Is your glass half full?
Is the glass half full or half empty? This classic question derives from psychologists showing a picture of a half-filled glass of water to their patients. Depending on the response, they determine their patients’ general orientation and outlook on life. This is far too simplistic of a method to get at the real issues but is nevertheless an interesting exercise.
The S&P 500 is up 15% over the last year but down 10% over the last 10 days. Is your glass half empty or half full? Our guess is that more of you are feeling half empty than half full at this point, whether you’re generally an optimist or a pessimist. Here’s why; traditional finance ignores investor emotion. Traditional finance focuses solely on return. Traditional finance would definitely see the glass as half full. You are up 15% over the last year and almost 300% since the 2009 low. By historical measures that’s a great return. Traditional finance can’t comprehend why investors would not be ecstatic about their return in the stock market.
Behavioral finance is a relatively new but fascinating field of study. It focuses on emotion and reaction, as opposed to return, to explain investor pleasure and regret. It focuses on how investors view market movements and how this impacts their decision making. At GreenPort, we’ve been spending considerable time researching behavioral finance and exploring how it might fit into our process. We are planning an interactive event this spring to explore the cognitive biases we all possess as investors. (That’s a teaser, we hope it worked.)
In the meantime, our guess is that most investors are feeling half empty. Within behavioral finance is a component called prospect theory. Prospect theory states that traditional finance fails to properly capture how investors view returns. Prospect theory shows that investors view returns relative to their personal high-water mark, not long-term success. So today, investors feel they have lost 10% of their money. They are not happy. Investors get little to no joy even if they have still made 15% over the last year. Our job at GreenPort is to make sure investor emotion does not lead to emotional decision making.
We continue to believe that the current sell-off is another, albeit more dramatic, panic attack within the current bull market, which started in March 2009. It’s understandable why investors continue to be nervous. Investors lost 56.8% prior to the 2009 lows. Here’s a look at prior panic attacks that caused at least a 5% correction during the current bull market. There were many more pullbacks that didn’t quite reach the 5% threshold. Here is a short sample of reasons for market sell-offs in the last few years: North Korea, Trump impeachment, Brexit, Fed tightening, FBI flagging HRC, Greek debt, ETF flash crash, Crimea invasion, Ebola scare, etc.
We aren’t making light of these prior sell-offs and certainly don’t believe trees grow to the sky. The reason we believe that markets will eventually move higher is that we don’t see a systemic reason for the sell-off and believe it is primarily a reaction to higher interest rates, which are the result of an improving economy. With the new Fed chairman, Jerome Powell, taking over for Janet Yellen, there is fear that the ultra-easy monetary policy will change too quickly. The market has a way of testing new Fed chairmen and making sure the change doesn’t happen, even if it scares us all by selling off.
The GreenPort Team