IoS: Mark Jones: Sell! Sell! Sell!

Mark Jones: Sell! Sell! Sell! That's the roar from the ranks of panicking financial market traders, caught up in the madness of the crowd. But they would be better off stepping outside the herd, taking a leaf out of Ronan Keating's songbook, and saying 'nothing at all'

Independent on Sunday Sunday, 23 March 2008

If personal happiness is all about being in control, then we live in very unhappy times. Anyone whose prosperity and livelihood is locked up in the money markets watches helplessly as those markets plunge and bounce and our nest eggs are flung around in the chaos. Even if our money is not invested in equities, we can't help but feel the market will get us in the end. Budgets will freeze, consumer spending will dry up. At work you suddenly see the HR chief around a lot and the finance director is urgently searching for that book on downsizing he hasn't looked at since the early Nineties.

It's a bad, bad feeling. Remember how we felt when we read about that Devon couple who came back from holiday to find that their lovely house had been trashed by a party of gatecrashing teenagers? We are that couple, and that is what's happening to our money: it has been taken over by teenagers. The market is a creature of hormones and wild mood swings, destructive, euphoric, depressive. One day it's going baseball cap in hand to the central banks and moaning that it's not fair that it has a hangover and broke a bank or two. The next it seems plain evil, spreading false rumours, destroying institutions and people for the hell of it.

As for the banks and the finance ministers, they are like ultra-liberal parents who are suddenly asked to enforce some discipline. There's little they can do but spend lots of money clearing up the mess.

The teenager analogy isn't original. It comes up a lot at times like these. So does the tendency to anthropomorphise and psychoanalyse the market. When profits are strong, house prices buoyant and the FTSE never makes the front page, investing is a stable science. We consult league tables, examine risk indices, trust the computer models. When the bad times come we start seeing the financial world in cartoon terms.

So what can you do to evict the teenagers from your house and wrest control again? Like many people, I'm an averagely stupid investor who is now more than averagely confused and uncertain about what to do. I listened to last week's reports and kicked myself that I didn't see the various rallies coming; then kicked myself I didn't get out when the going was bad.

Of all the reports, one stuck with me. On Radio 4, the BBC's economics editor, Evan Davis, who sounded audibly tired of trying to explain and second-guess what turn the credit crunch would take next, began talking instead about market movements in behavioural terms. His thrust was this. In good times, traders' optimism is easily fuelled: they are listening out for data that will support their decision to pile into those shares or support that flotation or rights issue. Bubbles and booms are the consequence. When bulls turn to bears, they suddenly see the world in shades of blue and only hear music in the minor key. The people making decisions on investments are tuned in exclusively to the bad news channel. Sentiment and psychology are more important than stats.

I thought about this ­ let's call it the subjective fallacy. You get the same phenomenon in politics. In his early days of his premiership, Gordon Brown could comment on the weather and it would seem like the wisest, most trustworthy meteorological analysis you'd ever heard. Today, you'd go scurrying for an umbrella if he told you the sun was shining in a heatwave. Spin-doctors say we listen to the communicator, not the communication. Our truth is subjective.

So what do we trust: psychology or economics? In its early days, the latter was a branch of the humanities. Adam Smith's first major work was not The Wealth of Nations but The Theory of Moral Sentiments. One of the Victorian era's most influential work on economics was written by a Scottish songwriter and poet called Charles Mackay. His Extraordinary Popular Delusions and the Madness of Crowds sought to explain the reasons for the South Sea Bubble and Dutch tulip mania; it is still cited by investors today.

Yet in the century that followed, economics became redefined as a science as the statisticians and model-theorists took the high ground: until 2002 when something strange and rather unexpected happened. The Nobel Prize for Economics went to a writer who had never studied the subject. Daniel Kahneman was a research psychologist and his studies showed (this is a crude summary) how humans make errors when they think they are being at their most analytical and objective.

Here's a typical Kahneman experiment. He asked an audience to give him the last four digits of their social security numbers, then estimate the number of physicians in New York. The two sets of numbers had nothing to do with each other, of course; yet the correlation between the answers people gave was well beyond what might be expected by chance. The process is known as anchoring. We are highly influenced by the numbers and facts we're given, even if they are guesswork or wildly inaccurate. So we could all have a bet on the number of runs England are going to score in the second innings of the current test match. I'll go first and say 420. You might think that number is ridiculously high based on what you know about the England team and the record of teams batting last. Yet the chances are you will err on the high side when you make your own estimates; I've influenced you.

Alistair Darling's growth forecasts set out in the Budget were widely criticised for exceeding the City's most optimistic figures. Perhaps Darling will be proved right in time and we should then praise him for not falling victim to anchoring. (Alternatively, he is just being a cynical politician bending the numbers to make us believe everything is going to be all right).

So back to the matter of feeling in control. Here's how some investors do it. They are called contrarians; they exploit the foibles and group-think of the supposedly objective analysts, economists and company managers. Their unofficial leader is David Dreman, investment house owner and a columnist in Forbes magazine. The contrarians trace their lineage back to Mackay and are often known for their pessimism ­ they are "perma-bears", sellers rather than buyers. But they are just as likely to be very busy snapping up stocks in times like these. They seek out otherwise sound companies who are just in the wrong sector at the wrong time; or less sound companies whose prospects are not quite as bleak as the herd thinks. One Wall Street group which specialises in the field calls itself "the Dogs of the Dow". A leading British exponent of the behavioural finance school puts it like this: "I buy other people's anxiety."

So you should buy, not sell. Fine if you're Warren Buffett (who many think of as the most successful contrarian of the lot); or if, as a City friend puts it, "you've got balls of steel". But we are not all the richest man in the world and our cojones are made of flesh and blood. If the market keeps on falling, banks keep imploding, you can't help but think the rational thing to do is bail out. After all, people who bought stocks before the Wall Street Crash would have waited until the 1950s for their investments to return to par.

The behavioural finance experts have one last piece of advice. Take it easy this weekend. Enjoy the spring. Forget about the stock market. Don't listen to your broker, listen to Ronan Keating. Ronan may not have been thinking about long-term investment stratagems when he crooned, "You say it best when you say nothing at all"; but the advice could be very useful all the same.

Jonathan Harbottle, marketing director of Liontrust, a fund management company specialising in behavioural finance, puts it like this: "Market timing is a mug's game. Two-thirds of people who think they can spot the bottom of the market get it wrong. Long term, investing in equities is proven to be the route to real wealth."

Harbottle makes a further argument for inactivity, also beloved by the Dogs of the Dow and their friends, which goes like this. While you're waiting for your rubbish shares to recover, they are paying you for the privilege. Dividends are calculated on the share prices; the share price is low ­ you get a better dividend. So sit tight.

That may just be the hardest thing of all. James Montier of Société Générale, who has been described as "one of the truly great minds on the psychology of investing", uses the example of a goalkeeper facing a penalty. The ball goes down the middle 28.7 per cent of the time (apparently). But goalies always dive left or right. Montier believes it's because we feel better ­ more in control ­ if we're seen to be doing something. You could take the analogy further. Investment experts, like goalkeepers, trust in their ability to read what's going to happen ­ which way the market/ball is going to go. But they don't know; the stats don't change.

So as an averagely stupid investor, I'm plumping for inactivity. After all, isn't that the best way to treat teenagers? Ignore them. They're only after your attention.

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