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taking stock

Well, so much for the much-vaunted September effect.

Based on the historical evidence, this is supposed to be the most bearish of all months for stocks, regardless of economic or market circumstances. And these are scarcely the best of economic times.

After sifting through reams of trading data going back a couple of hundred years, researchers found that September was the only month in which market players the world over consistently ended up in the red - about 1 per cent on average. It's still early, but so far the historical pattern isn't holding up. Which shows why some students of the markets regard a mere 200 years of statistical evidence as too little to be conclusive.

The question is why equities keep moving upward (albeit at a slower pace), after an already stunning rally over the past six months. Sure, the economic outlook has improved, but the good old days aren't coming back any time soon.

Consumers are still in no mood to spend, job losses mount, most of what growth we've seen, including China's, stems from massive government spending, and corporate profits are likely to languish once the savings from cost-shearing have been absorbed.

You could call it the triumph of hope over logic, as several astute market watchers have done. I prefer to think of it as the latest manifestation of the no-investor-wants-to-be-left-behind law. But whatever the reason, it's plain the behaviourists have it right. Human nature being what it is, people typically have short memories, do not always act rationally and are prone to repeat their mistakes.

Like everyone else, investors "give in to mood swings that lead to impulsive decisions," says Jim Mahar, an associate finance professor at St. Bonaventure University in upstate New York. And it's why, despite our better judgment, we are still tempted to try to time the market and latch on to hot stocks, funds and trends.

"The excitement of beating the market - and getting to brag about it - leads investors to make decisions that they never would in a more sterile environment."

We called on Prof. Mahar not because of his teaching gig but his intriguing sideline as the proprietor of FinanceProfessor.com, a marvellous compendium of finance news and commentary, academic discussions, recommended reading and pointed opinions from the blogosphere.

What started as a newsletter to enable his economics students and graduates to keep up with new ideas has evolved into a valuable window into current thinking on the hottest trends and controversies in the world of finance and economics. Nobel laureates have been known to show up there. And from his unusual vantage point, Prof. Mahar often gets an early look at research and analysis that might not hit the learned academic journals for months, or even years.

As might be expected, the hot trend these days is behavioural. (That's apart from the painful soul-searching among prominent economists who discovered in the current global crisis that their cherished beliefs about free markets were not scientific truths.)

Last month, Prof. Mahar posted a summary of a psychological study showing that temptation is a much stronger force than people realize. He wondered jokingly if the Lord's Prayer might make for useful financial advice.

His own solution to curb irrational tendencies? Make a plan in advance and put the whole investing process on autopilot. "Take the discretion out of investing so you won't be able to take unwise chances or take risks that a rational investor would not."

In other words, invest in indexes.

Wait a minute. Isn't that what the believers in efficient markets, the ones whose theories have been ripped to shreds by the global meltdown, were telling us to do?

Well, yes. "Ten years ago, people believed in the perfect efficiency of markets and that indexing was the right recipe for success," Prof. Mahar says. "Now behavioural science is catching on, and the best way to protect ourselves from ourselves is with indexing. The prescription is the same. The disease is different."

Hey, maybe it's time to take some money out of this game and get that September effect rolling again.

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