Investor Mood Cycles

Jul 2003 //
Optimism/Pessimism
History
Behavioral Finance
Cycles

From time to time, investors’ moods might be characterized as optimistic.  Frankly, optimism usually comes after stock prices have already risen for a while.  To judge from historical experience, when stock prices continue to march higher, investors’ moods often improve from optimistic to excited.  Then, if stock prices move yet higher, investors might become thrilled.  And finally, if stock prices seem to soar even higher than anyone ever expected, investors frequently become euphoric.  Following euphoria, however, market history tells us that stock prices often begin to decline.  (After all, most everyone has already bought.)  As stock prices move steadily lower and lower, investors’ moods usually evolve from euphoria to anxiety, denial, fear and then perhaps desperation.  Even that’s not always enough pessimism to get the last of the emotional investors to sell, however.  So then the going really gets tough.  As prices continue to fall lower than anyone expected, investors’ moods swing to panic, capitulation and even depression.  Many of our clients know what comes next.  Stock prices begin to rise, of course!  (Selling is exhausted.)  Investors begin to see a few rays of hope, and then maybe they experience relief.  Next comes optimism—and we’re back where we started.  The point of this discussion, dear clients, is that extreme emotions are usually contrary indicators of future stock prices.  In other words, successful investors need to buy when other investors are depressed and sell when they are euphoric.  Although this is easy to state, it’s hard to do, even for some of the best investors.