Investing is a human endeavor that is subject to human emotions. When markets are up and doing well, confidence runs strong and investors take on more risk. When markets are doing poorly, conviction is lost and safety is sought. This dynamic is captured in the old Wall Street adage that financial markets are moved by fear and greed, a concept rephrased by Warren Buffet, “Be fearful when others are greedy and greedy when others are fearful.” Of course, investors devote vast amounts of time and effort to understand economic fundamentals and conventional financial theories such as the capital asset pricing model (CAPM) and the efficient market hypothesis (EMH). These rational financial theories do a reasonable job of predicting and explaining most of the action and events of the market, but certainly not all. In fact, these and other modern financial principles assume that people, for the most part, behave rationally and predictably. However, human behavior, the ultimate source of investment decision making, is anything but rational or predictable. Indeed, fear and greed are human behaviors born of raw emotion.

Traditionally, we have associated over-bought markets as being driven by greed and over-sold markets as being driven by fear. The equity markets have more than tripled since March of 2009 and the market has now gone 43 months without a 10% correction. So, it’s hardly a stretch to consider the current equity market over-bought. However, we suggest that the current over-bought market is being driven not by greed, but by fear, or more precisely, a derivative of fear, need. Seven years of zero bound interest rates have left institutional and individual investors falling woefully short of returns required to satisfy their short and long term financial needs. Accordingly, investors in need of higher returns to achieve their goals and objectives have been forced to take equity-market risk with funds that would otherwise be allocated to lower risk bonds. While the Federal Open Market Committee is likely to raise rates sometime soon, the Fed has been very clear that the progression of rate increases will be very slow. As such, investors will continue to have a “need” to take more risk in order to meet their goals.

So, does this dynamic mean that the equity markets will continue to move up until interest rates normalize? We think not. The economic recovery from the Great Recession is historically long in the tooth, and recent economic data has not confirmed sustainable economic growth. To the extent the economy falters and equity markets begin to retreat, we believe that investor “need” may revert to investor fear, and equity markets may correct as they have historically in the wake of such emotion. Accordingly, our message today is that the markets’ continued move up, especially in the absence of sustainable economic improvement, is being driven by emotion rather than sound fundamentals. While our portfolios are diversified for long term exposure to various asset classes, it is incumbent upon us to raise awareness of the current circumstances surrounding the equity markets in order to better manage expectations.

PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances. Investment decisions should always be made based on the client's specific financial needs, goals and objectives, time horizon and risk tolerance. The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.

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