Emotions and Markets

‘Tis the season and, as you know, emotions run high at this time of year.   Unless we control them, these emotions can hurt us on either side.  Excessive happiness leads to potentially overbuying (and January financial hangovers).  For certain others the euphoria of the Holidays leads to their sense of being ‘left out of it’ and depression is prevalent.  The stock market also has emotions but, unfortunately, it is not limited to any certain calendars.  It would be helpful to review these emotions.

At the onset, let us say market emotions are real.  Those who say finance is objective either haven’t studied history, or choose to view themselves as above average (which is ego or emotion, or both).  The crazes of the past 400 years in capital markets are well documented.  Fortunately,  markets do correct, but in the short term, you don’t want to bet against them as market timers are wont to do (additionally, it is why you are always given balance in your portfolio here).  As famous British economist John Maynard Keynes wryly noted;

The market can stay irrational longer than you can stay solvent.”

Back to emotions.  There are really two categories; broad market psychology emotions, and the emotions of the individual investor.  In the former category of market emotions, we see it mostly occur at the extremes.  It is usually accompanied by guys on TV talk shows screaming into the monitor “The market is heading lower!”, or its schizophrenic cousin “You have to buy now!!”.  These rants inevitably evoke emotions.  There is absolutely zero evidence either side knows when to make these calls, so they are inevitably wrong.  However, they play to their extended family counterparts of panic and greed.  To be clear, the effect of these emotions do not control markets long term, but they probably add to the extremes (markets down 32% go to down 38%, as in 2008).  There’s no objective way to measure this effect, but no one really doubts they exist.  In fact, in a reality that must be looked at with bemusement, Wall Street has capitalized on these emotions and now has ‘Fear and Greed Indicators’ you can trade on.  I’d humbly suggest you pass on that Christmas present.

The second and far more damaging emotional array comes from the investor themselves.  In a classic book “The Psychology of Investing”, Professor John R. Nofsinger describes at least 37 common investor biases / emotions that (very unfortunately) control most of the average man’s investment decisions.  You don’t have to fall prey to them all, just a dab’l do ya, and (unless you are from Lake Wobegon) you will experience them.  They range from the Illusion of Control (I picked right last time, so I can do it again), to the Familiarity Bias (I know this company better than any other investors).  These behavioral issues have such a large impact on finances for the family that the 2002 Noble Prize in Economics went to a psychologist (!) who studied their pernicious yet common effect.

In this Holiday season, enjoy the people around you, and be thankful for many things.  One of the items you may wish to be thankful for is that you now know of these market emotions, but as long as we are together you will not fall prey to them.  Of all the visions that may dance in your head, you will be dancing around these emotions so that your sleigh always comes in.