Fear and Investing (Part III)

This article marks the third installment in a series that I initiated back in June 2022. My goal from the outset was to draw a parallel between consumer behavior, as reflected in Google Trends, and the monthly fluctuations in the S&P500 index. The chart above showcases the market's changes depicted in orange, accompanied by the monthly patterns of individuals Googling the term "Recession" illustrated in blue. The reason behind this was to show the stock market is not just a numbers game; it's correlated with our dreams of retirement, our children's college funds, and our other investment goals. As humans, our emotional reactions are linked to the market's performance, often providing clues into its future movements.

A Year in Review

It's been a full year since the last update (you can find the link to that article at the bottom). In this 12 month span, we've witnessed the market rollercoaster through a tumultuous 2022 and a promising recovery in 2023, albeit until August hit. As we look at the latest 12-month data, a persistent pattern continues to unveil itself. The chart above, with its waves of market dips and peaks in "recession" searches, reveals a noteworthy inverse relationship. When the masses are overcome by fear, and fear-based narratives dominate the media (yellow arrow), the market tends to slide (red arrow). As that collective worry subsides and we realize things may not be as dire as we first thought, the market tends to reverse its decline.

A year ago, I made some light predictions based on the information at hand. Let's look at those calls:

Correct

1. "Our financial systems are not failing as they were in '08" - With the exception of a few minor hiccups involving regional banks, this has held true.
2. "We are (mostly) past the COVID-19 global pandemic in 2020" - The pandemic is under control. Hopefully I didn't just jinx it.
3. "There are reasons to believe we may be in the 6th or 7th inning of this market volatility." - We were actually in the 8th or 9th inning. Maybe some bonus points.
4. "Inflation numbers appear to be peaking" - Inflation has receded from a peak of roughly 7.7% in October last year to around 3.7% today.

Wrong

1. "This will cause the Fed to slow down or cease interest rate hikes" - While I might have been partially correct, they did continue raising rates, albeit at a slower pace.
2. "There are positive signs out of Ukraine which could eventually lead to a ceasefire." - Painfully wrong so far.

The purpose of this analysis isn't to boost my ego with a 4 out of 6 success rate (although not bad). It is to underscore the fact that emotions play a pivotal role in investment decisions. Despite our assertions of rationality and logic guiding our choices, emotions take the front seat more often than not. Picture your emotions when your account shows consistent growth versus when it plummets by 15% in a month. The latter triggers a more intense reaction, one that often leads to action that can be hurtful. This is where "loss aversion" comes into play.

Loss aversion is a cognitive bias that describes why, for individuals, the pain of losing is psychologically twice as powerful as the pleasure of gaining. The loss felt from money, or any other valuable object, can feel worse than gaining that same thing.*

The Emotional Auction

At its core, the stock market functions like an auction. When panic sets in and everyone's offloading their stocks, losses mount due to the fear of further decline. It seems counterintuitive, but it's a reality. Even financial advisors aren't immune to these emotional tides. However, to serve our clients effectively, it's crucial to conduct research and gather data as objectively as possible. This allows us to provide data based advice, addressing the emotional aspect as a secondary consideration.

The market is a mirror reflecting our collective emotions. Understanding this can lead to more informed and less emotionally driven investment decisions.

*thedecisionlab.com/biases

**For reference, Google Trends is a free service anyone can use that allows you to see what is on peoples' minds at any given time. You can search virtually any word or phrase and it will tell you what is the most popular time frame or frames for that specific word or phrase, based on a scale of 0-100. A score of 1 means the search terms lowest point of relative popularity and 100 would mean the opposite, the highest point of relative popularity. Google has also gained quite a bit of popularity over the past 18 years. That could certainly skew the numbers.