A common joke among advisors is that if you put 10 economists in a room together, we will get 10 different ideas of where our economy is going. The fact of the matter is that no one has a crystal ball that they can use to predict changes in the economic engine with 100% accuracy. In terms of the economy, much of the opinion
pieces the public receives are just that: Opinions from those that are paid to make a story. During periods of volatility the risk that you avert your attention away from true fundamentals and towards what may be considered “noise” in the market is very real. The noise in this echo chamber can rattle even the most seasoned investors. This leads me into the topic of my article: fear, greed, & the economy, and how these in combination with behavioural finance patterns can either increase or decrease your wealth.
Behavioural finance is the study of how emotional and psychological factors affect your investment decisions. Now, I won’t put you through a class of every single factor, but to help give you an idea of some behavioural finance patterns, I have included a couple of relevant definitions below.
Herding: the tendency to use the behavior of others as an input into one’s decisions.
Recency bias: the tendency to more easily recall recent events and to think that such events are more probable than is really the case.
Fear & Greed
Fear & Greed are two factors that I speak of often. These are negative traits that can greatly reduce the performance of your investment portfolio over time. It is important to identify these traits so to not succumb to enacting investment decisions based upon them.
Fear: The act of letting emotions get the best of you in a negatively volatile environment. When you are surrounded in an echo chamber of negativity (as described above), fear may set in. Perhaps, we just went through a recession and your beliefs are that the economy will never reach its past strength. Or maybe it was that everyone you knew was fear selling so you followed the herd and sold the investments in your portfolio. Both are great examples of how your emotions can get the best of you and how wealth can be destroyed. When you invest based on the conviction that you hold quality companies, and that you paid quality prices for those same companies, these fears should be subdued.
Greed: The fear of missing out (FOMO) plays a big role in terms of greed. The disciplined investor would argue that as we reach the peak of an economic cycle the market values of many companies become overinflated, so it is prudent that we only invest in quality companies at quality prices. However, that is not the case for those wrapped up in greed. Greedy investors neglect to truly value the company they are investing in, therefore, the investment thesis is no longer based on fundamental strength, but rather on the idea that the next guy will be dumb enough to pay more for an already over priced company. At some point realization of true worth sets in, and the market value of this company could fall, potentially leading to large losses. Both Herding, and Recency biases play a role in greed as well.
Where we are in the economic cycle can greatly affect the types of returns we see. This is why we need to invest with a full business cycle in mind. Currently, the economic data suggests that we are somewhere near the peak of the economic (or business) cycle.
The Yield Curve
As of August 27, 2019, the 10-2 year
yield curve was sitting at -0.04. This
is concerning because an inversion
indicates that we are approaching a
recession. The general consensus is
that a recession usually follows 15
months after - however, take that with a grain of salt. Some economists suggest that because of interest rates close to 0% for the past decade the yield curve indicator accuracy is distorted. This is an
interesting point of view, but most still view it as a very important and accurate indicator of where we are in the cycle. So for our purposes, we will take the possible distortion with a grain of salt as well.
The purchasing managers’ index tracks industrial activity across the United States. The most recent volatility that we have seen in the market was largely in part due to the weak reading from this index. Standing at 47.8 (for September 2019), This is the
lowest the index has been since the
end of the financial crisis in 2009.
Any level below 50 typically indicates a contracting manufacturing sector.
In addition to the recent yield curve
inversions, this has been fueling the
fear of an upcoming recession.
Domestic consumer spending represents about 70% of the United States GDP. Some economists believe that this data may prevent the United States from entering a recession. The strength of the domestic consumer could lead the United States to have a soft landing instead. This would overall be a positive for our investment portfolios, however, I believe it is paramount to err on the side of caution.
Although it is impossible to accurately predict the economy, I believe that it is very important that we take the data at hand to help structure our portfolios and investment decisions. Based on some of the data above, it is not the time to be taking unnecessary risk in your portfolio. However, I still hold the conviction that we need to remain invested. We could have an amazing year(s) ahead of us and if we are not invested, we hold the risk of missing out. This could lead to you not having enough money come retirement or running out of money in retirement. Both are very important risks to consider alongside the investment risk in your portfolio.
We are likely entering a volatile period in the markets which is why I started off this article with behavioural finance traits. It is my view that, if holding quality companies at quality prices, short term noise (regardless of how loud or prominent) is not important and should not be the basis of your investment decisions.
One of the best ways to overcome negative behavioural finance patterns, is to work with a knowledgeable financial advisor. As always, my door is open for any questions, comments or concerns.
This article should not be used in and of itself as the basis of any investment decision. All changes to your portfolio should be discussed with a financial advisor.
The opinions expressed within this article/communication are those of the Financial Advisor and are not necessarily those of Keybase Financial Group Inc. Any data provided is for illustration purposes only. Clients and prospective clients should always read a product prospectus and fully understand all of the risks associated
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