There's growing evidence that investors and company execs are far more negative than the data justify. That's an opportunity for those who see past the pessimism bubble.
Economists like to cast us all as logical actors who thoughtfully weigh costs, benefits and potential risks. But that's not how people actually behave.
A bubble in the bond market?
These instincts power economic bubbles like the ones we've lived through in technology and real estate. And right now we're seeing another bubble -- in pessimism.
Most investors associate bubbles with market booms and excessive greed. But fear is arguably a more powerful emotion than greed.
And right now, as debt troubles in Europe have caused the U.S. economic recovery to slow, just when we'd started to put the banking crisis behind us, a paralyzing state of fear has taken hold of many everyday investors and corporate executives. Msn.Video.createWidget('PlayerAd1Container', 'PlayerAd', 300, 213, {"configCsid": "MSNmoney", "configName": "player-money-articles-16x9", "player.vcq": "videoByUuids.aspx?uuids=60d9a1e5-7d26-41ea-99e5-0643f1008ccc,2a9e2f97-d5f6-4c3a-86b6-a38843d47cab,4533ffb2-8962-4445-b2ae-621110a6e594,1fa0bc26-7c73-4db4-bf53-20ec7eeabb0c,93378626-be47-4cc4-83e4-7973b1e92f26,a4e846d6-ee47-48c8-8a7b-02dca9becb1d,e93907d9-51d7-4e8a-add4-17837d88d012,6f2f8d63-b4db-46ee-b1df-90049f5c2d65,ca348adf-c4ee-496a-b1df-984f1e6b2ee9", "player.fr": "iv2_en-us_money_article_16x9-Investing-Extra"}, 'PlayerAd1');Msn.Video.createWidget('Gallery4Container', 'Gallery', 304, 150, {"configCsid": "MSNmoney", "configName": "gallery-money-articles", "gallery.linkbackLocation": "bottom_left", "gallery.numColsGrid": "3", "gallery.categoryRequests": "videoByUuids.aspx?uuids=60d9a1e5-7d26-41ea-99e5-0643f1008ccc,2a9e2f97-d5f6-4c3a-86b6-a38843d47cab,4533ffb2-8962-4445-b2ae-621110a6e594,1fa0bc26-7c73-4db4-bf53-20ec7eeabb0c,93378626-be47-4cc4-83e4-7973b1e92f26,a4e846d6-ee47-48c8-8a7b-02dca9becb1d,e93907d9-51d7-4e8a-add4-17837d88d012,6f2f8d63-b4db-46ee-b1df-90049f5c2d65,ca348adf-c4ee-496a-b1df-984f1e6b2ee9;videoByTag.aspx%3Ftag%3Dmoney_dispatch%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1;videoByTag.aspx%3Ftag%3Dbest%2520of%2520money%26ns%3DMSNmoney_Gallery%26mk%3Dus%26vs%3D1"}, 'Gallery4');How else can you explain the fact that investors in short-term Treasury bills are happily accepting negative inflation-adjusted returns? Or that U.S. businesses are letting their machinery rust away, sitting on money instead of paying for basic maintenance? Or the rare disconnect that's developed between bond yields and corporate earnings?
Like all bubbles, this one, too, will end -- and sooner rather than later. If we want to use that end to our advantage, we need to understand why fear and uncertainty have reached such unjustified levels. Let's consider first what drives bubble psychology.Follow the herd The study of market bubbles is in flux, but some answers are starting to emerge. They suggest that humanity's tendency to get its social cues from others -- so-called herd behavior -- is responsible. This means that risky actions, such as stretching budgets to buy homes or to buy tech stocks on margin, become contagious across an economy as we mimic the way those around us are acting.
In a recent experiment, Sheen Levine of Singapore Management University and Edward Zajac of Northwestern University found evidence to support this theory (.pdf file). Participants were given fake money to buy fake stocks. Before trading started, all learned how to properly value the "stocks" they were about to trade. But as trading progressed, prices became more and more separated from fair value. The test subjects forgot their training and focused more and more on what everyone else was doing.
Economist Douglass North, who won a Nobel Prize in 1993 for his work on the subject, notes, "We form mental models to explain and interpret the environment . . . (which) may be continually redefined with new experiences, including contacts with others' ideas."
Simply put, we can't help but observe and adopt the behavior of others. It's how our brains are wired.
The experiment by Levine and Zajac shows, on a small scale, that this dynamic plays out even in efficient, transparent markets in which investors have all the information they need to make reasoned decisions. That means that despite all the advances we've made to create a better, safer and more responsible financial system, we can still be brought down by our natural urge to follow the crowd.
Continued: Is a bubble blowing?More from MSN Money
No inflation means no recoveryIs America the next Japan? Investors betting the bear is backIs investing (in companies) dead?Is corporate America rusting away?1 | 2 | 3 | next >
Rate this Article Click on one of the stars below to rate this article from 1 (lowest) to 5 (highest). LowThank you for rating.UGR('ratCntrl')High var avgRating=0;avgRating=7.818182; if(avgRating!=0){avgRating=avgRating/2;avgRating=Math.round(avgRating*100)/100;var sDisplayText="Average rating: " + avgRating + " from ";var usersCount=22;sDisplayText = sDisplayText + usersCount;if (usersCount==1)sDisplayText=sDisplayText + " user";else sDisplayText=sDisplayText + " users";avgRatingElem=document.getElementById("averageRating");avgRatingElem.innerText=sDisplayText;} View all top-rated articlesE-mail us your comments on this article Discuss in a message board MSN Money InsightNew Investor CenterMarket DispatchesJubak's JournalTop Stocks blogCompany FocusContrarian ChroniclesSmart Spending blogFast AnswersDecision CentersStart InvestingMutual FundsFind Hot StocksSimple StrategiesPower ToolsInvesting for IncomeReal Estate InvestingStocks to WatchMcDonald'sTravelersMasterCardNovellSchlumbergerYahooToyota MotorBoeingRecent Articles by Anthony MirhaydariNo inflation means no recovery 09/08/2010Is America the next Japan? 08/25/2010Is investing (in companies) dead? 08/18/2010More . . .Fund data provided by Morningstar, Inc. © 2009. All rights reserved.StockScouter data provided by Gradient Analytics, Inc.Quotes supplied by Interactive Data.MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.Msn.Video.createWidget('Gallery8Container', 'Gallery', 500, 230, {"configCsid": "MSNmoney", "configName": "gallery-money-article-site-wide"}, 'Gallery8'); 4CommentsNewestOldestBestWorstControversialGP-95 hours agoAnother well written well reasoned article article by Anthony M. Sure hope he's right. 0 0ReportSpamrevel227 hours agoInteresting. BUY BUY BUY! But I've been buying since March last year, so I'm happy. 0 0ReportSpamYuansomemore8 hours agoHow else can we explain America "letting its machinery rust away?". Are you kidding me? Have you been asleep the last 10 years? Pick a product, any product. Then get it quoted across the world. Where will those quotes drive production? Michigan? The math has been done. Check the labels in your local Walmart. 99 times out of 100, the answer is some country in Asia.
This isn't due to any prejudices or fears developed over eons of evolution. This is the result of fundamental economic forces. Production goes to the lowest cost provider. If it doesn't, your competitor will get it there faster than you can say "Made in China".
The machines are not just rusting. They are waiting. Waiting for honest currency valuations, an end to unfair subsidies from World trade "partners" , and someone to give a damn in Washington.
2 0ReportSpamLost Dollar8 hours agoAre Investors Rational or Irrational? Does Behavior trump Logic? I remember back in Undergraduate School taking Industrial Psychology with emphasis placed on B.F.Skinner's theories. I remember the Grad Student who taught the class was working on his PHD, and he said that B.F. Skinner Conditioning really worked. He said, "I have conditioned a Pigeon to undergo enough shock to acquire food that feathers are flying everywhere." So, no one is killing us to eat, but are we fearful of getting slaughtered in the market? It must say something that investors have pulled out of equities into bonds in large numbers. I honestly do not have a crystal ball that will tell you what will happen next month much less tomorrow, but is it possible that Pessimism can make a Bubble? Tech Stocks and Real Estate both created Bubbles, but Investors negative attitudes towards the market? 0 0ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of ConductPlease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment? var initData = {"strings":{"lc_shw":"true","lc_dtf":"%M/dd/yyyy %h:mm tt","lc_dtf2":"ddd %h:mm tt","lc_gmt":"-5","lc_erg":"Comments are currently unavailable. 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Like all bubbles, this one, too, will end -- and sooner rather than later. If we want to use that end to our advantage, we need to understand why fear and uncertainty have reached such unjustified levels. Let's consider first what drives bubble psychology.Follow the herd The study of market bubbles is in flux, but some answers are starting to emerge. They suggest that humanity's tendency to get its social cues from others -- so-called herd behavior -- is responsible. This means that risky actions, such as stretching budgets to buy homes or to buy tech stocks on margin, become contagious across an economy as we mimic the way those around us are acting.
In a recent experiment, Sheen Levine of Singapore Management University and Edward Zajac of Northwestern University found evidence to support this theory (.pdf file). Participants were given fake money to buy fake stocks. Before trading started, all learned how to properly value the "stocks" they were about to trade. But as trading progressed, prices became more and more separated from fair value. The test subjects forgot their training and focused more and more on what everyone else was doing.
Economist Douglass North, who won a Nobel Prize in 1993 for his work on the subject, notes, "We form mental models to explain and interpret the environment . . . (which) may be continually redefined with new experiences, including contacts with others' ideas."
Simply put, we can't help but observe and adopt the behavior of others. It's how our brains are wired.
The experiment by Levine and Zajac shows, on a small scale, that this dynamic plays out even in efficient, transparent markets in which investors have all the information they need to make reasoned decisions. That means that despite all the advances we've made to create a better, safer and more responsible financial system, we can still be brought down by our natural urge to follow the crowd.
Continued: Is a bubble blowing?More from MSN Money
1 | 2 | 3 | next >
How else can we explain America "letting its machinery rust away?". Are you kidding me? Have you been asleep the last 10 years? Pick a product, any product. Then get it quoted across the world. Where will those quotes drive production? Michigan? The math has been done. Check the labels in your local Walmart. 99 times out of 100, the answer is some country in Asia.
This isn't due to any prejudices or fears developed over eons of evolution. This is the result of fundamental economic forces. Production goes to the lowest cost provider. If it doesn't, your competitor will get it there faster than you can say "Made in China".
The machines are not just rusting. They are waiting. Waiting for honest currency valuations, an end to unfair subsidies from World trade "partners" , and someone to give a damn in Washington.
Read Full Article »
