The Psychology of Investing, a quick overview!

The psychology of the market dictates the ultimate valuation of securities. Whether analysts or investors believe a stock should be valued at a particular price, it is the psychology itself that drives valuation levels.  In the depths of a bear market, emotions are high and liquidity concerns drive valuations. Valuation levels are driven well beyond where securities should be priced. At the height of a bull market, the opposite extreme is at work.  Investors believe that stock prices have nowhere to go but higher.

Markets tend to top out due to complacence and then are driven lower as the herd starts to realize that there is a change in direction underway.  Fear tends to occur at bottoms.  The VIX (a stock volatility index also known as the fear index), the ultimate fear indicator of the market is a barometer to the health of the market.  A high number on the VIX reflects an extremely weak market and therefore a bottom should be coming.  When panic sets in, the opportunity for investing is lurking around the corner.  A low number on the VIX reflects complacency or a topping process.  Look out for a declining market.

Asset Allocation for 2011

As we approach the end of 2010, the investment environment has changed dramatically. Bonds that have been viewed as the quintessential safe haven in these tumultuous markets are showing negative returns.  

Can you imagine a bond return with a negative sign beside it?  In fact bond returns have been looking weak for a few months now.  November returns for bondholders will start to reflect the true damage that has taken place in this asset class.

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