Undoubtedly you have heard about lemmings.  They are those furry little rodents who live in the upper reaches of the arctic and have been known to swarm in large numbers and suddenly rush off of cliffs and fall to their death.  The truth is that they don't commit mass suicide by running off cliffs in large numbers.  They do migrate in large numbers from one feeding area to another and they seem to do so in a very chaotic manner.  No one is really sure what triggers this behavior but it does seem to occur every 3-5 years. 

The same could be said of sheep, caribou, buffalo and so on.  At some point their animal instincts simply take over and they take off in a crazy, frenzied rush to get somewhere fast.

Stock market investors have similar tendencies, even though we consider ourselves to be higher on the food chain than lemmings or sheep.  Perhaps that means we just have more sophisticated reasons why we suddenly decide to head off one direction and blindly follow the herd.

Herd behavior on Wall Street is a well-documented fact.  From 1995 to 1999 S&P 500 index funds had an incredible run.  Investors flocked to those funds as they averaged well over 25% annually during those years.   Money was flowing into equities and specifically tech stocks like there was no tomorrow, further fueling the frenzy.  Just like the lemmings investors were massing and moving in one powerful direction.  People were taking out equity loans on their home and moving those funds into the market.

By March 2000, 85% of the funds invested in mutual funds were in tech funds.  That frenzy continued through 2000 and into 2001 even as the overall market averages were dropping.   Finally in mid 2001 investors could see they were getting close to the edge and began to bail out of the tech funds.  Unfortunately by following this herd, a substantial number of investors lost significant portions of their net worth. 

What causes this behavior on the part of investors?   Why do they act this way?  In a sense these investors are just like lemmings.  Lemmings wake up one day and see that they are running out of food and then quickly decide they better be moving on. or they will starve.

Investors wake up and see that the short-term performance of their portfolios is falling behind and they feel compelled to make a change.  A 2001 poll of investment advisors by Yankelovich Partners pointed out that 55% of clients were more concerned about quarter-to-quarter returns then they were five years earlier.

Investors also tend to lose their patience.  They look at the quarter to quarter performance and see it lagging.  They watch an interview on CNN and are swayed by the opinions of the "talking head" and feel compelled to take action.  Behavioral finance researchers note that when faced with new information, investors feel they have to do something.  They get restless because of one of two reasons.

Greed is a powerful emotion and it is especially potent when you feel like you are losing out on a great opportunity.  You hear something and decide to get on the bandwagon.  Most of the time we are not conscious of this thought process, we just take off and change…just like the lemmings.

Fear is the other powerful emotion that causes us to make changes.  We see somebody else selling a mutual fund and then decide we have to move too….just like the lemmings who see they are running out of food and off they go!

Unfortunately, the consequences of these changes are seldom in the investors favor.    When investors react to new information they frequently go in the wrong direction and often at a large cost to their investments.   One study conducted by a psychologist at Harvard compared the performance of four groups of investors on the basis of buying and selling stock in two different companies.  One stock was volatile and the other was relatively stable.  Two of the groups were given a steady stream of info about the two stocks while the other two received little information. 

The group with little information ended up outperforming the groups that received more information mainly because they made fewer changes than the more "informed" groups.

Right now the investor lemmings are massing.  They are waiting for a signal to move in a direction and when they do they will be off in another hurried frenzy.  Currently things are pretty confusing.  In a recent poll by Business Week of 67 market forecasters the average return for the S&P500 in 2003 is supposed to be 19.2%.   Only 3 of them saw the return being negative for the fourth year in a row.

Perhaps they are basing their forecast on the fact that in the last 106 years there has only been one period where the Dow went down 4 years in a row.  So from a statistical point of view it is reasonable to assume that this year should be up….right?

Obviously, there are many factors they consider when coming up with their forecasts, but it is worth considering one important concept.  Bear markets such as we have recently seen are the means by which the excesses of bull markets are squeezed out of the system. 

1998 saw the high point of the longest running, most powerful advance in over 60 years.  It stands to reason that the market needed correction, and probably significant correction for that matter.   The question is: is the correction over?

Money began moving out of the market in June 2002 in a big way.  That started almost 2 years after the end of this bull market.  The last major retreat in the market in 1987 came a mere 3 months after it had peaked.  Maybe there is a little more correction left in this market.

If you are starting to feel like a lemming in middle of the herd and the herd starts taking off, you may want to make sure you have your life jacket on just in case that cliff by the ocean is near by. 
 

© 2003 Mark Neil    Photo links to the lemming zoo website in Canada.