Market Update| The Psychology of Investing| Dec 1, 2021
Kevin Becker - Dec 01, 2021
Some of the most seasoned investors have trained themselves to avoid emotional impulses
Well, with Remembrance day behind us and US Thanksgiving in the rearview mirror, it appears we are now fully into the festive season. Karen and I were in the mall the other day to start looking at Christmas shopping ideas and though it was not as traditionally busy as before Covid, there was definitely an urgency to get gifts now while they are still available. This of course seems to be stemming from the news that most companies have shipping constraints and there may not be much product as we get closer to Christmas. Whether this becomes reality, we will have to wait and see, but it got me to thinking about the psychology of investing and how people react to news. Are smartphones and instant news good for the investor or is this detrimental to their overall portfolio. These are areas I think we should explore more of in this newsletter, but first a recap of the last week.
It was a short week with a big drop for stock indexes triggered by the discovery of a new COVID-19 variant out of South Africa. According to UK Health Security Agency, the new variant B.1.1.529 has 1) double the number of mutations of the Delta variant, 2) a spike protein that is dramatically different from the original coronavirus, and 3) mutations that are likely to evade the immune response generated both prior infection and vaccination (more below). Undoubtedly, the thin liquidity and short trading session today may be compounding the carnage. That being said, with investors’ positioning heavily skewed to the long side in stocks, liquidation phases will erupt every now and then. The double-digit decline in many traveling stocks, oil prices, and several cryptocurrencies today reminds us of just that. This risk-off tone has taken US 10-year bond yields down the 200-day moving average at 1.50%. Whether or not we eventually push through this support, this weeks virus news has likely lengthened the bridge between tapering and hiking when it comes to the Fed’s monetary policy in 2022.
This week, our focus is on the new COVID-19 variant dubbed “Nu” causing a swift repricing in several asset classes today. So far, scientists have little information on the transmissibility (R0) and the severity of symptoms of this new strain. Its unusually large number of mutations could mean current vaccines may prove less effective. In a press release, BioNTech announced that the company, along with Pfizer, would be able to adapt the mRNA vaccine within six weeks and ship initial batches within 100 days. Otherwise, the negative impact of successive COVID-19 infection waves on mobility (using Google Workplace Mobility indexes) has had a decreasing impact over time. As such, one important test for markets will be whether “Nu” impacts mobility and the rate of vaccination, especially in Europe where several protests erupted against pandemic-related restrictions. While we want to be cautious on global equities, we don’t want to grow too bearish at this point understanding that “Nu” could prompt many central banks to backtrack from the more hawkish rhetoric some spelled out lately. Last, this week’s sharp drop in stocks removes some froth and brings some sanity back into markets after a relentless ~10% rally since the low on October 4.
The Psychology of Investing
According to recent reports, investors using a U.S. discount brokerage platform are checking their portfolios at an alarming rate of seven times per day.1 It’s not difficult to do. Today, often all it takes is one quick swipe on our smartphones. However, frequent portfolio checking may be hazardous to your investing health.
Modern behavioural scientists have determined that our cognitive biases can sometimes cause us to make decisions that may not be in our best interests. Our brains operate in two cognitive states: automatic and reflective. Our automatic system is uncontrolled, fast and unconscious. Our reflective system is controlled, effortful and deductive. Cognitive biases occur when the automatic system, often influenced by the current environment, dominates the reflective system. This is why going grocery shopping while hungry can lead to unhealthy food choices: our reflective system is easily overridden by a state of hunger.
By checking portfolios frequently, there is a greater chance that we will trigger these biases. One reason is that frequent checking means a higher probability of seeing a loss, which may drive us to want to take action. By checking S&P/TSX Composite Index performance on a daily basis, there is a 48 percent likelihood of seeing negative performance. If you were to check only once per year, this would decrease to 28 percent.2 However, even seeing positive performance may trigger us to make certain decisions, such as selling a well-performing investment too early.
In investing, being aware of these biases can help us to make better decisions. “Herd behaviour,” the tendency to follow the actions of a larger group, may cause investors to buy or sell due to pressure from others who are doing the same. “Recency bias” causes investors to believe that recent patterns or events in the markets will continue into the future. “Confirmation bias” suggests we put more emphasis on information that agrees with what we believe, discounting opinions and data that disagree with these beliefs.
In fact, according to scientists there are 188 known cognitive biases that can affect our thinking and our actions. The visual above shows just a handful of the complete list of biases as published on visualcapitalist.com. The full infographic, found at www.visualcapitalist.com/every-single-cognitive-bias/ presents an interesting look at how our brain can sometimes work against our better judgment.
The good news? With a bit of effort, we can learn to control these behaviours. Some of the most seasoned investors have trained themselves to avoid emotional impulses. We can also integrate different techniques into our investing programs, like regularly rebalancing portfolios, using managed products to put buy and sell decisions in the hands of experts, or incorporating systematic saving or investing programs to avoid market timing.
Most importantly, don’t forget the influence that human behaviour can have on investing and plan ahead before it can have an impact. This may include sticking to your wealth plan during volatile times or avoiding the urge to react to social and media pressure. And, remember, we are here to help provide support as we work with you towards achieving longer-term success.
1. On average. www.reuters.com/breakingviews/chancellor-robinhood-is-more-sheriff-than-rebel-2021-07-15/; 2. S&P/TSX Composite Index 1985 to 2020.
On a final note, we were looking like normal was just around the corner and now we may have to deal with a new strain of COVID, but there is hope that we can emerge from this fairly quickly if the vaccine companies are correct that a quick fix to the present vaccine can be tapered to provide more resistance to this strain. With the arrival of winter we must be vigilant to take care, if we do this our resilience should be rewarded.
I would like to extend our sincere thanks to those who have introduced us to friends and family. We are here to provide support, whether it is a fresh opinion on an existing portfolio or advice relating to a new situation.
Thank you for your confidence in our services.
Here’s to happy days ahead for the upcoming holidays and hopefully some well-deserved relaxation and fun this festive season.