Half way through – how do you feel?
If you were to ask people how they think the US Stock Market is performing this year, the sentiment would likely be mixed. You probably wouldn’t hear “amazing”, “strong” or even “good” as we close out the first half of 2016. Some people may even feel disappointed with the market’s performance. However, if you look at the Dow Jones Industrial Average (“DJIA”) from January 1, 2016 through June 30, 2016, you’d see a 3% increase…annualized that would be a 6% upturn for the year. This is not bad by any means. So, why aren’t people pleased? What is the reason for the disconnect?
The first two months of 2016 were certainly nothing to write home about. By February 11th, the DJIA was down 10%. That’s a bad year, let alone a bad month! The BREXIT vote took place in late June and we saw the market pulled back 4.8% within several days as a response to what some call an unexpected result. Yes, the market is up 3% as of July 1st, however it’s been anything but a smooth, steady ride.
There are a couple of psychological principles or “traps” that investors may be experiencing. The first one is the Recency Effect. It is premise that a person will recall recent information or events better than information or experiences that were presented in the past. The second is called the Negativity Bias, or the Negativity Effect. This is the notion that, even when of equal intensity, things of a more negative nature have a greater effect on one’s psychological state and processes than do neutral or positive things. In other words, something very positive will generally have less of an impact on a person’s behavior and cognition than something equally emotional but negative.
The most recent event that had a negative impact on the market is BREXIT, and we don’t think its long term effects have revealed themselves yet. With that said, as of July 1st, the DJIA did recover, within a few points, the decline it experienced after the vote. The Negativity Bias would be one explanation as to why people are still focused on the downturn and not necessarily the rebound.
Whenever the market is volatile, and 2016 has had its share of volatility, it is critical to have a system that keeps the emotion and the psychological traps out of your investment decision making process. Without a non-emotional investment process that relies on unbiased data in place it would be easy to lose sight of the fact that the US Stock Market is up 3% at the halfway mark and is certainly not in “bear” territory at this point. In fact, there are some sectors of the US Stock Market such as commodities, energy and precious metals which have fared quite well. As professional investors we believe it is critical to acknowledge the psychological traps and mitigate their effects by using impartial data and a well thought out investment playbook that is reviewed and executed on a consistent basis. This allows us to make changes when they make the most sense according to the actual market numbers and not by how we (or anyone else) is “feeling” about it.