For this week’s article, I contemplated writing about former chairman of the Federal Reserve's Ben Bernanke’s speech at a CFA event in Boston. During the speech, Bernanke laid out several reasons for why he believed the market still had room to run. All of his reasons were intelligent and well thought out, but I was concerned that I would have to include some type of caveat about how the speech was just one man’s opinion and not necessarily what would happen. At the same time, Bernanke is a highly respected economist and his opinion does matter. This brings up an important topic and one that I’ll be discussing at our annual investor conference several weeks from now: our collective opinions on the markets matter.
This year our investor conference will focus on smart investing and how decision-making plays a role in how we invest. You may be thinking to yourself “of course decision-making plays a role in how we invest – I have to decide what to buy/sell and when to buy/sell it.” This is true, but what’s really important is how you come to that decision as well as how others come to that decision. I recently read the book Misbehaving by famed economist Richard Thaler in which he discusses how our emotions cause us to make irrational decisions, a topic that has come to be known as behavioral economics. What’s interesting about Thaler’s findings is that it’s not just our own emotions that affect the returns on our investments but also the emotions of others.
When I was first learning to drive one of the things my dad repeatedly cautioned me on was to remember that even if I was driving well, others might not be and I had to drive for all of us. In many ways, the market operates on a similar premise. When we see the ticker for the S&P 500 move up or down, we’re seeing the result of hundreds of thousands of decisions being made. If the majority of those decisions are to buy, the ticker moves up. If the majority of those decisions are to sell, the ticker moves down. This is where Bernanke’s speech comes in. On his own, one person’s decision making does not move the market. When I log in to trade one share of Apple, the market doesn’t take notice. I am just one single thread in a large tapestry. However, when an influential individual like Bernanke makes a statement about the economy to a large room of investment professionals he has the potential to alter their decision making. It doesn’t mean that he’s right but it does mean that more and more individuals are making a certain type of decision and those decisions collectively influence how the market moves. What this means is that not only to do we have to invest based on economic indicators but we also have to invest with the expectations and emotions of others in mind. Just like I need to be mindful of the other drivers around me when I’m driving, I also need to be mindful of other investors when I’m trading. Are they feeling positive about the market or are they fearful?
To prove that investor sentiment matters, consider one final example: on Monday, October 19, 1987 stock markets around the world crashed with the Dow Jones declining by more than 20%. What’s interesting about Black Monday is that it’s difficult for economists to nail down what exactly caused the crash. There was just a compounding amount of fear in investors. The emotions of ourselves and others matter because they influence the decision-making that moves the financial markets. If you’d like to learn more about behavioral economics we invite you to attend our annual investor conference (you can learn more about it and register here).