Lose your ‘recency bias.’
Tune out the ‘nattering nabobs of negativism,’ i.e. the media.
Don’t confuse market melt-downs, due to poor market mechanics, with the end of the world.
Lose your ‘recency bias’ especially as it pertains to past market trauma
“The tendency to think that what’s been happening lately will keep happening is one of a group of Behavioral Financial Biases that can cloud investors’ judgment. Recency Bias can cause investors to stay in stocks or other instruments because they have been performing well, despite warning signs like historical or relative high valuation. The bias can conversely keep investors from buying when stock prices are low, as in early 2009 when, because for months stocks had been falling, under Recency Bias one would expect that to continue.” (ycharts.com)
As it pertains to our current market I think for many the ‘recency’ may not be so recent. In other words the trauma inflicted upon investors in 2008/2009 remains fresh in the minds of many. Those that continued to hold stocks during that trying time never want to experience that severity of loss and fear again. There are those who sold in the panic and subsequently came back as investors. They hold the same fear. And then there are those who never came back, fearful to this day of a similar event occurring in the near-term. After 10 years of continually rising stock prices most have not bought into the ‘recency bias’ that this uptrend will stay in place. On a pure sentiment basis I view this as very positive. You have to look forward, not back.
Tune out the “nattering nabobs of negativism,” i.e. the media
I have been writing kortsession.com since February of 2013. Ergo, you have a history of the negativity posted by the media (v. my counterpoint) and a market which has shrugged off their constant negative drone and more-than-doubled in price and made new all-time highs. The media message has been be careful, play it safe and that the next big debacle is just around the corner. The message really has not changed during the last decade. Here is a sampling from this week’s Barron’s (you need a subscription to view):
Don’t confuse market melt-downs due to bad market mechanics with the end of the world
Black Monday, October 19, 1887 (a 22% drop in the dow Jones industrial average in one day) was a panic low. Like our most recent excursion to panic city this move was triggered by the Fed. More importantly it was significantly exacerbated by the advent of computerized automated trading, a new concept called “portfolio insurance”, and the partial abandonment of the “uptick rule” to make it easier for the computers to short the large baskets of stocks needed to implement “portfolio insurance.” It was a misunderstood market mechanism that caused that panic, not a disastrous change in fundamentals.
Over the past couple of decades Wall Street has created a couple of mechanical elements (a.k.a. investing tools) that may contribute to sharp moves, up and down, not necessarily fundamentally driven. With the popularity currently given to passive investing we have had a plethora of new exchange traded funds (ETFs) created along with high speed/high frequency computerized trading.
“Many notable investors have raised concerns about the influence of ETFs on the market and whether demand for these funds can inflate stock values into fragile bubbles. Some ETFs rely on portfolio models that are untested in different market conditions and can lead to extreme inflows and outflows from the funds which have a negative impact on market stability.” (Investopedia) On top of this many ETFs use leverage in their capital structures which may compound these problems. “Problems with ETFs were significant factors in the flash crashes and market declines in May 2010, August 2015, and February 2018.”(Investopedia)
Then there is the issue of high frequency trading (HFT). “High-frequency trading … is a program trading platform that uses powerful computers to transact a large number of orders at fractions of a second. It uses complex algorithms to analyze multiple markets and execute orders based on market conditions. Typically, the traders with the fastest execution speeds are more profitable than traders with slower execution speeds.” (Investopedia) HFT can move markets very quickly. A statement, pro or con, by a Fed Governor on the economy or the proper level of the Fed funds rate can move markets dramatically in less than a minute.
ETFs and HFT in combination (Bad Mechanics) can move markets both up and down significantly in a short time with little or no change in the underlying fundamentals of a stock or the economy. Nonetheless, when it hits on the downside it can look like the end of the world is at hand.
We just went through an awful turn in a good market -10/4/18 thru 12/24/18
This turn occurred with little in the way of fundamental change and all of the above DO’s and DON’Ts were applicable for those who wished to take advantage of the values that were created during the that period. Most importantly the” recency bias” and skepticism that has accompanied this market all the way up is still in place. The ‘wall of worry’ is still in place. Better yet, valuations have improved with the S&P 500 trading at about 16 X estimated 2019 earnings, yielding about 2% (v. 2.68% on the UST 10-yr note). The media has not been your friend when setting investment policy, save when you lean against their counsel. As such, I continue to believe that this secular bull market has significant room to run.
What’s your take?
The information presented in kortsessions.com represents my own opinions and does not contain recommendations for any particular investment or securities. I may, from time to time, mention certain securities for illustrative purpose, names where I personally hold positions. These are not meant to be construed as recommendations to BUY or SELL. All investments and strategies should be undertaken only after careful consideration of suitability based on the risks, tolerance for risk and personal financial situation.