This blog post originally appeared on RealMoney Silver on June 30 at 7:55 a.m. EDT.
There is no observed improvement in the emotional stability of the average investor, notwithstanding dramatic advances in financial literacy or in the sophistication of computer software. The investor of the 1990s is probably no less prone to excitability and self-delusion than the investor of the 1920s. Paul McRae Montgomery... has made a lifelong study of the role of perception in the financial markets. There is the logical and calculating part of the human mind, Montgomery has observed , but there is also the emotional and impulsive region. Each plays its role in the supposedly cold-blooded calculations of buying and selling stocks and bonds. To suppose that the value of a common stock is determined purely by a corporation's earnings discounted by the relevant interest rate and adjusted for the marginal tax rate is to forget that people have burned witches, gone to war on a whim, risen to the defense of Joseph Stalin, and believed Orson Welles when he told them over the radio that the Martians had landed. Investors are prone to be bullish at the top of the market when prices are high, and bearish at the bottom when prices are low. Like war, speculation is a social activity. It is carried on by groups. -- James Grant, Minding Mr. Market: Ten Years on Wall Street With Grant's Interest Rate ObserverAs I have written repeatedly, all is not rosy -- far from it! My intention is not to be a Pollyanna; I recognize the current soft patch in domestic economic activity. Housing, in particular, remains sluggish and confidence subdued. Moreover, there exists numerous P/E multiple deflators and nontraditional headwinds to growth. The following factors don't necessarily prevent an extended bull market, but they most certainly have deflated P/E multiples -- the S&P 500 now trades at only 11.5x 2011 forecasts -- and have put a cap on the market's upside potential:
- rising taxes;
- fiscal imbalances in federal, state and local governments;
- the absence of drivers to replace the prior cycle's strength in residential and nonresidential construction;
- the long tail of the last credit cycle (Greece, Portugal, Spain, etc.); and
- inept and partisan politics.