Myth #4: The economic cycle is
suspended
A common mistake investors make at business
cycle extremes is to assume the business cycle
won’t turn back the other way. After several
years of good times it is common to hear talk of
“a new paradigm of prosperity”. Similarly,
during bad times it is common to hear talk of a
“new normal of continued tough times”. But
history tells us the business cycle will remain
alive and well. There are no such things as new
eras, new paradigms or new normals.
Myth #5: Crowd support
indicates a sure thing
This “safety in numbers” concept has its origin in
crowd psychology. Put simply, individual
investors often feel safest investing in a
particular asset when their neighbours and
friends are doing so and the positive message is
reinforced via media commentary. But it’s
usually doomed to failure. The reason is that if
everyone is bullish and has bought into the asset
there is no one left to buy in the face of more
good news, but plenty of people who can sell if
some bad news comes along. Of course the
opposite applies when everyone is bearish and
has sold – it only takes a bit of good news to
turn the market up. And as we have often
seen at bear market bottoms this can be quite
rapid as investors have to close out short (or
underweight) positions in shares. The trick for
smart investors is to be sceptical of crowds.
Myth #6: Recent returns are a
guide to the future
This is a classic mistake investors make which is
rooted in investor psychology. Reflecting
difficulties in processing information and short
9
memories, recent poor returns are assumed to
continue and vice versa for strong returns. The
problem with this is that when its combined
with the “safety in numbers” myth it results in
investors getting into an investment at the
wrong time (when it is peaking) and getting
out of it at the wrong time (when it is
bottoming).
Myth #7: Strong
economic/profit growth is good
for stocks and vice versa
This is generally true over the long term and at
various points in the economic cycle, but at
cyclical extremes it is invariably very wrong.
The big problem is that share markets are
forward looking, so when economic data is
really strong – measured by strong economic
growth, low unemployment, etc – the market
has already factored it in. In fact the share
market may then fret about rising costs, rising
inflation and rising short term interest rates. As
an example, when global share markets peaked
in October/November 2007 global economic
growth and profit indicators looked good.
Of course the opposite occurs at market lows.
For example, at the bottom of the global
financial crisis (GFC) bear market in March
2009, economic indicators were very poor.
Likewise at the bottom of the mini-bear market
in September 2011 economic indicators were
poor and there was a fear of a “double dip”
back into global recession. But despite this “bad
news” stocks turned up on both occasions, with
better economic and profit news only coming
along later to confirm the rally. History indicates
time and again that the best gains in stocks are
usually made when the economic news is poor
and economic recovery is just beginning or not
even evident, as stocks rebound from being
undervalued and unloved.