A FEW MONTHS
back, we outlined some of the basic logicalfallacies
that can lead your investment thinking astray. One that I've been hearing quite a bit of lately is that of false attribution. In trader talk, it's putting the ass in assume.
Even among experienced professionals, there's a rather surprising ignorance of the factors that really move markets. Every high-school economics class starts with the basic law of supply and demand, but pundits, media commentators and even market professionals who should know better choose to focus on just one side of that irrefutably important concept.
Turn on any newscast and you'll hear the same shockingly ignorant analysis: If the market drops, it's because investors sold their shares. If the market rallies, it's because everybody bought. After all, buyers make a stock go up; sellers force a stock's price down, right?
But while most commentators are quick to interpret a market trend as the result of some action of investors, it's often their inaction> that's ultimately responsible for the move.
The law of supply and demand is also that of demand and supply, and often it's not the presence of buying, but the absence of selling>, that can make a market move higher.
It's what causes those "bear-market rallies" we've come to expect in most of the washed-up names of the S&P 500. A company like Oracle releases a bit of good news, and the stock immediately opens up 5%.
That evening, from Lou Rukeyser to Lou Dobbs, the pundits will say that buyers were out in force for Oracle that day. But truth be told, the move could just as easily have been attributed to a lack of sellers than an abundance of buyers.
On the flip side, when a stock or even the broad market declines, you'll almost always hear the move attributed to "profit taking," "selling pressure" or "the shorts." But again, what makes a market drop isn't necessarily an abundance of sellers, but an absence of buyers. It's what you'll often hear described as a "buyers' strike," and it often causes a rapid, sudden price drop in a stock.
Probably the best recent example of this came in the wake of Sept. 11, when the market reopened after a historic weeklong shut down. After closing at 9630 on the 10th, the Dow (as indicated by the open-outcry Dow futures) reopened at 9000 on Sept. 17, immediately erasing billions of dollars in market capitalization. And what we now know is that the market opened down 630 points not because everybody sold...but because very few people were willing to buy.
When it comes to my own analysis, I find it useful to concentrate not on what people say, but what they do. From quitting smoking to working out, millions of people every day make promises to themselves that they'll never keep. And given the amount of money still in large-cap growth mutual funds, you have to wonder if most people are suffering the "crisis of confidence" the commentators speak of with such authority.
If Americans are nervous about stocks, you wouldn't know it from looking at their portfolios. According to the Investment Company Institute, stock mutual funds still had net assets of some $3.4 trillion as of April. That's almost three times the amount held in taxable- and municipal-bond funds combined. And while it's 9% less than the assets in stock funds a year earlier, that decline is more than accounted for by the overall market's loss in value. Whether they're patriotic or just plain paralyzed, the average Joe's money is still unquestionably in it for the long haul.
For the record, we asked "What's the Rush? The problem has come from a relative absence of buyers.
At this point, the public is still way long the former highfliers in the S&P 500. And if those folks do> experience a crisis in confidence and the buyers' strike becomes full-fledged selling...well, let's just say you don't want to be standing in the way.
Jonathan Hoenig is Portfolio Manager at Capitalistpig Asset Management, a Chicago-based hedge fund. At the time of writing, Hoenig's Fund may have positions in the securities mentioned in this article.>