In tune with whims of Mr Market

The one thing I can predict with some confidence is that investors, (the pack name for which is "the herd"), will overreact to events whether positive or negative.

This means that one of the most valuable tools for investors is to develop the "critical thinking" that allows them to separate from the herd at times when the pack is heading for the cliff-edge. Lemming-like. A thought for today: are you the "doomed conformist"?

Where from this confidence? OK, I wasn't around during Tulipmania (1640) and The South Sea Bubble (1770s); and despite appearances I wasn't there at the time of the 1929 stock crash. I was there for "Black Monday" of 1987; and the end-of-the-world Y2K crash. And I am here for Black Monday to Friday of 2008. What a week that was.

I am also not saying that predicting the future is easy. Most of the calamities mentioned here were clear over-pricing bubble-issues. The credit crunch has a little more "systemic risk" in it for comfort.

Is the system changing? We were buying into a "capitalistic model", weren't we? If so, does the US government buying around 80 per cent of AIG represent a turn towards socialism? I prefer Peter Land's view at Brewin Dolphin "the Fed has simply become a huge hedge fund manager".

Certainly, the system needs some oil. How can one house foreclosure in Middle-America (or wherever it was), lead to the collapse of lending institutions; of inter-bank lending; and the calling-in of lenders of last resort (after which, as the name suggests, there is no one else)? A deck of cards if ever there was one and a crisis of system confidence for sure.

Mass behaviour

So back to the lemmings. Lemmings get a bad press for their behaviour which is a bit harsh as the mass-suicide is based on myth and Walt Disney films. Not unlike market sentiment (see below). The current herd instinct will have justifiable concern if the entire system, the one in which private enterprise, laissez-faire regulation, and globalisation was replaced by something else. This article assumes that there is no dastardly systemic plot. It assumes that the "clerical errors" that allowed the credit-credit crunch to take root are tipexed-out, and eventually repaired.

On this basis, we open the door to Mr Market. A metaphorical invention of Benjamin Graham, tutor to Warren Buffett. Buffett uses "Mr Market" as a reference point for market behaviour; the behaviour of the herd. There are probably four components of Mr Market's personality that has some picture-painting value.

Personality trait number one: Mr Market is a servant; not a guide. Trouble can be encountered when we follow Mr Market everywhere he goes. He is prone to extremes of personality disorder. However, for most of the time he is rational. For the most part, it is unwise to bet against the herd. As a servant he provides investors with a "fair value" for pricing stocks, and, he produces widely acceptable methods of valuation. So he has a wide following.

The second and third elements of this personality-watch occur when Mr Market enters into his periods of extreme enthusiasm or extreme depression. Investor "critical thinking" is required during these personality extremes. Did Mr Market go overboard during last week? Or, is he understandably excitable today and likely to go over-board shortly?

There will be a point shortly when two of the better cliché-quotes need to be uncovered: "when there is blood in the streets invest" (Rothschild); and "crisis is when wealth is handed over from the timid to the brave", Glyn Owen (RMBI). Assuming there is no massive systemic sub-plot (he said lemming-like), current market prices indicate that Mr Market is close to "depression-mode". In other historical depressions, you could expect the market to be "up" significantly within a year or two.

In other words, the lemmings will continue towards the mythical edge. The contrarians with their "critical thinking" will read the sentiment factor and buy. Saving regularly? That time is today/tomorrow. Back to the clichés: "only baboons pick bottoms". For regular savers: either the market collapses totally, and you won't really need the money anyway, or it doesn't and it will recover. For capital-sum investors, where the impact of downside volatility is more obvious, than today and tomorrow could be soon. Not today. Not yet, but watch the space.

This leads to the fourth element of Mr Market's personality-watch: his friend, Mr Media. Mr Media is influenced by Mr Market's temperament swings. Prices "surge" when Mr Market exudes enthusiasm; and they "crash" with Mr Market's depression. The problem of course is that newspapers need to print news. News and insight are two different things. Today's price and tomorrow's potential are two different things. Today's inward investment is tomorrow's growth story - this means that investing in a market today should be influenced by two things: today's price, is it too high or is it low and a buying opportunity compared to where it will be when everything is stable?

Today, with the press blaring out negativity, it is easy to see why the herd has set-off for the cliff. The credit crunch gives them good reason to be scared. Yet the credit crunch will probably resolve itself, and as soon as Mr Market senses this his enthusiasm will return. Returning with him is less rewarding than returning before him. This plot is confirmed from Tulipmania to Y2K. The only exceptions: Japan and the Great Depression. If deflation sets in then that is a different story. And that is a different article.

- The writer is chairman of Mondial Financial Partners