prudent investor newsletters: Denials are Hazardous to One’s Portfolio

The Phisix bear market has caught many by surprise. And the typical reaction: massive denials.

As shown in the above diagram, denials are natural or common traits of a fledging bear market cycle.

Denials are just one of the 15 psychological defence mechanism[1] used by us…humans. Psychologist categorizes denial as a primitive defence mechanism.

In psychoanalysis denials come in three forms[2]; Simple denial (literal deny the reality), minimization (admit the fact but deny its seriousness via rationalization) and projection (admit the fact and seriousness but deny responsibility or pass the blame on someone else).

The latter can be associated with regret theory or the psychological anguish from an opportunity loss. For example in investing, the fear of regret can make investors either risk averse or motivate them to take greater risks[3]. This partly explains why people tend to double down on losing positions in order to avoid the fear of regret.

Denying responsibility and passing the blame on someone else can also be read as the heuristic called self-serving attributional bias[4]

For instance, the mainstream’s tendency to pass the blame on foreigners as culpable for the current market meltdown signifies as signs of denials and of self serving or self attributional bias.

Denials also go with the endowment effect or the status quo bias or where people tend to put more value on what they own or technically “where most people would demand a considerably higher price for a product that they own than they would be prepared to pay for it (Weber 1993).”[5]

By denying the reality of a bear market, many maintain the notion that securities they own are unlikely to be affected by the growling grizzly bears.

But what are the odds of stocks surviving a bear market?

Not good if the 2007-2008 serves as a model.

Using the US as example, here are some excellent news quotes

From a 2009 article from Bloomberg as I previously posted[6]: (bold mine)

Wal-Mart Stores Inc. is the only Standard & Poor’s 500 Index company that has rallied during the entire 22-month recession.

From another 2008 article from Bloomberg[7]:

The worst annual decline in the Standard & Poor's 500 Index since 1931 has dragged down every industry in the benchmark gauge and 96 percent of its stocks.

All 64 of the S&P 500's so-called level-three categories, groups such as ``distributors'' and``leisure equipment'' with as few as one company, dropped in 2008. Four hundred eighty-two companies slipped as the 500-stock index slumped 46 percent, poised for its biggest yearly retreat in eight decades.

I have pointed out in the past[8] that even when the Philippine economy nearly fell into a recession in 2007-2008, and even when earnings declined modestly from record highs, the Phisix crashed 56% and hardly any liquid stock remained unscathed or unaffected by the bear market destruction.

Conventional fundamentals hardly had been a factor in stock market pricing. Yet the investing public has been remiss of the lessons of 2008, mostly due to the indoctrinations of the industry.

Looking at international markets the Phisix fell as deep as with other emerging market equities from a contagion and not from a crisis. Foreign and US stocks, the latter the source of the crisis, have also been battered[9].

The bottom line is that when the bear market tsunami strikes almost all boats sinks by the end of the cycle.

US treasuries, European and Global bonds and high quality US corporate debt defied the US bear market of 2008

Of course today isn’t 2008. But there is hardly any evidence of which stock/s will defy the bearish downpour. In Walmart’s case, 1 out of the S&P 500 companies is a rarity.

Realize that for every 50% decline this would translate to a 100% upside move to recover. And for every 40% loss means 67% upside for a recovery. Finally for every 30%, 42% upside growth is required.

These numbers are not insignificant. And should there be a crisis, some stocks may even vanish: think Enron, Bear Stearns, Lehman Brothers.

Instead of having 1 live bullet and 5 empty chambers in a revolver, playing bull in a yet to mature bear market is like playing Russian Roulette in reverse: 5 live bullets and one empty chamber.

If there may be any bullish actions in place, we may consider…