Stocks for the Long Run : the Definitive Guide to Financial Market Returns and Long-term Investment Strategies

over five-year intervals. Portfolios that had been winners in the past five
years subsequently lagged the market by 10 percent, while the subse-
quent returns on the loser portfolio beat the market by 30 percent.
One of the explanations for why this strategy works relates to the
representativeness heuristic we talked about before. People extrapolate
recent trends in stock prices too far in the future. Although there is some
evidence that short-term momentum is positive in stock returns, over
the longer term many stocks that have done poorly outperform, and
stocks that have done well underperform. Another strategy based on
out-of-favor stocks is called the Dogs of the Dowor the Dow 10 strategy.^32

Dave:There has been so much to absorb from today’s session. It seems
like I fell into almost all of these behavioral traps. The comforting news
is that I’m not alone and that your counseling has helped other in-
vestors.

336 PART 4 Stock Fluctuations in the Short Run

FIGURE 19–1

Investors Intelligence Sentiment Indicator, 1986 to 2007

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Iraqi

Invasion of

Kuwait

Bond

Market

Crash

Asian

Crisis

LTCM/

Russia

Terrorist

Attacks

October

Market

Crash

Fears of Crash

Induced by Decline

Bear Market

Bottom

(^32) This strategy is discussed in great detail in Chapter 9.