American consumers seem to be happy campers right now. And why shouldn’t these folks be happy as we enjoy the lowest unemployment in 50 years and the stock market continues to reach historic highs? Things look and feel good now, but how long can it last? Is it real or is it fake news?
British economist John Maynard Keynes is credited as saying, “The market can remain irrational longer than you can remain solvent.” Yes, it is true that markets can become irrational. But many times, there is more at play than the numbers and sound bites delivered in market reports. Skeptics caution that as we enter the longest bull market in history, multiples are very high and a pullback is in order. In contrast, those with a bullish view, argue that the most massive tax cut in more than 30 years can support continued growth in the markets.
Eventually the skeptics will be right. Markets can’t go up in a straight line forever, but that does not mean they will fall tomorrow. Markets are driven not just by logic and rationale, but by emotion. Last weekend’s false reports about missiles heading to Hawaii led to 37 minutes of intense emotion. Similarly, the lingering effects of Hurricane Maria in Puerto Rico and conversations about border walls, tax changes, and trade deals are all emotionally charged events in the news cycle. Can such events trigger emotional decisions? Absolutely!
Sure, our team is made up of professional investors. However, we are also human, and subject to the influence of emotions. We apply a systematic, rules based-approach to investing to minimize emotional interference. Essentially, this approach is followed to help avoid the consequences of decision fatigue. The more decisions that need to be made, the worse those decisions can become. Additionally, the concept of “recency bias” – the tendency to place excessive focus on recent factors – can influence decisions. As today’s market hits one peak after another, investors can begin making snap decisions based on emotions and even hunger.
Yes, hunger! A 2010 study by a Stanford professor considered judges’ probable approval or denial of 1,100 parolees. The earlier in the day an inmate went before a judge; the more likely he or she was approved for parole. As lunch time approached, judges became harsher in their parole decisions. But after resting their brains and feeding their bodies, judges’ decisions in early afternoon became more lenient. As the day lengthened and more decisions were made, prisoners once again experienced less favorable rulings.
All humans –investors, judges and inmates are subject to emotions and fatigue. A rules-based approach to investing minimizes the number of repetitive decisions that need to be made and helps manage the biases that influence individuals’ thought processes.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.