Emotions should not drive economy

By DAVID MOON, Moon Capital Management
May 30, 2004

When I saw the pictures of naked prisoners in the Abu Ghraib prison, several thoughts crossed my mind. I also have certain thoughts every day when I read of another US soldier killed by an Iraqi militant or see video of another American getting his head sliced off.

But of all the reactions I've had to these images, never have I concluded that Coca Cola or General Motors are less valuable as a result of the developments in Iraq. Apparently, I am in the minority. News headlines over the past few weeks report things like 'Stocks Drop on Iraq Woes' and 'Prisoner Abuse Sparks Selling.'

Once again, investors are being moved by their emotions rather than their intelligence. (In the case of some investors, however, their poor decisions probably are an accurate reflection of their intelligence, rather than emotion.)

Greed and fear are opposite sides of the same coin. The same type of emotion that prompts someone to buy a stock solely because it has already increased 50 percent in price is similar to the motivation of an investor who sells a stock simply because Tom Brokaw's nightly report is depressing. Neither investor bases his decision on the specifics of the stock they are so passionate about buying or selling.

At the Ohio State Fair in 1880, General William Tecumseh Sherman was right when he said, 'War is hell.' But his comments were intended to describe the personal and physical carnage he had witnessed in two wars. He was not referring to Wall Street.

It is human nature to perceive causation and patterns where neither exists. Wars, even the two worldwide versions experienced in the early 20th century, have not necessarily caused horrible short term economic or investment outcomes. (The longer term economic impacts of wars are multifaceted and not easily described in a sentence, or even a few pages.) Yet investors regularly sell stocks in reaction to geopolitical events, rather than economics.

Stock returns over any specific period are a function of several variables. The earnings and changes in the financial condition of companies are important, as is the general level of interest rates. When measuring the performance of a stock over any discrete period, however, the beginning price of the stock is also a big determinant. If a stock is grossly overpriced at the beginning of a year, changes in interest rates or earnings may have little to do with how the stock price moves that year. The price may decline simply as a reconciliation of the price and value of that specific company. The same possibility exists for cheaply priced stocks as well.

Albert Einstein was right: 'Everything in life should be made a simple as possible, but not more so.' Valuing stocks is a fairly simple process that requires making a few dispassionate estimates after having an understanding of the underlying business. But it is not as simple as letting the headlines from page A1 of your newspaper drive your decisions.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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