Mind-Set of Investors Hints Market Has Yet to Hit Bottom
What does it take to make a market bottom?
More than we’ve seen so far, some Wall Street pros say--despite the Nasdaq Stock Market’s two-day rise from Friday’s 26-month low.
The Nasdaq composite index rebounded 61.51 points, or 2.9%, to 2,204.43 on Tuesday, and the broader market also advanced.
The flip side of the irrational exuberance that inflated the technology-stock bubble of 1999 and early 2000 is a fearful mind-set that takes hold when investors have been drained of confidence, according to people who study market psychology.
Yet despite recently recording the worst year-over-year decline in Nasdaq history--a drop of 58% from last March--the bear market for tech stocks probably has yet to run its course, many such experts say.
Brad M. Barber, a UC Davis finance professor and specialist in the developing field of behavioral finance, said when investors truly lose confidence, they shrink away from the market in droves. One natural result is that trading volume dries up.
Nasdaq trading has held at relatively high levels in recent weeks. By contrast, volume had crumbled by the time tech stocks made a short-term bottom last May, after falling for two months.
Measures of investor sentiment, similarly, have sagged from their peaks but are well above usual bear-market lows, experts say.
Some Wall Streeters have been waiting for what market technicians call a “capitulation” episode--a big one-day crash on huge trading volume that wipes out the last vestiges of optimism and, paradoxically, sets the stage for a sustainable rebound.
However, Lisa Kammert, U.S. market analyst for Birinyi Associates in Westport, Conn., said not all market downturns culminate in a capitulation.
In late summer 1982, which most analysts consider the start of the historic bull market that roared straight through the 1990s, the end of the 1980-82 bear market came quietly, without any slate-clearing plunge occurring first.
Yet in just the first 20 days of the market surge that began that August, key indexes jumped nearly 20%, Kammert said.
The lesson is that if you miss the bottom, you may miss a lot because the start of a new bull market often is marked by explosive stock gains.
But in times like these, the market seems to work its hardest to discourage investors from hanging around for that rebound.
People who were trained through the 1990s that “buying the dips” was a profitable strategy have had that instinct drummed out of them in the last year in a series of false Nasdaq starts that pros uncharitably dub “sucker’s rallies.”
A classic market bottom has two components, Kammert said: first, an “oversold” condition, with major indexes significantly below their 50-day moving average, a key measure of the recent trend; and second, a sharp increase in buying interest.
There are many ways to measure buying interest. Birinyi looks at how stocks trade each day on upticks in price versus downturns in price.
If a $50,000 trade closes on an uptick in the stock’s price and a $20,000 transaction closes on a decrease, there is said to be a $30,000 net inflow, or buying interest, in that stock, by Birinyi’s definition.
Although the Nasdaq composite index is deep into oversold territory by many measures, money flows to that market are still neutral to negative, Kammert said Tuesday.
Moreover, she said, there remains a good deal of positive sentiment among investors about stocks’ long-term prospects--not what you’d expect to see at a market bottom. Though such optimism may be a testament to the durability of investors’ hopes and dreams, it doesn’t make a good jumping-off spot for a rally. Most bull markets rise from the ashes of despair.
If stock market faith dies slowly, it can be even slower to rekindle, even after prices begin to resurge.
After the crash of 1987, trading volume plunged and stayed down for two years, noted Meir Statman, finance professor at Santa Clara University. Stocks overall advanced in 1988 and 1989, but many investors didn’t care.
“There can be a sense of bitterness,” he said. “If returns are negative or low, stocks will fade away as a topic of conversation and people will talk about real estate.”
One psychological factor that can make pessimism spread is what researchers call “representativeness,” the tendency to over-generalize from specific information.
Instead of taking a new bit of data and factoring it in with everything else they know about a stock, investors sometimes let the latest piece of news--especially bad news--overwhelm their thinking, said behavioral-finance expert Jeffrey Heisler of Boston University.
A different but equally common error that investors make is dwelling on the fortunes of particular stocks rather than on the direction of their entire portfolio, Heisler said. This tendency can lead to counterproductive decision-making.
For each stock they buy, investors tend to have two “reference points,” he said. These points often are the price at which they bought the shares and some other “survival level” at which they will bail out of a losing position.
The existence of these reference points can lead to otherwise inexplicable selling pressure.
People’s reluctance to admit their mistakes can mean that they will resist selling losing stocks even after the reason they bought the shares in the first place is no longer germane. However, when the price crosses below the survival level, it will get dumped, Heisler said.
On the other hand, a stock that is rallying can sometimes meet heavy “resistance” on the way up as it crosses such reference points.
If you bought a stock at $25 and have been kicking yourself as you watched it drop to $15, you may be only too glad to sell out and just break even if the stock rallies back to $25, Heisler said.
Such individual decisions, multiplied by millions of investors, can result in selling pressure that causes market rallies to stall out and die, giving way to another sustained decline.
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STOCKS ADVANCE
Nasdaq gained as investors shook off more bad news from tech firms. C4
