club, made up of individuals with IQ's in
the top 3% of the population.
In the real stock-market
world the Mensa investment club has performance of 2.5% annually
over the past 15 years. That compares with the S&P's 15.3%
over the same time span. Moreover, in 2000, 88 trades took place
in an effort to make money by dealing with trendy technology
stocks.
The lesson seems to
be that superior intellect should offer an advantage, and yet
what it takes to do a good job is pay attention to fundamentals,
and sensible future thoughts such as business plans. Interestingly
enough, most investment clubs actually know that and concentrate
their efforts on doing the right thing.
Editor's Note:
James Fraser is editor of The Contrary Investor, 309 South Willard
St., Burlington, VT 05401, 1 year, 24 issues, $125.
