Last year's bear market got everyone used to being inundated with bad news about the economy and the stock market. Yet although many of the core concerns that brought on the financial crisis remain, the biggest trap you could fall into is to become a permanent pessimist about future prospects, both for the world economy and your own personal finances.
Dealing with cognitive dissonance
Right now, investors have to juggle a lot of conflicting information in their heads. On one hand, there have been several signs of improvement in recent months:
- The financial sector has shown significant signs of healing, as Bank of America
(NYSE:BAC), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC)all appear poised to join the several other financial institutions that started repaying their TARP borrowings from the government.
- Merger and acquisition activity is on the rise, with ExxonMobil's
(NYSE:XOM)$41 billion offer to buy out XTO Energy (NYSE:XTO)being the latest in a string of multibillion-dollar deals done lately.
- Government data has looked somewhat brighter lately. The nation's gross domestic product rose in the most recent quarter, and job losses continue to moderate as the unemployment rate fell last month.
Perhaps most encouraging for investors, the stock market has recovered a huge portion of its losses from the past two years. Although the S&P 500 is still off by around 30% from its highs, recall that those losses got pretty close to 60% during the height of the crisis in March.
Yet there's plenty for investors to worry about as well. Just because banks have recovered somewhat, that doesn't mean they're healthy, even despite government programs that have supported them financially. The Exxon deal is an all-stock offer, a suggestion that the oil giant believes its shares aren't undervalued, despite being one of the only large-cap U.S. stocks to suffer losses so far in 2009.
Moreover, retailers saw only lackluster gains in sales in November, with Costco
One of the hardest things for investors to do is to change their minds. When you spend a lot of time and effort putting together a well-researched investment rationale for the strategy you use, you want to get as much mileage from it as you can. The last thing you want to do is to go back to the drawing board and make major changes, even when new conditions warrant a fresh look at the situation.
That's part of what has made so many investors reluctant to put their money back into stocks lately. During the bull market back in 2007, most investors seemed to believe that any pullback in the markets would be temporary. It took a cataclysm on the magnitude of what we saw last year to convince people that stocks can actually go down.
Similarly, right now, there's more than enough bad news to justify a pessimistic outlook, even as stock markets around the world continue to rise strongly. By the time support for the bullish case becomes overwhelming, you'll have missed out on a huge part of its gains -- and it may actually be time to start thinking again about when those gains might come to an end.
Keep your balance
One of the most important traits of great investors is their ability to pay attention to the new information they constantly receive and integrate it into their investing strategy. To be successful, you have to be resolute and disciplined in your approach, but you can't be so stubborn about your decisions that you fail to recognize when you've made a major mistake.
Just as smart investors didn't let endless optimism carry them away during the last bull market, don't bet your financial future that the economy's current challenges will continue to get worse rather than better. Keeping an open mind is the best defense against only seeing what you want to see in the news you get going forward.
Bull or bear, you can count on at least some stocks doing well next year. Take a look as Rick Munarriz picks five stocks that should beat the market in 2010.
Fool contributor Dan Caplinger learned the dangers of permanent pessimism during the bull market of the 1990s. He doesn't own shares of the companies mentioned in this article. Costco is a Motley Fool Stock Advisor recommendation and a Motley Fool Inside Value selection. The Fool owns shares of Costco and XTO Energy and has bought a bear put spread on Abercrombie & Fitch. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy steers you clear of traps.