Wednesday, March 16, 2011

Emotional Investing


The Japanese crisis is upon us and I would not want to discount the human tragedy and the suffering of the Japanese people. But the stock markets are reacting as if the worst case scenarios are fact rather than possibility. Initial damage estimates in Japan are approaching $180 Billion - huge! But the markets have lost all their 2011 gains; worldwide stock market losses are reaching a trillion or more. As usually, we are overreacting in crises.

You may disagree, but statistics show differently. Here is a tabulation of crises in the last century and subsequent stock market performance in the U.S. as compiled by David Dreman:


Crisis EventDate of Market LowAppreciation
after 1 year
Appreciation
After 2 years
Berlin Blockade07/19/1948-3.3%13.3%
Korean War07/13/195028.8%39.3%
1962 stock market break06/26/196232.3%55.1%
Cuban missile crisis10/23/196233.8%57.3%
Kennedy assassination11/22/196325.0%33.0%
Gulf of Tonkin08/06/19647.2%3.1%
1967/1970 stock market break05/26/197043.6%53.9%
1973/1974 stock market break12/06/197442.2%66.5%
1979/1980 oil crisis03/27/198027.9%5.9%
1987 crash10/19/198722.9%54.3%
1990 Persian Gulf War08/23/199023.6%31.3%
Average appreciation25.8%37.5%


According to Dreman, "these were eleven crises since World War II, ranging from the Berlin Blockade (when we stood eyeball-to-eyeball with the Soviets on the brink of war) to the crash of 1987 (the worst crash of the twentieth century). Of the 11, 6 were political; and the other 5 were brought on by economic, investment or financial factors. The figures measure the Dow Jones Industrial Average at the bottom of each crisis when experts predicted prices could only tumble lower, along with the subsequent 1 and 2 year performance."

So if you have cash, this may be a good opportunity to buy stocks at a 'discount' and the table shows that on average, you would likely be ahead 25.8% in one year and 37.5% 2 years from the bottom. Of course, picking the bottom of the crises perfectly is not possible (unless very lucky), but still when you buy during this crises you will probably profit handsomely a year from now.

If you feel bad about profiting while others are suffering, why don't you make a donation to the Red Cross in anticipation of your profits? The markets will go up and down regardless of your investment actions, but your donation will certainly help the victims of this disaster.

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