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Generational Dynamics Web Log for 25-Jan-08
Do people with brain disorders make better investors?

Web Log - January, 2008

Do people with brain disorders make better investors?

More bizarre claims from pundits who can't even figure out price/earnings ratios.

One hears so many bizarre things from the bubble cheerleaders at CNBC that it's almost a notable event when someone says something sensible.

However, what I heard on Friday morning really takes bizarreness to the level of being freakish.

The premise is this: The stock market increases of the last few years that pushed stocks well into historically high bubble territory are really "normal," and the recent downtrend in the markets is because investors are being too "emotional."

The best investors, according to these people, are those with certain brain disorders that make them unemotional. Sometimes one just can't believe one's ears, and one wonders just what brain disorders the speakers have.

Both speakers were "consultants" to investors. I infer from their remarks that their advice is most often, "Buy! Buy! Buy!" Let's see how they explain themselves.


James Grubman (top) and Darrin Farrow <font face=Arial size=-2>(Source: CNBC)</font>
James Grubman (top) and Darrin Farrow (Source: CNBC)

One speaker was James Grubman, a "psychologist and consultant to families of wealth, and an adjunct professor in the financial planning program with McCallum graduate school of business at Bentley College." (Incidentally, I've been an "adjunct professor" a few times in math and computer subjects, and what it means is that they bring you in part-time to teach a course or two.)

The second speaker was Darrin Farrow, president of Pension Builders & Consultants. (Unfortunately for him and a lot of people, he's apparently on the road to changing from a "pension builder" to a "pension destroyer.")

Grubman: A lot of investors are really reacting to panic and fear that is feeding on itself, and so this is a time when understanding what your risk tolerance is and being able to tolerate some of the anxiety about the markets is really very important to keep your head about you.

Farrow: I think we're finding herd mentality taking place. If you look at the fundamentals, the P/E's are very fair. If you look at 2007, the S&P had a P/E of under 16, which means the fundamentals are strong - the market may be undervalued. But because we tend to be more emotional when we buy and sell stocks, the subprime fears and the unknown are making people sell stocks. Whereas, conversely in 1999, when you had the technology forming, you had P/Es upwards in the 30s and 40s. People were buying because it felt good, but you look at the fundamentals, they should have been selling. So unfortunately, people pay more attention to how they feel than the fundamentals, which is what they should be paying attention to.

[[This stuff about P/Es, or price/earnings ratios, is total, utter, blithering nonsense, as we'll describe below, from a person who earns a living by advising other people how to invest. His clients would be better off with a dart board.]]

Unfortunately 80% of buying decisions are based on emotions, and our emotion directly contradicts the fundamentals of prudent investing.

Grubman: There's some interesting research that shows that people who actually have too little emotion because of brain disorders sometimes do better at investing, because they're not tossed around by how they're feeling. We also know from certain research in behaviorial finance that people feel losses much more strongly -- 2 times more strongly -- than they're happy about gains. So a drop in the market of 1000 points would have to be matched on the upside by almost 2500 points to have the same level of emotion. We really hate to lose money.

[On outsourcing the management of one's portfolio.] Well, many wealthy investors and high net worth investors do do that by using wealth managers, and I've been talking to many of the wealth managers that I consult to in the past week, checking with them. And they're actually finding that their clients are not calling as much, but I find that the advisors themselves are more nervous for their clients' money.

[[This is an interesting touch. "If your advisor tells you to sell, then he's just being emotional. Hire me as your consultant and advisor instead, and I'll tell you to buy."]]

Farrow: [On being less emotional about investing.] I think passive management is probably the route to go. Active managers, even portfolio managers, tend to buy into emotion and the same fears and overconfidence that the lay person does. Passive management, index investing is where they should be looking.

Let's start with the S&P Price/Earnings index.

There's a price/earnings ratio chart at the bottom of this web site's home page, and it gets updated automatically every Friday. Here's the January 18 version of the chart:


S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 18-Jan-2008. <font face=Arial size=-2>(Source: MarketGauge ® by DataView, LLC)</font>
S&P 500 Price/Earnings ratio and S&P 500-stock Index as of 18-Jan-2008. (Source: MarketGauge ® by DataView, LLC)

Now, Farrow says,

"If you look at the fundamentals, the P/E's are very fair. If you look at 2007, the S&P had a P/E of under 16, which means the fundamentals are strong - the market may be undervalued."

Well no, this is nonsense in several different ways:

Now let's go on to another portion of Farrow's statement:

"Whereas, conversely in 1999, when you had the technology forming, you had P/Es upwards in the 30s and 40s. People were buying because it felt good, but you look at the fundamentals, they should have been selling."

This is about as silly as you can get. If you look at the above graph, then by his reasoning, you should have been selling throughout the whole period, perhaps only buying again near the beginning of 2005.

Well, he can't be that stupid. This is a pretty clear indication that Farrow is simply a liar, a person who makes up facts in order to get fat commissions from his wealthy clients. This is the same thing that's become common these days -- from investment banks, hedge funds, ratings agencies, or bond insurers. It's perfectly OK to defraud your clients or the public, as long as you can get a fat commission for doing so.

As I've said many times, if you really want to look at "fundamentals," then you can look that the following graph of P/E ratios back to 1871:


S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007
S&P 500 Price/Earnings Ratio (P/E1) 1871 to August 2007

As this graph shows, the historical P/E ratio averages around 14, and has gotten as low as 5-6 several times in the last century, most recently in 1982. It experienced an enormous spike, starting in 1995, and is now clearly poised to fall again to the 5-6 range. This would push market prices well below the Dow 4000 range.

Finally, let's take another look at Grubman's comment:

"There's some interesting research that shows that people who actually have too little emotion because of brain disorders sometimes do better at investing, because they're not tossed around by how they're feeling."

This comment about brain disorders is absolutely hilarious.

What's interesting about this is that these two people are lying through their teeth because their incomes depend on it, which means that they're operating totally on emotions, not on fundamentals.

I guess the moral to this story is the following: If you're going to pay a consultant to give you advice about investments, then make sure the consultant has a brain disorder. (25-Jan-08) Permanent Link
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