As prices rolled over and began heading down in 2000, in an effort to extend the Game and provide buying support, professional investment advisers on TV, sell-side researchers, the popular press, and corporate executives themselves began stressing the benefits of a buy-and-hold strategy. “Nothing to fear,” they said. “Prices always go up.” As prices declined further and many investors’ paper profits became unrealized losses during the next two years, expert advice progressed to buying on the dips. “Just a profit opportunity,” they said. Many executives supported that view, lamenting on TV that their stocks had declined significantly and were drastically undervalued. Regulators and market makers weighed in as well. Even the Chairman of the New York Stock Exchange, Richard Grasso, joined the spin effort when he commented on NBC’s Meet The Press, “I think investors, unfortunately, have been disappointed by a number of failures on the part of some companies to be truthful and honest with their investors, and the public’s confidence has been tested. The market however … has historically always responded to the economy. Our economy is strong.”
The next wave of advice to investors was to “leg into investments,” buying stocks on a schedule over time since “bottoms” are hard to predict. Did anyone ever advise investors about the wisdom of “legging out” while they had unrealized gains, noting that tops are also hard to predict?
Naturally, investors readily accepted all this expert advice because it promised exactly what they wanted to hear. Like everyone else, they relish being right. This common human trait can become a decided disadvantage, however, when making investment decisions. When an investor buys a stock and the price goes up, all is well. When the price falls part of the way back toward the purchase price, some investors continue to believe they are still right and do nothing. Others recognize that they were wrong not to sell at the top, but to reaffirm their rightness, wait for the stock to recover and once it recovers, they are right again and do not sell.
Sometimes when the price falls to a break-even level, investors sell. (Of course, selling shares at the same price at which they were bought never results in breakeven after taking into consideration transaction costs, inflation, and the time value of money.) More frequently, the pain of lost paper profits creates paralysis, and investors just hope their “rightness” will be reaffirmed. All advice that promises redemption is welcomed, and all advice to take a loss is rejected until the pain becomes unbearable.
Playing With Emotion
Despite deep analytical resources—better computing power and independent third-party research on the Internet—most individual investors make their buy or sell decisions based almost exclusively on emotion. Professional investors and traders are more disciplined, but they also often cling to an old idea in the place of new logic. Greed fueled the Share Price Game for a long time, and fear caused a rapid collapse when many sold their shares after prices had declined below the investment price.
In exchange for participating in the luxury of liquid capital markets, all investors pay the price of having the value of their savings (and therefore the level of their future lifestyle) recalculated minute by minute. When a relatively small percentage of everyone’s savings was in equity securities, most investors in the market did not track their investments daily. Once more investors had a greater stake in volatile equity stocks, and television constantly tracked their ups and downs, investing became far more emotional. The Share Price Game capitalized on the resulting euphoria on the way up. Investors have paid the price on the way down. Emotional investing is stressful, but that’s an inherent part of the Game.
Assessing the Landscape
The broad-based increases in P/E ratios described earlier demonstrate a significant rise in expectations about future performance. This should cause investors to question the contention of many “experts” that the excesses of Tyco, WorldCom, Enron, and others are isolated cases and not the common practices of most companies.
Many executives lament that the market has given them a “no confidence” vote, asserting that they are completely innocent of reporting inflated earnings, raising investor expectations beyond realistic levels, and thereby encouraging an emotional and speculative bubble. Certainly, some executives can legitimately make these assertions. Still others may be culpable in the Share Price Game, but have stopped well short of committing fraud, have consistently reported results in conformity to GAAP, and have acted in what they perceived to be the best interests of shareholders. But this does not necessarily make them innocent of contributing to the bubble and the losses that investors have experienced. After the biggest run-up of stock prices in history, many investors were lucky simply to break even. As paper profits soared in the 1990s, investors spent on better lifestyles financed with debt. That debt now has to be repaid, and future investing will be fueled by an increased sense of desperation.
Critical questions remain to be answered. Will investors consider whether they would have been better off if prices had not diverged so dramatically from real value? Or will they still buy into the Greater Fool Theory and remain willing pawns in the Stock Price Game? With the stakes higher than ever, will executives, directors, politicians, the media, and investment advisers of all kinds try to prevent another bubble and restore some sanity? Or will they try the same old tricks? Now is our chance to make change and follow better practices for the health of the markets and suffering investors.