Do Bull Markets And Great Depressions Affect Your Stock Market Psychology?

One of the social theories out there that seems intuitively appealing (at a minimum) is the notion that the market conditions that exist at the time you came of age has an outsized influence on your subsequent behavior. If you find people who have lived through the Great Depression, they have socks hidden throughout their houses with balls of $100 bills in them. The post-death inventorying of the possessions of their estates is a macabre Easter egg hunt where you stumble upon assets in the most unexpected of places. Because of the widespread availability of credit and lack of society-wide severe economic hardship, Americans coming of age during the 1990s aren’t conditioned to make savvy street-smart economic preparations like that.

If this kind of thing does affect your psychology, it could be useful to try and step back from yourself to see whether you’re being unnecessarily conservative or aggressive with your investing habits. For instance, complete avoidance of the stock market is a common characteristic of Depression Era survivors (you can easily envision a guy in his 40s building a portfolio of REIT investments and being thankful that he doesn’t have to actually operate the real estate, while a version of himself that endured the Great Depression would demand the hard real estate so that he can experience the psychological affirmation of driving by the property and seeing that it is “there”).

If someone wasn’t psychologically equipped to handle the daily price quotations inherent in stock market investing, that’s a good thing that you know yourself because bad results occur when you tell yourself that you can handle realistic worst case scenarios when that is not actually the case.  That’s where all that dreaded “sell low” stuff enters the picture.

How do you overcome an innate emotional bias? Well, if you’re persuaded by logical accounts of history, I would review this passage by Mark Hulbert in an April 2009 New York Times article, a month after the S&P 500 hit its most recent market bottom:

Historical stock charts seem to show that it took more than 25 years for the market to recover from the 1929 crash — a dismal statistic that has been brought to investors’ attention many times in the current downturn.

But a careful analysis of the record shows that the picture is more complex and, ultimately, far less daunting: An investor who invested a lump sum in the average stock at the market’s 1929 high would have been back to a break-even by late 1936 — less than four and a half years after the mid-1932 market low.

In the early 1930s, you had deflation and you really high dividend payments, so the worst economic catastrophe in the past six hundred years had you at breakeven in four years (and this is assuming you had the worst timing possible in human history at the time you made your lump sum investment). If your reaction to that kind of information is along the lines of, “Well duh, of course it works out. Celling cereal, soda, toothpaste, hamburgers, milk, bread, paper, medicine, and petroleum at a profit always gives you something to do, so of course things move directionally up over time”, then you already have the temperament to deal with sharp price swings.

I even have to step back from my own financial writing from time to time and wonder if I have any biases that would be preventing me from having the best understanding of the investing art possible. For instance, I have spent very, very little time in my life studying bonds compared to common stocks. I suspect if I had come of age in the 1970s and entered a world of 19% mortgages and 15% savings accounts, who knows what this site would have been like? “Why Get 10% Annual Returns From The Stock Market When You Can Get 50% More From Putting Your Money In The Bank?”

I’ve found the best way to remedy against potential is to always go back to Benjamin Graham’s classic question: “On what terms, and on what price?” With most bond offerings connected to the U.S. government, you’d be lucky to get a percentage point above inflation over the long term, assuming historical rate of around 3.4% remain the standard. They may be useful for preserving wealth, but at the present terms, they are not useful for building wealth.

But I do always try to adapt. For instance, I’ve come around to the notion that it could make sense to hold non-dividend stocks for the long term if the profit quality is high, the growth rate is satisfactory, and you can see that capital is being taken care of well: companies that, in my own research, meet this criteria are Berkshire Hathaway, Google, and Autozone. In the case of Berkshire, the focus would be on the quality of the profits, with Google the focus would be on the growth of the profits, and with Autozone, you’d be focusing on the company’s decision to systematically reduce the share count through buybacks instead of paying out a dividend. See, this dog picks up a new trick here and there.

In a way, I’ve been pleasantly surprised that dividend growth investing still remains popular on many forums, even though we are approaching a fifth consecutive year of stock market gains. I mean, think about what the 1982-2000 bull mark did to the art of income investing; what kind of weirdo would be focusing on 1% and 2% dividend yields when stock prices are going up by 12% annually? My guess as to why dividend growth investing seems to be still catching on is that, people who bought shares of Chevron, Exxon, Nestle, and Emerson Electric during the recession are seeing dividends that grew in bad times and are now growing at faster rates as the economy recovers.

Once you have five or six years of dividend growth under your belt, especially with reinvested dividends, it’s hard to turn away from dividend investing because you’re seeing how your cash flow is automatically improving on your behalf in a significant way. If you got in on Chevron six years ago (during the early stages of the crisis before the price really declined), you would have seen your dividends grow on a $15,000 initial investment into a little over $1,000+ annually today. And the story is only in the third inning; Chevron has years and years of adding to this performance ahead of it. When you see how a meaningful amount of capital at an opportune plus six years of patience can start putting money in your pocket, the experience of success that comes with truly trying to understand a business and actually reap the rewards of business ownership can overcome initial biases caused by coming of age during either a time of cratering or ballooning stock prices. Once you realize it’s not about price, but rather, about actual business ownership, all of the nonsense that dominates the popular debate about the stock market starts to go away.


Originally posted 2014-09-15 08:00:20.

Like this general content? Join The Conservative Income Investor on Patreon for discussion of specific stocks!

2 thoughts on “Do Bull Markets And Great Depressions Affect Your Stock Market Psychology?

  1. ddh81 says:

    Hey Tim,

    I generally agree with the thoughts in this post, but upon reading the beginning of your last sentence…”Once you realize it’s not about price”……I had to cringe just a bit. All the long term successful investors you refer to in this blog and on SA talk about price all the time. Hope I’m not taking you out of context. 
    Anyway, Howard Marks often discusses his earliest days in the business when everyone owned the best companies in America, known as the Nifty Fifty, and subsequently lost their shirts due to what had become excessive overvaluation. Even the finest stocks can be too expensive to be a good investment (although I would agree Chevron does not fit in that category).

  2. scchan_2009 says:

    I think price does matter, but value matters even more than price. Hence the correct approach is to look for value (quality) first and aim not to overpay; if you are going to overpay, at least try not to overpay ridiculously. Nothing worth infinite price anyway (Charlie Munger said that, not me). You should never assume another guy to buy your securities at a higher price (even with dividends compounded) than you have paid for (so called “greater fool theory”). 
    The question when is the price look “reasonable”, and determination of a reasonable price is more an art than science; just as much as determining what companies are good value is more like an art than science. I am never comfortable how “scientific” finance and investing work.

Leave a Reply