Thinking Logically About the Market
Greed is the Root of All Evil
In Case You Missed It
In this week's Stock Market Video, I confirm that our market timing indicators have turned positive, telling us that it's time to do a little buying. But this is a young rally, and we have to expect a correction after such a nice four-week rally. So it's not the time to bet the farm. I also point out that the Fiscal Cliff and Euro-drama are the main impediments to further progress, and that good news there will likely bring more buying. Stocks discussed: On the plus side, stocks like eBay (EBAY), Facebook (FB), Salesforce (CRM), Amazon (AMZN), Tesla Motors (TSLA), Nam Tai Electonics (NTE) and Huaneng Power (HNP) look like leaders. On the negative side, Apple (AAPL), Gap (GPS), and UnderArmour (UA) look like old leaders that are past their primes. Click below to watch the video!
Thinking Logically About the Market
I’m always interested in how the human mind works, including mine, so I’ve read three books this year that promised to give me some insight. And what I found, while it wasn’t exactly unexpected, was a little discouraging.
Because as a person who makes a living by taking in data, processing it to try to make sense of it and then writing about what I find, the findings that these books delivered were not helpful to my self-confidence.
The first book was “Thinking Fast and Slow” by Daniel Kahneman, which was published last year. Kahneman has a Nobel Prize in Economic Sciences, a discipline that seems to attract bright people with an interest in how people make decisions. That’s probably because if you study any part of economics, you’re studying the sum total of all the decisions that people make about what they buy, sell, spend, invest in or otherwise engage in activities that moves money around. And the lessons about decision making that economics teaches have applications in medicine, politics and any other activity that gives humans choices about what to do.
Among other things, Kahneman has discovered through years of careful research that people don’t think well about statistics, vastly overestimate their understanding of the world and underestimate the role of chance in producing outcomes, and, in general, just aren’t as rational as they think they are.
The second book is “Don’t Believe Everything You Think: The 6 Basic Mistakes We Make in Thinking,” by Thomas Kida. Kida’s book, which is both fun to read and very well footnoted, lays out the six Basic Mistakes right on the cover. They are: We prefer stories to statistics; We seek to confirm, not to question our ideas; We rarely appreciate the role of chance and coincidence in shaping events; We sometimes misperceive the world around us; We tend to oversimplify our thinking; and We have faulty memories.
The third book was by Ray Kurzweil, who may be familiar to you as the genius behind text-to-speech synthesis, optical character recognition (OCR), speech recognition and electronic keyboards. Kurzweil’s book is called “How to Create a Mind,” and it’s about reverse-engineering the human brain to figure out how it really works.
Not surprisingly, Kurzweil comes to the conclusion that brains are not very good at processing logic. That’s why a really big computer like Deep Blue could finally overpower the best chess players in the world; it just churned its way through the logic of each chess position, finally peaking at 200 million board positions.
The good news is that our brains are good at recognizing patterns. In fact, they’re extremely good at recognizing patterns, and that’s how we do most of our critical thinking.
So what does all this mean? Are we supposed to just stop thinking, because we’re not very good at it?
I don’t think that’s what these authors—and all the others who have published the hundred of books and articles with essentially the same message—have in mind.
Every author I’ve ever read on this topic is always careful to point out that we can actually improve our ability to act rationally, to substitute logic for emotion and wishful thinking. And I’m sure they would all say that reading their books is an excellent step in the right direction.
I’m going to make just one other suggestion, which I suppose is predictable. I’m suggesting that if you find an investment letter like Cabot Market Letter that has been honing its thinking about the market for over 40 years, discarding what doesn’t work and strengthening what does, maybe it makes sense to let it help you improve your own thinking. The Market Letter will nudge you away from jumping in late in a market rally. It will caution against trying to call a market bottom while showing you how to confidently identify a new bull market and the stocks that are leading it.
In short, Cabot Market Letter is a guide to the kind of pattern recognition that our brains are set up for. It has certainly changed my thinking in the seven years I’ve spent at Cabot. It can do the same for you. Learn more here.
Here's this week's Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.
Greed is the Root of All evil
Tim’s Comment: Some say money is the root of all evil; others say lack of money. But the original sentiment, supposedly expressed by St. Augustine, was that “love of money” or “greed” was the culprit. In the stock market, where the twin emotions of fear and greed have long ruled, this is often true. Greed is what entices amateurs to enter the market near bull market tops. Greed is what makes people buy on margin when they can’t handle the risk. And greed is what drives people to invest in stocks they don’t understand.
Paul’s Comment: Since greed (avaritia) is one of the Seven Deadly Sins, it seems a little harsh to say, as many commentators do, that stock markets are run by fear and greed. If wanting to make a little money is a sin, then Earth is, indeed, overrun by sinners. But what seems more likely to me is that the sinful greed referred to is some kind of excessive desire for money, and it’s that excess that warps judgment, encourages taking on too much risk and drives more admirable thoughts and actions from our lives.
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In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.
Tom Garrity, the research wizard behind Cabot Small-Cap Confidential, gives some nuts-and-bolts advice on how to handle small-cap stocks, including when to average up in profitable stocks and when to take profits.
I used this issue to talk about the simple rules of growth investing and how those rules can get to be more complicated once you begin applying them to actual stocks. Stock discussed: Ocwen Financial (OCN).
Chloe Lutts, Editor of Dick Davis Digests, uses this issue to discuss the various explanations that the contributors to the Digests give for the difficulties that investors face in the markets. And there are lots of them.
Have a great weekend,
Editor of Cabot Wealth Advisory
and Cabot China & Emerging Markets Report