The current state of the stock markets is in a depressed mode and everyone is shunning equities. News paper reports, TV shows, business magazines add to the availability heuristic of depicting the equity investments in poor light. This recency effect has made equities a risky proposition for the investors. Let us analyze our biases and see if this is true.
In this age of information with the click of a button we have to be vary of the sheer loads of irrelevant information that is imposed upon us. However do we really know the type of information we need to make a good decision? Say for instance a pharma analyst. He would know all about the different drugs, their formulations, their uses, the names of the competitors and the works. But does that mean that he knows how to value a pharma company? Well my experience says no. We are bombarded with all such information in the guise of knowledge. But that is not the right fodder for making informed decisions.
Then there is this question of not understanding what is risk and the difference between risk and volatility. Volatility is wrongly assumed as risk. The problem with risk management is that it assumes that volatility equals risk. This is far from the truth. Volatility creates opportunity. Were stock markets more risky in 2006/2007 or 2008/2009? According to the risk managers 2006/2007 was less risky as it had low volatility and they were comfortable investing during such times. So did their risk models. In contrast these same risk managers found 2008/2009 very risky as it was volatile and they advocated cutting back on risk. In fact the opposite was true. The volatility of 2008/2009 offered great investment opportunities and for a wise value investor bargains were available. In fact the rewards were much more than the risks.
Investors sway between hopes for riches and fear of poverty. In bull markets as in 2006/2007 the hopes for riches were running high and the investors were buying stocks at any prices. Then came the crash of 2008/2009 and the fear of poverty became high. Investors started shunning stocks and sold them at any price. This was irrational behavior of the crowd. A rational investor would have fear of poverty in 2006/2007. He is making profits and what if the markets go down? He would lose and become poor. He would have hopes for riches in 2008/2009. Everyone is selling stocks, the prices are depressed. He is getting bargains and he will make profits when the markets will revive. Greed would be good at this stage.
The current times also offer hope for riches. Some of the valuations are attractive.
