The markets began 2016 with a fever induced by concerns about global growth, dysfunction in China, rapid declines in commodity and energy prices and rising interest rates in the United States. These fears led to one of the most negative calendar year starts ever in US markets. On top of implosion in the Mid-East, contentious US presidential primaries and elections in 2016 and numerous other macro-economic concerns, it seems we were looking at a year filled with challenging problems.
Later in the quarter, the pessimism cleared and the markets rallied. For complete coverage:
http://markets.on.nytimes.com/research/markets/overview/overview.asp
It is ironic that one of the big issues driving the initial negativity was falling energy prices. For as long as I can remember, the price and scarcity of oil was one of the most powerful drivers of market fears. There has been a theory of “Peak Oil” that was first mentioned in 1885 by the state geologist of Pennsylvania when he warned that “the amazing exhibition of oil” as “a temporary and vanishing phenomenon-one which young men will live to see come to its natural end.” Turns out we are a long way from running out of oil, energy or all manner of things that the doomsters have been sweating for a very long time.
http://www.wsj.com/articles/peak-oil-debunked-again-1417739810
Low energy and commodity prices = hard times? The thesis is that the low prices are a sign of slowing global productivity by big global players like China and Brazil. Another thread of the theory is that super low prices will put a lot of energy companies into financial distress that will flow into loan and bond defaults. Alternately, productivity will increase and a wide range of benefits will accrue to the massive and diverse group of energy consumers ranging from trucking, manufacturing, chemical and material producers, agriculture, gasoline users (everybody) and so on…I pick door number two!
The vivid memories of the Financial crisis of 07-09 are still paramount as every time a sector of the global economy has difficulty; a waiting army of doomsayers surface to warn of a new “meltdown” or other similar yet unlikely catastrophe.
As we discuss repeatedly, fear is a very powerful driver of markets, traders and investors. It is important that we continue to vigilantly guard against this emotion or fear, rather than the boogieman that we imagine is just around the next corner.
It is commonplace to witness great certainty in what is being feared is actually ready to descend upon the masses. Then, the people who saw it coming will witness the unprepared dolts pay the price. When the predicted damage is averted again, pundits move on to the next bundle of worries that are about to spiral into chaos. Yet, somehow progress is made and the financial system and global economy adapt and move forward. Most of what the market fears never seem to come to fruition.
My friends, whatever the markets throw our way, we need to be prepared to maintain resolve in order to reap the middle run and long term rewards of equity investing. One of the significant barriers that I see is the interaction of two powerful cognitive biases that lurk inside of all of us: Overconfidence bias and Loss Aversion.
Confidence in our abilities is one of the most powerful character traits that build success in family, love, science, athletics, professional life and just about every endeavor attempted. The deep belief in our ability to act in intelligent, skilled and high performing ways can be the key ingredient in achieving success, breakthroughs and innovation that drive our world forward. The moment of doubt is not what propels us to scale the most important challenges that we face but rather the absence of hesitation and doubt form the triumphs of mankind.
Loss aversion is the natural human tendency to travel the safer road and to constantly seek to diminish or eliminate risk of ruin. This trait of safety in the face of all the complex risks that we face in our daily life is automatic and done often without conscious thought. The human mind is built on a platform of risk aversion, as survival was a daily challenge for much of human brain development.
The balance between human confidence and the natural tendency of loss aversion is critical to success. We must be able to pursue the goal without being paralyzed by the potential downside. The essence of human progress is when we can throw hesitation aside and strive for what seems improbable or even impossible.
Our Homo Sapien brains have been programmed over tens of thousands of years with these traits that have had useful utility in survival and prosperity of our ancient ancestors.
The modern world presents many challenges that our Neanderthal forefathers and foremothers could not have imagined. Knowledge in seeking improvised shelter and slaying a wild boar is just not a valuable as it used to be. We live with the caveman’s instinct and thought mechanisms deep in our brainstem, while we use pocket supercomputers, GPS, and a multitude of modern tools to traverse ever more complexity in our daily lives. The cellphone media and socially over-connected world of 2016 is a long way from even ten, or twenty years ago, not to mention one or two thousand years in the past.
The human mind is being bombarded with information at a pace that grossly exceeds our abilities to effectively digest much of what is broadcast in any meaningful way. The modern info stream exacerbates the thinking and judgement errors made by evolutionary traits that are now manifesting in cognitive bias errors.
Modern media is crafted to attract attention in many ways. Fear is exploited in many financial and general news programs. Viewers cannot look away from the terrible events that seem to occur endlessly around the world. The 24/7 media stream is happy to camp out at the site of the latest tragic event until the next attention grabbing story draws attention.
There is a growing body of research in the realm of cognitive biases that has begun to reveal how many human conscious and sub-conscious psychological tendencies put individuals in positions that are counter their best interests.
https://www.cia.gov/library/center-for-the-study-of-intelligence/csi-publications/books-and-monographs/psychology-of-intelligence-analysis/art12.html
A particularly striking example is that of “Overconfidence Bias” i.e., overestimating or exaggerating one’s ability to successfully perform a particular task. This is where our human confidence gets us into trouble in subtle yet critical ways.
Individuals are often susceptible to overconfidence when they take current events, financial media or peer group commentary as evidence for forming strategies or actionable changes to their investment portfolio. I often witness this as clients voice strong opinions over matters that I perceive as common and best ignored. Often these powerful viewpoints are based on little more than coincidental exposure to a financial media commentator, radio show or stray comments from family or friends.
This is not to claim that in my role as a professional advisor I know what is important to consider and what is not. I will say that I have been immersed in financial media, academic research and study of best business practices for most of my adult life and that I have built up a certain tolerance to the excitement of a given day, month or down year.
The reality of news, scary events, political rancor, oil price changes and all of the infinite things that continuously shape the economy is that the impacts are extremely difficult to interpret in real time. The implications of any given event are impossible to predict with certainty, thus reacting is counterproductive as middle-run and long-run outcomes are unknowable. The critical trait of successful long term investors is to have a philosophical platform for our thinking so that the impact of dramatic events is reduced. Daily news is mostly noise that does not change the nature of the long term process of building up financial strength through unshakable belief in the value of long term, broadly diversified equity investing.
It is at the very moment of overly confident assessment that the thinking bias of loss aversion can drive our thinking to thoughts of safety and protection from loss when doing nothing is the best course. The danger of overconfidence stoking loss aversion is very common in that people enter a state in which their fears become real; they are certain in simplistic assessments of complex matters that should be ignored.
Our modern media scape has a powerful effect in that infotainment has become a seductive outlet for many people in the effort to make sense of what is happening in a scary and complex world. It is not likely that the world has changed all that much, but the endless exposure to 24/7 coverage of everything that is happening via cable news outlets and powerful cell phones with media capability is a relatively new phenomena for investors to adjust to.
The cell phone as a TV replacement is a consciousness altering intruder of mammoth proportions. Look around any group of people and observe how many of them are glued in a weird attention vortex of fascination from pictures of what a friend had for lunch, picture of a new dating prospect or web page of some pointless triviality. The constant companionship of the “smart” phone is a portal into internet driven media striving for attention with whatever technique that can be employed to get the users attention.
In between the distractions, cell connected citizens are never un-coupled from updates of anything that happens in the realm of national or world news. It is unlikely that there are many worse things happening than other periods of history, but rather that we are much more aware of what has happened. This is likely to exacerbate fear and risk aversion as we exist in a realm of awareness of many terrible things that happen on a daily basis in our giant world. Our mind has little ability to create context or perspective for the sheer quantity of things that are reported to us in an un-filtered wave…think of the notion of drinking unfiltered water every day and the impact that would have on one’s health, and yet this is what many people are doing with their information flows.
This awareness creates a sense of knowing (overconfidence) when all that has really happened is that the daily noise of our giant planet is being condensed and streamed into our consciousness without qualitative assessment. This is rarely valuable or actionable material for reliable investment decision making. All of this imagery compounded by “infotainers” and their charming commentary deludes people into a state of (unwarranted) knowing, when in actual terms individuals may be drastically ill-informed.
As the quantity of information increases, the quality of it spans a long range and this variation in usefulness is not obvious. The minute by minute coverage of terrible events worldwide does not seem to be very useful, but networks with time to fill do not filter stories for relevance other than viewership ratings. The progression of news coverage is driven by profitability out of necessity, as one must always remember that television and most internet media is fundamentally an advertising business, not one of deep and intensive journalism.
Internet media driven by sensationalism and the race to be noticed is continuously being made more competitive. All of this competition drives coverage to an odd place that is governed by sensational and attention grabbing material rather than nuanced journalistic pursuit of complex, granular information and intellectual discussion.
This environment yields a structurally flawed connection between “infotainment” and viewer insight and comprehension. In-depth economic discussion and analysis is nearly unwatchable for most of us in comparison to hysterical warnings of monetary crisis, replay of the housing meltdown, geopolitical conflicts and all of the broad range problems that lie ahead.
The takeaway for many people is one that seems stark and actionable, when often there is no reason to be alarmed. Thus, the overconfidence that is transmitted by televised and internet “news” creates a feeling of knowledge where that intelligence does not exist.