It’s been a while since I last posted – three weeks to be exact. I just went back and read my last post. Wow – so much has changed! I last wrote on March 5th when the S&P 500 was trading near 675, we had been beaten up for six of the previous seven days, and there was much despair. I wanted to call a bottom, but was hesitant to do so given I was already wrong when we were near 750.
Now, three weeks later, the S&P 500 is trading at about 825. That’s a gain of just over 22%. If I’d taken a position in the leveraged S&P 500 ETF I was considering, I’d be up about 44.5%! That certainly isn’t bad in three weeks. Alas, if only I had. We’ve all heard the phrase “Hindsight is 20-20″ – nowhere is it more true (and more painful) than in the financial markets. In hindsight if I’d gotten in on the double-long ETF, I’d have made quite a bit; in hindsight if I’d not been in Lehman at the time of the collapse, I’d have saved a lot!
As I contemplate my decisions, it becomes apparent that the only reason I didn’t go long is because I was wrong when I thought we wouldn’t dip too far past 750, and because there was an onslaught of punishing days in late February/early March. Thinking 750 was near the bottom, I did get in a little near that level, and so by 675, my long position was already in a loss (just like everything else in the portfolio). Being in such a loss position really makes you want to take risk off the table - in case you lose more. However, this is exactly the time that one should be putting risk on the table. Averaging down as the S&P went from 750 to 675 would have been great! I had never appreciated how much of an impact fear, greed, and psychology in general have on the markets. It’s funny, when you’re studying in business school you’ll rarely hear the words “markets” and “psychology” used together – it’s always more about “risk aversion”, the “rational investor”, and “no arbitrage” (or at least that’s what my experience was like). We spend hours building pricing models based on rational investors and efficient markets, but don’t realize until we actually participate in the markets that though rationality and efficiency make sense in theory (and in practice, to some degree), psychology and emotions are indeed credible forces in practice. In b-school I too was quick to dismiss behavioral finance, but in hindsight I realize that I have much to learn from it.
I guess at the end of the day, I’ve reinforced the lesson that it’s important to diversify – both in terms of the variety of assets you invest in, as well as the cost basis (time you purchase) of any one asset. If one had $10,000 to invest, it would make much more sense to put in $1,000 a week for 10 weeks rather than to put all the money to work at once. Of course, this is probably more true at times like these when market volatility is unprecedented. In a rising market you’d take a hit doing so – but then who amongst us can predict rising markets? So, you’re better off averaging your cost basis just in case. Related to this, it’s important not to let your gains get to your head, and your losses hit you too hard in the gut – if I’d gotten in at the bottom - 675, and was right, there’s a chance that I would’ve thought the S&P was going to 1,000 and put even more in around 800. It’s possible that right after this second infusion of cash the market falls and I lose anything I may have made (or more). Or maybe by 750 I see the money made on the position and decide to lock up the gain – I sell, just to have the market rise another 75 to 825 after doing so. On the flip side, if you take your losses too hard you become paralyzed (as I was) and unable to take advantage of the rising market.
Of course all of this talk implies that one can time the market, which has been proven to be very, very hard to do (if not impossible). The current rally could go to 1,000, or come sliding right back down in the next three weeks – who knows? However, wisdom and experience should help to better time ones entrances and exits from the markets – that’s what I hope to gain from this whole episode…