On May 10, 2013
The Psychology of the Markets: 2000 Years & Going Strong
In the constant bombardment of anxiety-riddled headlines, we are always on guard to determine that which is fundamental risk and that which exacerbated to justify our sentiments at the current time. This has some components of “Hume’s Problem of Induction” and the “Reflexive Theory of Psychology” intertwined. Hume’s Problem of Induction states we use experiences to justify beliefs we have with things we have not observed. The Reflexive Theory in its most simple terms states that our participation in a certain event causes interpretation errors due to our participation bias. In even simpler terms, we cannot remove ourselves from the experiment we are participating in. It reminds us of the Roman author Seneca’s writing “On the Shortness of Life,” written around 55 AD.
“Life is divided into three periods: past, present, and future. Of these, the present is short, the future is doubtful, the past is certain. For this last is the one over which Fortune has lost her power, which cannot be brought back to anyone’s control.”
Fast forward almost 2000 years and we are still grappling with some of the same dilemmas. The patterns of history continue to follow similar patterns but have small impactful nuances that affect the immediate history to be made. The dissecting of the credit crunch is well detailed with many versions on who is at fault – or at minimum – played a key part in its amplification beyond a normal economic cycle. However, the one constant is the psychological reaction to these once-in-a-generation events. Though “Black Swans” exist, the seeing of one does not necessarily constitute a flock around the corner. And if it did, then Black Swan events would be seen as regular occurrences and thus become absorbed in to the average person’s daily experiences.
This is why we have seen a rise in more extreme calls of calamity. It seems that most investors have become aware of the pain of bear markets and therefore begin to see it as a higher potential occurrence than 15 years ago. The main difference that this apathy could cause is the pragmatic behavior of investors to not make their investment vulnerable to bubbles…though eventually that changes as well. This “Wall of Worry” we are building, which is as strong a maxim as “don’t fight the Fed,” seems to be laying a brick in this wall for every brick ascended.
In the Martketwatch article, 93% of financial advisers had PTSD after 2008, we begin to see the magnitude of the impact of The Great Recession. The article states 40% of financial planners suffered extreme Post-Traumatic Stress (PTSD) symptoms. The broad-based definition for PTSD in the study makes one wonder how the other 7% didn’t experience even a single moment of PTSD during this timeframe. This study confirms what others have attempted to prove – that perhaps the most damage done by The Great Recession was to the psychology of the investor and manager. In fact, the article states there has been an increase into market timing as an investment strategy. We often cite reversion to the mean, and this has the feeling of the pendulum swinging a bit too far to the other side from buy-and-hold strategies. Perhaps a moderate hybrid approach is the long-term answer, balancing tactical allocation with longer-term buy-and-hold components. We believe portfolios have moved to be more broadly based on multiple contingency.
As the markets are making new highs, we must be vigilantly aware of our biases to make as objective of a decision as possible. Though anxieties are running high on both existing events and those we may be fearful of, we must be careful not to dance on the ledge of anxiety. There are many events to be concerned about, but we continue to see much of the framework and architecture of the economy and markets from several years ago, still present and improving. We continue to believe that over the intermediate and long term the markets will continue to move higher and recover from any slight sell off that might occur.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.