An Emotional Burden
Doug Walters
At one point in human evolution, our instinct to flee during times of emotional stress served us well. However, that same primal instinct is detrimental to investors. Now is a good time to shift your focus from the emotion to the evidence.
Contributed by Doug Walters , Max Berkovich ,
U.S. stocks dropped a bit this week as investors contemplate rising new COVID cases globally, the coming election, progress on stimulus, and some positive vaccine headlines. It is a lot for investors to take in. As we discussed on our recent webinar and last week’s Insights (Following the Evidence), setting emotion aside and focusing on the evidence is always the best approach.
When it comes to investing, our brain can be our own worst enemy. As it turns out, we have many instincts hardwired into our brains that aided our evolutionary survival but work against us in modern times as we build our nest egg. Understanding these biases is a critical skillset for investment professionals and something we see as important to educate our clients on. One such example is illustrated beautifully in a study by Shiv et al. in 2005. The experiment involved unique test subjects with brain lesions that prohibited them from feeling emotion. What Shiv found is that when emotion is removed from the investment process, better decisions are made. Those with “normal” brains were influenced by emotion and made poor decisions, even when the optimal decision was obvious.
In the real world, the optimal decision is often less obvious, but the principles remain the same: act on evidence, not emotion. So the next time you feel emotion creeping into your investment decision-making, think about Baba Shiv and refocus your attention on the evidence.
Testing the Impact of Emotion on Investment Returns
The Shiv et al. study from 2005 compares how investment decisions differ for participants who cannot experience emotion (due to brain lesions) compared to those who feel emotion. The study involved 20 rounds of coin-flipping. “Investors” had the option to sit out or invest $1. If they won the coin toss, they would receive $2.50. If they lost, they would lose $1. Clearly, it makes sense always to invest. Yet, after a loss, the “emotional” investors were much more likely to sit out. We see this in the real world. As markets decline, emotions drive investors out of the market, even though logic says the market is now better value.
Headlines This Week
Stimulating conversation
- The stimulus deal has been in the headlines all week, with very little progress made.
- According to Bloomberg news, Treasury Secretary Mnuchin made some concessions with House Speaker Pelosi, agreeing on a package that would be worth around $2 trillion.
- Even if a deal is struck, getting support from the Senate will be challenging as there is significant disagreement with the bill amount and what the bill funds.
- Across the pond, the European Central Bank (ECB) is preparing additional aid with a package estimated to be around €500B.
- The ECB’s President Lagarde said there was no reason to wait, as Europe is seeing a rise in COVID-19 infections.
Paycheck
- New unemployment claims came in better than expected with 787,000 new claims, the lowest since the pandemic started.
- Continuing claims dropped more than expected to 8.377 million.
- However, this number does not include those receiving emergency unemployment compensation. There are still 23.2 million in total receiving some assistance.
This Old House
- The demand for housing continues to run hot, fueled by low rates and people moving out of cities and into suburbia.
- Low supply and high demand for existing homes are putting upward pressure on house prices.
- Building permits for new construction is getting closer to the level last seen in 2000 and slightly above the 30-year average.
The Week Ahead
Big Numbers and Big Noise
Preliminary 3rd Quarter Gross Domestic Product (GDP) at home and in Europe will be released next week.
- The numbers are expected to be huge. For example, quarter over quarter GDP growth for the U.S. is expected to be 30.8%.
- Just for reference, the 2nd Quarter had a 31.4% quarterly decline.
- The Eurozone in the aggregate is expected to report a 6.8% drop from last year and a 10.0% increase from the 2nd quarter of this year.
Attack of the Tech
The busiest week of earnings is next week. All eyes will be on the technology heavyweights.
- Apple Corp. (AAPL), Microsoft Corp. (MSFT), Facebook, Inc. (FB), Alphabet, Inc. (GOOG, GOOGL), and Amazon.com, Inc. (AMZN) are all reporting next week.
5-Year Plan
The second biggest global economy will chart its 14th five-year plan as China’s Communist Party Central Committee will meet for four days.
- The ruling Communist Party’s elite will chart both the economic and social course for the next 5 years.
- Sustaining steady growth is expected to be the priority and a focus on spurring domestic demand, innovation, and self-reliance as a road map to get there.
- Experts are closely monitoring whether China adopts a more flexible economic growth target, especially after dropping it this year due to the coronavirus crisis.
- A rigid target has been linked to reliance on debt-fueled stimulus in the past to reach targets at the price of encouraging more productive investment in the long-term.
- China’s challenges include an aging population, weakening effects of globalization, and growing tension with the U.S. and other global players.
ReiteRATE
Several Central Banks have interest rate decisions on their calendars, including the Bank of Canada, the Bank of Japan, and the European Central Bank.
- With rates low-to-negative, decisions may not be interest rate related, but more on stimulus plans and non-traditional tools.
- Additionally, the press conferences will be watched for additional of data on the global economy.
Other Nuggets
As always, the last weekly Jobs numbers will be critical with the election on November 3rd.
- Inflation readings, durable goods orders, housing numbers, consumer confidence, and regional manufacturing surveys round out the calendar.
- Maybe a stimulus bill before the election?
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