MARKET PSYCHOLOGY
Valuation models come and go, but human nature doesn't change. So it makes sense, according to Russell Fuller and Richard Thaler, to base investment strategies on psychological principles rather than the usual research reports and performance indicators. Behavioral finance, as this approach is known, has spawned successes such as Fuller & Thaler Asset Management, in part by suggesting unlikely ways to pick stocks.
While conventional wisdom assumes that investors act rationally, behavioral finance theorists believe humans are wired to make certain kinds of mistakes. The trick is to recognize these errors, such as anchoring and overconfidence, and buy or sell before the market catches up with you.
Anchoring, for instance, leads investors to act as though present conditions will continue. Take the case of Qualcomm, the S&P 500's best-performing stock in 1999, whose price peaked on January 3, the first trading day of the new year. "Were new investors motivated by rational assumptions?" asks Howard Simons, professor of finance at the Illinois Institute of Technology. "Or were they anchoring an irrational belief that the price would continue to rise at such an unsustainable pace?" Either way, they got burned as the stock lost 39 percent of its value by January 28.
Dallas-based Fuller & Thaler uses behavioral principles to manage $900 million in institutional assets. The firm also advises the Undiscovered Managers Behavioral Growth Fund, a mutual fund that has gained 124.02 percent over the past 12 months and 29.46 percent this year (as of March 6).
Undiscovered Managers requires a $250,000 minimum investment, but you can test behavioral ideas with any sum using a classic behavioral bellwether known as the magazine-cover indicator. By the time a stock is covered in the monthly press, the theory goes, its potential market is oversaturated and the price is sure to tumble in short order. Case in point: America Online. After prominent coverage in virtually every major US news publication following its merger with Time Warner, AOL stock promptly slid 50 percent.
- Jonathan Hoenig (www.capitalistpig.com)
Fuller & Thaler Asset Management:www.fullerthaler.com.
Undiscovered Managers Behavioral Growth Fund:www.undiscoveredmanagers.com.
NEW MONEY
Financial Services Monster Mash
Skinner Bucks
Virtue Capital Gains
Webjacked
