The death of equities: Here we go again

(MoneyWatch) Perhaps the most infamous of all market forecasts is "The Death of Equities," the cover story of the August 13, 1979 edition of BusinessWeek. In it, the magazine argued that "for better or for worse... the U.S. economy probably has to regard the death of equities as a near-permanent condition." The article's timing could not have been worse -- over the next 20 years the market returned about 18 percent a year.

A May 14 editorial in The New York Times, headlined the "End of the Affair," echoed the earlier article. It marshals some facts in making a similar point about the state of the financial markets:

• "Investors are shunning the stock market, and who can blame them?"
• "As serial bubbles have burst, faith in the market has been rewarded with shattered retirements."
• "Trust has been destroyed by scandals and the slow, uncertain pace of financial reform."
• "Trading volume is down. Going back to 1960, trading had never declined for three consecutive years, let alone four and counting."
• "Since the start of 2008, domestic stock mutual funds were drained of more than $400 billion."
• "If the trend continues, the result could be a less robust market, with fewer companies opting to raise money by issuing shares and fewer investors willing to put their retirement savings into stocks."
• "Investors are not merely reacting to tough conditions, but rather are staying away because they don't trust the market, it's unfair to individual investors -- citing rebates from the stock exchanges that provide incentives for brokers to search for the biggest rebate rather than the best price for their client."

Whenever there's a doomsday story in the financial media, I often get requests for comments. My first reaction to this piece was to recall the "Death of Equities" story, and how wide of the mark it proved to be. I then noted the great irony in the Times editorial -- fear and lack of trust had led investors to withdraw over $400 billion from the market at the same time that the market had more than doubled! In other words, investors who ignored this new "death of equities" were the winners, while those who "paid attention" missed the greatest bull market since the 1930s.

The evidence is clear that individuals have the bad habit of investing as if they were driving forward while watching the rear view mirror, selling after periods of poor performance and buying after periods of strong performance. They're what financial economists call "noise traders," becoming overly optimistic in bull markets and overly pessimistic in bear markets.

While the winning strategy is to ignore the noise and adhere to a well-developed investment plan, if you can't resist paying attention to the noise, the evidence demonstrates that you would be far better off being a contrarian, doing the opposite of what the herd is doing. In other words, follow Warren Buffett's advice to "be fearful when others are greedy and greedy only when others are fearful." And remember that articles like this editorial are more likely to be yet one more contrarian indicator than they are to have value (other than as fodder for my blog).

And if you're concerned about broker rebates, the simple answer is to do what you should be doing anyway: avoid trading individual stocks. In general, stocks should be owned via investments in low-cost, passively managed mutual funds. That's the best way to achieve the broad diversification required to minimize the uncompensated, idiosyncratic risks of individual stocks.

The bottom line is this: If you insist on reading The New York Times for investment advice, limit yourself to reading Carl Richards' Bucks Blog.