On a frigid Saturday afternoon in early March, I stood on the sidelines of a youth soccer game with a friend who was shivering for reasons that had little to do with the weather.
Stocks had just concluded another brutal week, closing down 56% over the past 17 months, and she could not get the market off her mind. A widow who depends on her investments to pay necessities such as the mortgage and health insurance, she was being forced to contemplate a major change of lifestyle.
A couple of days later, after the market had rallied a touch off those historic lows, she e-mailed to say her financial adviser, who had preached long-term investing for years, sent her the following e-mail: "I write with a recommendation that we sell your investment securities -- stocks and bonds -- and park the proceeds in cash. . . . I am ranking capital preservation a higher priority now."
You know what happened next. After the decision to keep her fully invested during the market had cost a fortune, the adviser managed to exit just before stocks rose 20%-plus. And so my friend's portfolio -- her livelihood, not a speculative plaything -- has been left in the cold.
Regret stirs the bull
Multiply this experience by tens of thousands and you will better understand what's happening these days in the market.All those investors who sold heavily in February and March, when volume blasted to multiyear peaks and prices spiraled into the ground, now face the two most vexing investor maladies of them all: not the usual two-headed devil of fear and greed, but the fearsome pairing of regret and envy.
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And oh, baby, is regret corrosive. Every day you see the market rise when you're out of stocks after taking a big loss eats at your mind like an acid. It burns at your psyche until you'll do anything to make it go away. And because there is only one thing that can make that happen -- buying stocks on the rise -- you can see why stocks have relentlessly jumped higher of late. Every little dip is met with buying, and every big dip is met with even more buying.
A flu scare in Mexico? Bring it on. That's just the sort of headline-creating event that bears lust for in an environment like this, hoping it will validate their point of view. Yet paradoxically, it's much more likely to create a vacuum into which regretful buyers will lunge.
Given the slightest spark, the psychology of regret can force fund managers and retail investors into the market almost against their wills, and so can begin the next big bubble and boom. And as cynical as I am about company fundamentals and government intervention of late, this realization has helped turn me positive on stocks in the past month. It's not a matter of being bullish or bearish on the economy but being opportunistic for stocks -- more like a hawk than a lumbering ground-bound beast, scouring the savannah from the air for sustenance.
Strangely enough, veterans will tell you this is actually how most bull cycles start: in disbelief and rage. You might think bear markets end when the economy begins to improve in a pervasive way and big companies start to report better earnings. But that's a fantasy, a children's fable. Just as bear markets begin when everything is great, bull markets begin when everything stinks.
The inflection point comes when emotions run so high that economic and investment decision makers overcompensate. The economy hits bottom, for example, when industrial and retail purchasing managers get so pessimistic about future sales that they stop buying stuff to move through their factories and stores. And the market hits bottom when stocks have been run down so much that there are basically no more sellers -- when the last holdout, like my friend's fund manager, throws in his chips.
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Suddenly, then, on the factory floor, the mall and the Wall Street trading room, there is simply no more supply. And so the big market forces, the patient old families in Manhattan and London who end up with all the money decade after decade, recognize this change of mood and charge in to provide capital for industry, and buy stocks and property like mad. It's no wonder that Wilbur Ross, the greatest distressed-debt buyer and industry builder of our era, just announced that he'll form a fund to buy toxic securities from the banks so long as the government has his back.
Continued: The worst stocks rise the fastest
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