Many cite human emotions as the single greatest impediment to investment success. Intuitively, we understand the buy low and sell high thesis. Unfortunately, in real life, this is often not the case. In this post, we will discuss a few examples on how emotions obstruct prudent investment decisions.
Empirical Versus Anecdotal
It’s been said that investing is an art and a science. Some investment decisions are rooted in fact, while others are based on feelings or perceived experience. All of us have fallen prey to our emotions at some point. Here’s my story.
Prior to the mid- to late-90s, I believed one political party was right and the other wrong. My views have changed significantly since then. In the early 1990s, William Jefferson Blythe Clinton was elected President with 43% of the vote, thanks largely to Ross Perot. At the time I leaned pretty far to the right. My views have moved much closer to the center since then. On the day of the election – a rainy day in Baton Rouge as I recall, I was convinced that a Clinton victory would propel the stock market lower. I confess, my investment acumen was sorely lacking back then. Obviously, this “feeling” proved incorrect. The fact is that we were in the midst of one of the greatest stock bubbles of all time. Fast forward 24 years.
When Donald Trump was elected in November 2016, a client (who did not like DT) instructed me to reduce their stock holdings considerably. Despite my advice to the contrary, I relented (after all, I do work for him). We all know what happened next.
What was the difference between these examples? There is a substantial gap between academic and real-world experience. I was studying for my CFP in the first example and lacked the benefit of decades of research and practical application. In the latter example, I recognized the policies Trump wanted to install were very business friendly. For example, the regulatory constraints have been relaxed and taxes were reduced.
Whether you like this president or not, these “policies” have helped stimulate economic growth, bolster corporate profits, both of which have been a major catalyst for stocks. Yes, his tariff policy has caused considerable unrest in the markets, but we’ll have to wait and see how it ends.
Where Are We Now?
I believe we are in the late stage of the expansion cycle. From the end of the Great Recession on May 31, 2009 until shortly after the 2016 election, the economic recovery had been the weakest in the post WWII era. Why? According to one Fed President I spoke with in 2014, fiscal policy was a drag on economic growth. In fact, if fiscal policy had been more business friendly, GDP would have exceeded 3.0%. The fiscal drag was largely due to increased regulations and to a lesser extent, additional taxes imposed on certain businesses and wealthy individuals.
President Trump has reversed many of these policies. To be fair, unemployment declined significantly during the Obama years, but so did the labor force participation rate. Today, there is much less uncertainty in the business world and the economy is doing quite well.
A Recent Conversation With a Client
I was speaking with a client recently about the over-valuation of the stock market (using market cap versus GDP). I said stocks were about 48% over-valued in March 2000, just when the Tech Bubble burst. I added that overvaluation reached an all-time high of 50.7%, January 26, 2018. I also explained that on June 3, 2019, if the U.S. can avoid a recession until then, this will become the longest expansionary period in the history of the United States. He was obviously concerned and asked if I was going to reduce his stock exposure. I said not quite yet, but perhaps soon.
Despite these facts, I don’t believe the market is at the precipice. At least not yet. I do believe a significant decline in stocks is highly probable sometime in the not-too-distant future. Hence, it’s not a question of “if,” but “when.” We also know stocks can’t rise forever. We know a recession and correction/bear market/crisis will come at some point. We just don’t know when.
Although we have an abundance of data and information, the fly in the ointment resides in our interpretation. Predicting human behavior is unreliable, which is partly why our emotions mislead us.
Thanks for reading and have a great week!