Taking Stock / Wet Behind the Ears

?If you bought stocks or invested in a mutual fund in December because you believed in the January Effect Fairy, it's a sign that you're wet behind the ears.

Some people believe that stock markets will outperform in the first month of the year. Some people also believe in Santa Claus.

January 2008 was a terrible month for capital markets, in Israel and elsewhere. Nor was that actually surprising, given how the credit crisis had spread from the market of mortgages for deadbeats to other parts of America's economy, and to the global one as well. And if markets had reliably boomed in every January of every year, then everybody would be haring for stocks in December, and the great opportunity would vanish with a twinkle of fairy-dust.

Even if statistically, over the years and decades, January has been a good month on the markets for reasons of taxation, psychology or "window-dressing" in December, the capital markets are an efficient place. Any opportunity to make money without assuming risk would have vanished instantly. And January 2008 reminded everybody of the risk in making investment decisions based on historic statistics alone.

?If you were shocked when Tel Aviv stocks plunged by 10% in January 2008 - given that as 2007 was ending, investment managers were predicting fantastic returns in 2008 - it's a sign that you're wet behind the ears.

Investment managers tend to be a chirpily optimistic lot, at best, especially when the money at stake isn't their own. To be an investment manager handling other people's money, you need to be. If you aren't, you will have quite a problem marketing your services. Investment managers aren't just marketing money-management services, they are marketing dreams. People want to believe they will make money. They want to believe that everything that falls will rise anew. They want to believe that their investment manager, the "special" guy they chose, will do better than any other investment manager.

?If you confidently figured that you would know when to get out of the market in time and avoid taking a bath, it's a sign that you're wet behind the ears. Very wet. There aren't that many people in Tel Aviv, or in fact, anywhere in the world, who can predict market trends.

The number of investors who consistently beat the market over years is maybe a few dozen worldwide, and the ones that do it with the help of accurate forecasting is even smaller. Most of the investors who do outperform the market over time (which means earning more than benchmark indices) do so by picking the right stocks and hanging onto them for very long periods of time, including when the markets tumble.

It is the way of stock markets to generate the returns of five years in sudden spurts - violent movements lasting no more than days, weeks or months. It is also their way to wipe out your gains in about the same short, fierce periods of time. The only way to lock in those upward spurts is to stay in the market over time, 15 years at least.

?If every dip in the market looks like an opportunity to buy because the upturn will surely come soon, it's a sign that you're wet behind the ears.

U.S. stocks didn't budge during the 1970s. Investors who bought Tel Aviv stocks during the boom of 1993 had to wait ten years to regain their losses. Most of the leading U.S. stock indices have stood still over the last seven years, since the dot.com bubble burst in 2000.

Capital market history over the last 100 years teaches that stocks outperform most other investments over time, but there have been protracted periods when they did nothing. All veteran investment managers know that, they just don't want you to know it too.

?If you get all excited when company owners or directors buy stock in their own companies because the share price has been falling, it's a sign that you're wet behind the ears. Generally, company owners know better than outsiders what's happening at their firm. Their acquisitions could be indicative of something they know about developments at the company. But they have no clue about the future of financial markets, and the pages of history are full of company owners who bought their own shares in the dip and came a cropper.

Unlike you, company owners have ways to make money from their companies, so following in their footsteps may not serve you well. Also, sometimes their purchasing isn't motivated by knowledge of events to come at the company. Rather, it's motivated by the hope that investors will follow in their footsteps and lift the company's share price.

?If you sell your portfolio and mutual fund units in disgust as the market swoons, swear never to touch stocks again and place your money in some rising market like real estate, it's a sign that you're wet behind the ears.

Housing and real estate in general are only considered "safe" because they aren't traded on the stock exchange. But history is full of instances in which property prices dropped like stones, and not because of lava raining down on the town. Even after their rebound in the last couple of years, most assets in Israel are still worth less than they were ten years ago, in shekel terms. Just like stocks, property values rise and fall, and the periods of downturn can be long and painful.

?If you're rubbing virtual aloe on your burns and vow never to touch stocks again because the stock market is "no better than a casino," it's a sign that you're wet behind the ears. It isn't a casino.

Ultimately, asset prices reflect economic value. The rub is that sometimes, the prices detach from reality. They can become pumped up or deflated for the simple reason that stocks are bought and sold by people, and people have emotions, feelings, expectations, hopes and dreams that aren't always rooted in rock-solid reality.