By Michael McKeown, CFA, CPA - Chief Investment Officer
Last year Nobel Prize-winning economist Robert Shiller wrote Narrative Economics. It talks about how simple stories drive the economy and details that narratives can influence how people invest, save, and spend. These stories contribute to the booms and busts the economy experiences over time.
Examples of stories can range from the tech bubble, to the housing bust, or even all the way back to the Great Depression. But hindsight bias teaches us that many of these stories are so much easier to identify after the fact.
“Life is a picture, but we live in a pixel.” – Wait But Why
In day to day life, we are bombarded with news stories, fed through our phones, laptops, and TVs. But positive stories do not get the attention and eye-balls news media needs to sell ads. Negative stories grab our minds because it is a survival mechanism we evolved in order to avoid threats. This was great for our ancestors when running from predators but not as much today with the constant pinging of our phones. The following from the Wall Street Journal accurately details how our minds are wired:
“Our minds and lives are skewed by a fundamental imbalance that is just now becoming clear to scientists: the negativity effect. Also known as the negativity bias, it’s the universal tendency for bad events and emotions to affect us more strongly than positive ones. We’re devastated by a word of criticism but unmoved by a shower of praise. We see the hostile face in the crowd and miss all the friendly smiles. We focus so much on bad news, especially in a digital world that magnifies its power, that we don’t realize how much better life is becoming.”
There were several stories in just the last 12 months that drove market prices. It started with the Federal Reserve raising interest rates, then the trade war, then the inverted yield curve, then impeachment. Most of these events were painted as negative narratives at the time. The market shrugged these off for the most part and continued rising throughout 2019. (Of course, that has a little hindsight bias thrown in. Markets could have also gone the other way, and likely will one day. The reason will be obvious, after the fact).
The geopolitical risks escalated last week with the U.S. strike killing Iranian General Soleimani. While the human and political side of this discussion in the Middle East is magnitudes of more importance, capital markets will invariably be affected as well.
Following the strike, oil prices rose sharply above $70 per barrel. Stocks dropped slightly but remain near all-time highs. Bond prices rallied on the news as yields fell. Safe-haven money flows went to gold. We will continue to monitor the news trends, in addition to the valuation levels across asset classes for possible entries and rebalancing.
With the turning of the page to a new year comes Wall Street forecasts of what they see for the year ahead for stock prices and bond yields. We find it much more valuable to have a plan to respond to price action (to the up and downside), rather than giving point estimates which invariably turn out incorrect. In this way, risks can be framed as potential opportunity.
Kicking off the new year is a great time for reviewing the actions we control. Is the Investment Policy Statement correct for my financial situation? Are there tax planning items to consider for 2020? Is there a way to increase the savings rate? Am I getting the big purchases right, like houses, cars, and education? Is there anywhere to improve current services or costs through insurance, mortgages, banking, etc.?
Looking at personal financial decisions through this lens lets us individually shape the narrative, instead of the outside voices. We can focus on what matters for us and our situation. We control the action, instead of the negativity effect. In this way, financial goals become attainable and within reach. It is possible to break though the negativity and change the narrative.
"The negativity effect sounds depressing—and it often is—but it doesn’t have to be the end of the story. By recognizing it and overriding our innate responses, we can break destructive patterns, make smarter decisions, see the world more realistically and also exploit the benefits of this bias. Bad is stronger than good, but good can prevail if we know what we’re up against." - WSJ For the New Year, Say No to Negativity
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