It's high time we address a scurvy that is pocking stock market commentary across the nation, spreading investment fear in the hearts of otherwise rational men and women. The plague of which I speak? All the stock market commentary, made to sound ominous, that goes something like the following two statements:
"The Nasdaq is up a massive 40% this year, and the S&P 500 has soared 17%. Something extraordinary had better happen in the economy, or, after this steep rise, stock prices are bound to pop like a bubble."
"The Nasdaq is up 70% from its October 2002 low. Incredible! We obviously haven't learned anything from the bear market, because we're still bidding stocks up crazily. How can this extreme gain last?"
Comments such as these are shared daily now that the stock market has rallied, even though they're completely hollow statements. By making a big deal out of how much the stock market has risen from recent lows, everyone is assuming that those lows meantsomething. Citing the lows as reference points, everyone is in essence saying that stocks were perfectly valued at the lows. News flash: They weren't.
What everyone is ignoring is the likelihood that stocks were recently priced too cheaply, meaning that much of their subsequent rise is not indicative of stocks mindlessly soaring to levels of overvaluation again. Much of the recent rebound may simply be stocks readjusting to more reasonable prices.
Now, I'm not making excuses for current valuations. They may indeed be too high. Future earnings will dictate that. But the point is, you can't justify price concerns just by screaming how much the market has risen from a benign low point.
The financial media and many investors are essentially doing just that, all but saying, "The absolute low is the most relevant level from which to measure market rationality. At the low, we were rational. Now that we've gained 40% from those prices, we're being irrational," without admitting that the low may have been irrational to begin with.
Fellow investors, measuring how much stocks have gained from the recent bottom is irrelevant, and touting recent gains from lows as "enormous" is misguided. The numbers being cited -- from trough to recent peak -- tell us nothing about how stocks are bound to perform next.
Framing is everything
What we're doing again is using irrational "framing." David Gardner wrote about the psychology of framing years ago. Framing is the notion that the way we're presented information (how it is framed) dramatically affects how we perceive it. For its part, the media likes to frame events extremely (because that sells), so it frames its "market analysis" by using recent lows and highs.
The media almost never, for instance, writes that, "Stocks gained 2% today and are now trading at 1996 levels." What a yawner that true statement would be. Instead, the media wails, "Nasdaq stocks gained another 2% and are up 70% from 2002 lows. It's beginning to look like another bubble."
And you rarely hear the flip side, either: "Wow, the market is up 70% in 10 months. We sure had sold stocks to irrationally low prices." No. With the media, gloom and extreme framing is always the way.
As stocks went down, everything was cited from the absolute high: "We're down 70% from the March 2000 high. What horror." There was no looking back a few more years and saying, "We're still up from 1996 prices and the market is still achieving its average 10-year return." Now that stocks are rising, everything is cited from the absolute low, to make the fallacious point that we've risen too much.
Ah, the fickleness that one needs to stay gloomy.
Truth is, unless you're ready to cite stock valuations at the low, and stock valuations right now, and are able to predict what future earnings will be, then you have no sound basis for arguing that the market's low point signified a "correct" valuation and the subsequent rise (which looks large only when you measure from recent lows) means danger.
It's little surprise that our framing on many topics is messed up nationwide. Consider airplane crashes. Millions of people fear flying because whenever a plane goes down it makes front-page news. Yet, while a few hundred people or fewer might meet tragedy flying each year, 50,000 are lost to car accidents -- 1,000 people a week. But society hates to fly and loves its cars. We've framed the two modes of transportation incorrectly: planes risky, cars safe -- the opposite of what statistics prove.
I wish I had bought...
Returning to stocks, I've been guilty of poor framing this summer. I've looked at stock price gains that I've missed by considering only the recent lows (silly me) and then kicking myself for not buying at those very lows (as if that were easy). Here are some examples of now "obviously absurd" lows:
Stock Recent Low Now
Yahoo (NASDAQ:YHOO) $ 9 $37Amazon (NASDAQ:AMZN) $ 7 $50Cisco (NASDAQ:CSCO) $ 8 $20Genentech (NYSE:DNA) $28 $83
It may hurt, but I should not be saying, "Such and such company is up 200% from its low -- I've blown it, I totally missed it." What I need to do instead is look at current valuations and make a decision based on today's price and perceived potential. At any point in time, that's what one needs to do with any individual stock.
We also need to avoid looking at past highs and letting that "framing" influence our decisions. For instance, "Sun Microsystems (NASDAQ:SUNW) once traded at $60 and now it's $4, so it must be a deal!" Not really. The past, as they say, is gone, and those highs (perhaps like recent lows) were not rational. The only relevant questions: What is the business worth today, and likely to be worth later?
Conclusion
Watch how you "frame" information as you invest. Don't kick yourself for not buying at lows (thereby missing further opportunities), but analyze the potential from today; don't let old highs tempt you into buying; and don't let a stock market that has risen sharply from lows scare you just because it rose.
Lows are not the measuring stick for "fair value." Overall, remember that timing the market is folly. Use stocks as a savings vehicle for money you won't need for at least five years, and, ideally, invest more every paycheck.
Jeff Fischer's mood is up 300% from recent lows. Of stocks mentioned, he has a bit o' Cisco. The Fool has a disclosure policy, which was nominated for 13 Emmys and won none.
