Everything is horrible - why the rally?
So, let us play through a scenario. You suddenly go into a coma in February and wake up seven months later. Upon awakening, you are told that the world has been rocked by a virus that has killed nearly 800,000 people and infected almost 23 million worldwide. The US is suffering from social unrest that is sparking riots. The unemployment rate in the US has spiked to 13 per cent, and GDP plummeted by an historical annual rate of 32.9 per cent. Then I tell you the stock market just hit a new all-time high after posting one of the strongest rallies in history!
You probably would start laughing. The two scenarios could not possibly exist in the same reality — could they? We all know now, however, that they can. So why, when the general economy is in tatters, is the stock market rallying to new highs? I have read a lot of rationales lately on why this has happened, including the Federal Reserve liquidity programmes, the unprecedented fiscal stimulus, ultra-low interest rates, the explosion in retail participation, and the fact that the market is forward-looking and is seeing through the crisis. All of these make some sense and probably contributed to the rally. I am going to offer something different, though. Emotional and behavioural factors to consider for investing or just thinking in general, given a world of conflicting content:
1, Personal Experience v Facts. I think most of us tend to formulate our opinions with a disproportional weighting around our own experience. Our general mindset tends to be dominated by what happens to us personally or to those around us in proximity.
As a result, we become somewhat numb to numbers and bloodless statistics. If you were negatively affected by Covid-19 or some other calamity, you would weigh this experience accordingly. This is not to say something is not bad; it is just to realise that personal experiences may not be indicative of the whole and thus necessarily a true reflection of an event. The stock market is one such animal. It does not care about your experience. It reflects a myriad of opinions and reacts with the majority. If you find yourself disgusted or elated with the reaction of the market, it can often be tied somewhat to your current experience, even if the math or statistics reflects a much different reality to your own. It is also likely that you will weigh certain studies or stories disproportionately based on your experience rather than a dispassionate assessment of the numbers. Great investors invest in the world that is and not the one they want.
2, History Does Not Help. It is so easy to look at charts and say things like “don't sell; look at what happened in this event or that event”. But history, like statistics, does not account for your feelings.
Looking at a chart and thinking long term does little to assuage fear, and it is remarkable how rapidly risk tolerances evaporate in the face of melting markets regardless of historic rebounds seen in the past. History often offers little in terms of statistical significance. If you recently used the 1918 pandemic as your base case, you were using a sample size of one. I would suggest that it is not very statistically useful.
Thus, history, in many cases, offers little help if you are trying to assess the outcome of an event because there are not enough examples. Although I am a fan of financial history and have read my share of books on the subject, it's worth noting that it is the behavioural reactions to events that seem to be more persistent and predictable than the facts or circumstances. Great investors respect history but realise every event will have unique aspects.
3, Your Holding or Endowment Effect. Why would anyone listen to someone's advice to sell from someone who has already sold? That person will have no effect on the market as they are in cash already. In fact, they are potential buyers. The endowment effect suggests we value our current position [holding] more than what it may be logically worth.
If you are in cash, you will be “waiting” for the third wave or fourth wave of the pandemic to buy. If you are invested, you will believe the pandemic is not a big deal. Your opinion will be weighted by your current position. If your reaction to any criticism to something you hold an interest in becomes charged with emotion or scepticism of truth, it is worth taking a pause. You should also take note of whether you are attacking an author or contributor instead of his/her facts or statements.
All of this, of course, is tough to distance from. Why would you own stock if you were bearish? Shouldn't your view logically be bullish? You will begin to resist inconvenient truths. This will always be the tough part, and why much of the world should be viewed in probabilities and not absolutes. Be critical of your or other views that suggest certainty in matters that cannot possibly offer such. Great investors accept uncertainty and know when to change their minds and their current position even if it makes them dramatically alter their holdings.
This article probably comes across as a bit preachy, but I think it is timely for the world we live in now. I cannot remember there ever being a more polarised environment subjected to massive echo chambers of thought. A world where people have become somewhat myopic in their opinions based on political ideologies or personal beliefs.
It is time we all began to move back to more intelligent and civil discourse. We need to dispassionately consider facts and admit that there are some things we cannot possibly know with certainty. We need to think about how we are thinking.
Nathan Kowalski CPA, CA, CFA, CIM, FCSI is the Chief Financial Officer of Anchor Investment Management Ltd and can be contacted at firstname.lastname@example.org Disclaimer: The sole responsibility for the content of this article lies with the author. It does not necessarily reflect the opinion, policy, or position of Anchor Investment Management Ltd. The content of this article is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy or for any other purpose. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable. They are not necessarily all-inclusive, are not guaranteed as to the accuracy, and are current only at the time written. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their professional financial advisers prior to any investment decision. The author may own securities discussed in this article. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. The author respects the intellectual property rights of others. Trademark or copyright claims should be directed to the author by e-mail