According to William Shakespeare, hate is more powerful than love, and he effectively demonstrates this in the play "Romeo and Juliet." The love between the two young lovers never overcomes the enmity between the families of their respective parents.
In a recent production at the Cal Shakes Theater in Orinda, the program for the play offered an insightful piece written by Laura Hope. She points out that a 2001 study published in the Review of General Psychology proved conclusively that "bad is stronger than good." We all just react more intensely to bad news than we do to good news. When news outlets, for example, get tired of covering bad news and engage in a campaign offering "happy talk" they predictably lose readers and listeners who just get bored and tune out.
When it comes to investing, studies in behavioral economics prove that people are typically bummed out by investment losses. Unfortunately, that unhappiness is never sufficiently offset by euphoria experienced from investment gains. So here we are with across-the-board stock market gains of more than 4 percent for the month of July bringing the total for the year to almost 20 percent on most of the major indexes such as the Dow Jones, S&P 500, etc.
Considering the seasonal history of when the market tends to be the softest, we should expect a shoe to fall at any moment. As a general rule, the stock market gains an average of 6.7 percent during the months of October to March and 1.7 percent between April and September. It doesn't take much bad news to move the needle downward during the delicate summer doldrums, and Thursday saw a whiff of that.
Looking back, we can expect to experience déjà vu all over again. In 2010, we had a 15 percent decline in market values between April and September. In 2011 we had a 15 percent downdraft between mid-July and November. In 2012, we hit a 10 percent air pocket between May and June. So far this year, we've escaped unscathed, but the other half of the summer lies ahead.
On the whole, however, the outlook is good. The economy is growing slowly, which should keep interest rates low and companies profitable. Housing starts are up, and car sales are booming. What's not to like? Stock prices, as a multiple of earnings, are not in some stratosphere reflecting irrational exuberance. We should probably expect some profit-taking or market correction, but that just comes with the territory.
The key to avoiding the obsession with bad news is to focus on the long term. Over time, bad news never matters. Markets always recover thanks fundamentally to the resiliency of the human spirit, as Warren Buffett expresses it. It's the human desire for self-improvement, competition, and the need to make a living that sets the stage for the dynamism of the world's economy.
So be prepared for bad news someday and its adverse impact on stock prices. Bad news is always more compelling than good news. For example, American companies were more profitable in 2008 than they were in 2007, but that good news never made it out of the starting gate as our financial services sector collapsed.
Looking ahead, J.P. Morgan (the man not the company) once said it best when asked by reporters what he thought the market was going to do. He replied, "It will fluctuate."
Stephen J. Butler is CEO of Pension Dynamics. Contact him at 925-956-0505, ext. 228 or firstname.lastname@example.org.