Jun 05, 2009 @ 10:25 am
Bernard Baruch, one of the world's most legendary speculators, said, “ The main purpose of the stock market is to make fools of as many men as possible. ”
Right now, that's exactly what's going on. And I assure you, a lot of folks will be made into complete fools in the next year or so.
Chances are though, the folks who are going to look like fools are not who you think.
A Fool and His Money
The amount of bearishness from the market commentators is as strong as it ever was. The recent rally has only strengthened their resolve.
The thing is though, market meltdowns don't happen when everyone expects them to. They happen when everyone is feeling safe. They happen when the market is overconfident. They happen when no one can find a reason not to buy. Right now, there is none of these.
The big money managers still don't feel safe. The CBOE Volatility Index (a.k.a. the VIX or the Fear Index) is still at 31. The VIX is calculated by taking the implied volatility of option contracts on the S&P 500.
Simply put, the VIX is a measure of “portfolio insurance.”
When the VIX is high, the cost of insurance is high. It's like buying catastrophe insurance for a house in Florida. The cost of insurance is high because of all the hurricanes. The perceived risks are high and that risk results in a higher cost.
When the VIX is low, it shows the cost of insurance is low. Right now, with the VIX at 31, it's still relatively high. For instance, the VIX soared to a peak of 89 during the market extremes of 2008. The VIX, however, fell to less than 10 during the steady bull market between 2003 and 2007.
Basically, the cost of insurance is still high because the perceived risks are high. That perception still hasn't changed.
Fools Rush In - at the Worst Possible Time
Most investors were absolutely crushed last year. There were very few safe havens outside of gold and U.S. Treasuries (And how many folks loaded up on both of these seemingly diametrically opposed assets?).
Almost everyone lost money – in most cases, they lost a lot of it. The effect of that is no one wants to take very much risk.
There are hundreds of thousands of investors thinking, “Sure, inflation is coming. And I'll essentially be losing 6% a year in real terms. But hey, that's a lot better than 45%.” But still, the safety and security of not having to fear of having to open the monthly brokerage account statement is a welcome relief to many.
Remember, confidence is slowly gained and easily destroyed. That's why stocks go up slowly and fall quickly. Just like the old saying says, “Stocks go up stairs and down an elevator.”
Just take a look at how long it took for the markets to get its confidence back after the tech crash. After the steady collapse of the markets between 2000 and 2002, investors didn't want much to do with stocks. They were very few bright spots in the economy and no one knew when or how the recession was going to end.
It took two years for the “true bottom” to form. There were plenty of starts and stops. The markets would jump and then fall right back down. Most investors simply threw in their collective towels during that period. Of course, looking back, it was a terrible time to sell out of the markets.
A Fool's Hope: Buy High and Sell Higher
Now, look at what just happened. Between October 2007 and March 2009, the markets just continued to slide. Sometimes the fall was slow. Other times the down days were strung together five or six at a time.
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