Investor sentiment

Investor sentiment

The violent gyrations of stock market values during the last week of August have encouraged the belief that investment is about dealing, rather than looking for long-term income growth.

Such an investor blogged at the time: “Equities – at least the larger ones – oscillate in value. The rational idea seems so simple. You buy when they are cheap.

“And you slice some profit off when they recover. Buy cheap. Sell dear. The main reason that equities are available in the market so cheaply today (and they seem to me still to be cheap today) is that people like the original blogger found it vital, for the wrong reason, to pile out yesterday.”

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Simplicity of markets

Maybe that particular investor is sufficiently in command of his emotions to be successful, but few of us are. Indeed, even professionals in bank dealing rooms need a little help to succeed, hence the prevalence of crooked banking behaviour such as the price fixing of the Libor and Forex rates.

Moreover the development of high intensity dealing shows banks are fully aware that, without customer order flows to guide them, dealing profits are hard to come by, and are often only available for split seconds of time.

That oft repeated mantra of ‘Buy on dips’ only works in a bull market, so the question that every investor must always be asking is, “has the bull market ended and a bear started, or will markets just go sideways for a while?” This is only ever clear in retrospect.

Market sentiment is an explosive compound of greed for gain and fear of loss. Good dealers and investment managers can isolate themselves from these market emotions to some extent – better at least than ordinary investors – but they have other problems, chief of which is fear of losing their jobs if they calculate wrongly.

The function of most investment managers is not to invest client money safely but to avoid mistakes that might suggest that they or their employers are less than competent. So the sensible manager sticks to the consensus view, maintains a portfolio not that different to the index being tracked, and hopes for the best. This is the way to maintain, and hopefully to increase, funds under management.

Single capacity and the agency problem

Until the 1987 Big Bang, the financial industry was simple. Financial scandals during the 19th century finally compelled reform of the stock exchange with market makers and advisers split apart into what were known as ‘single capacity’ firms. Stockbrokers by the start of the 20th century were effectively private bankers, looking after the financial affairs of families through generations; market makers were known as jobbers.

To some extent this solved humanity’s most enduring problem – that of agency. If you need professional advice, how do you know if it is good and in your interest or, alternatively, that your adviser is not ripping you off? Stockbroking profitability depended on numbers of clients, and growth through introductions to their friends, and clients were predominantly concerned with the income generated by their portfolios. This was easily calculated.