This Halloween I’m Dressing as a Stockbroker

In a typical October, the trees shed their leaves and stocks shed their value. This one is no exception. During Halloween month, the scariest place is not the cemetery but Wall Street – not so much for the traders, who (unless trading on their own accounts) make money regardless of what the market does, but for the rest of us.

Very few “rules of thumb” for investors stand the test of time. There is a random element to price movements that baffle even expert analysts. For two decades Alan Greenspan was the most respected central banker in the world, yet in his latest book he admits he totally misread the movements of asset prices while in office. What hope is there for the rest of us? Strangely enough, one idiotically simple rule of thumb has been a winner for centuries: “Sell in May, go away.” The months November-April really have had better returns than May-October; October in particular repeatedly has been nasty indeed. A hypothetical investor who put $10,000 in stocks reflecting the S&P in 1958 (a recession year) and then followed the sell-May-buy-November strategy now would have a portfolio of $544,323. The reverse strategy (buy-May-sell-November) would leave the investor in 2014 with $9,728, a $272 loss. Professional investment advisers tend to pooh-pooh the sell-May strategy, because it seems to make no sense. To them it has the smell of superstition: an unreliable interpretation of a statistical oddity. Yet it is hard to dismiss the persistence of the pattern. Besides, it does make sense in human psychological terms, if not in terms of the underlying economic realities. Octobers are bad for the market because Octobers historically are bad for the market. It is self-reinforcing. Investors, aka humans, are jittery creatures when they suspect bears are about, either in the woods or in the market; they know October is an especially ursine infested month, and flee on hearing the first scary rustle or grunt.

Beyond this simple calendar trick, investment strategies by individuals and professionals alike are surprisingly useless. Often worse than useless. Several years ago Terry Odean, professor of finance at Berkeley, analyzed 163,000 trades in 10,000 individual brokerage accounts. Clearly the account-holders expected to benefit by the trades, i.e. do better than if they simply had held the stocks they sold. Yet, overall, the stocks they sold did better than the stocks they bought by an average of 3.2 percentage points. (Why? The human tendency to sell stocks that are up from their purchase price and to keep those that are down until their prices recover – “loss aversion” – meant they dumped their strongest stocks and ended with a weaker portfolio.) Odean and his colleague Brad Barber published an oft-quoted paper called Trading is Hazardous to Your Wealth, which demonstrated that active traders on average do worse than less active ones. Individuals who simply hold a diversity of stocks can expect to track the market. Beating the market rate of return is a matter of luck, and luck, as we know, is fickle.

 “Experts” are scarcely better with their stock picks. When Nobel-winning economist Daniel Kahneman was preparing a talk for investment advisers he received a wealth of data on their performance from their employing (well-known) firm. The advisers’ bonuses were based on the performance of their investment picks, so they had every incentive to choose well. His analysis of the data: “The results resembled what you would expect in a dice-rolling contest … the firm was rewarding luck as though it was skill.” To be sure, there really is a substantial amount of education and skill required to count as a financial expert. Few people understand how some of the more arcane derivatives really work. There is a huge amount of information (product lines, industry trends, balance sheets, corporate culture, etc.) to be evaluated when trying to make an informed judgment about a particular company. Yet, the informed judgments prove to be as hit and miss as the uninformed, for there are always more factors than what you see. As for whether the company is overvalued or undervalued (whether the stock will fall or rise), “Traders apparently lack the skill to answer this crucial question, but they appear to be ignorant of their ignorance.”

Well, as Socrates noted some time ago, this is not an uncommon human condition. I don’t pretend to be immune to it. I’ve never followed the sell-in-May strategy, for one thing, though I’d be far far better off if I had. My informed picks (not only in finances, alas) usually have been worse than my random ones. Yet it’s hard not to overthink the next decision anyway, even knowing that it won’t help. That, I suppose, is human, too.

1929, the archetypical Crash. Mr. Forbes' advice to buy was off by a few years: 1932 was market bottom. 1933 was the best year ever for stocks (yet to be surpassed) even though the Depression would last until 1940.