Earlier in the summer, we presented our Investment team’s top literary picks for the season. We hope you enjoyed them! Now, in the spirit of sharing interests, we’d love to hear which books and podcasts have caught your attention lately. Share your recommendations HERE and we may feature them in an upcoming edition of Inside Edge!
The worst day for momentum since 2009
Earlier this week many growth stocks (generally companies that are seeing rapid profit increases) took a dramatic turn downward as measured by Bloomberg’s Pure Growth Portfolio. In essence, many of 2019’s hottest stocks took a large hit, while the year’s most unloved stocks have enjoyed a rally.
This sudden reversal is what drove US momentum to have its worst single-day decline since 2009.
Can you stomach the next big market swing?
The quiz that your financial adviser may have given you isn’t really a good way of understanding your tolerance for risk.
If I ask you in a questionnaire whether you are afraid of snakes, you might say no. If I throw a live snake in your lap and then ask if you’re afraid of snakes, you’ll probably say yes—if you ever talk to me again.
Investing is like that: on a bland, hypothetical quiz, it’s easy to say you’d buy more stocks if the market fell 10%, 20% or more. In a real market crash, it’s a lot harder to step up and buy when every stock price is turning blood-red and your family is begging you not to throw more money into the flames.
This is why financial advisors use risk tolerance questionnaires to help determine how much risk their clients should be exposed to. Unfortunately, imagining your future behavior or accessing that behavior from a risk questionnaire isn’t as easy. New research shows financial advisers create drastically different portfolios even when clients appear to have the same tolerance for taking the risk.
Professionals in many fields are vulnerable to what the Nobel prize-winning psychologist Daniel Kahneman calls “noise,” or variation in judgment driven by such irrelevant factors as emotion, time of day or the weather.
To do better, think about how your past experiences might shape your future expectations. Did you buy your first stock at the beginning of a bull market? That could skew you toward taking more risk. Did you start a business during a recession? That could make you more gung-ho if it thrived or gun-shy if it failed.
One researcher suggests that the best guide to whether you will dump stocks in the next financial crisis is whether you did in the last one.
Your perceptions of risk are only part of the puzzle. At least as important is your risk capacity. Think of your spending habits, your non-financial assets and how easily you could sell them in a pinch. Also vital are your goals. You can’t know how much risk to take until you estimate when and how much you’ll need to spend in the future.
Ultimately any good adviser should devote more time to your risk capacity and your goals than to your risk tolerance.
A behavioral prescription
There have been 17 separate 5% pullbacks since stocks bottomed in 2009. Each one of them felt like the top. The chart below shows some of the headlines and quotes you might have read during these market declines.
It’s hard to see headlines like this and not act on them. We know now that our worst fears did not come to pass, but there was no way to know at the time that each and every one of these pullbacks would resolve themselves to the upside.
One of the worst things that investors can do is overreact to market volatility. It’s perfectly normal to feel something, but adopting an all in or all out mentality when the market goes up and down is destined to fail.
How the invention of spreadsheet software unleashed Wall Street on the world
At one point or another many of us have had to use spreadsheets for school, work, or personal use. This article points to some interesting correlations between Wall Street and the rise of the spreadsheet.
In 2010, a pair of researchers published a controversial economics paper. It was cited by UK politicians to justify austerity measures that sparked economic and employment crises, and anti-austerity protests—measures that the UN later called “punitive, mean-spirited, and often callous” inflicting “great misery.” In 2013, however, this widely influential paper was found to have been substantially off in its estimates, thanks in part to a simple spreadsheet error: specifically, “a few rows left out of an equation to average the values in a column,” the Guardian wrote at the time.
This famous foul-up is just one of many instances when digital predictions have let us down, creating a sharp contrast between the reality of things and what the numbers foretold.
Rock-bottom bond yields spread from Japan to the rest of the world
When the Bank of Japan’s board meets on September 19th, it is not expected to reduce its main interest rate, currently at -0.1%. But any increase in interest rates seems a long way off. And as long as rates are at rock-bottom in Japan, it is hard for them to be raised in other places. Bond-buying by desperate Japanese banks and insurance companies is a big part of what keeps a lid on yields elsewhere.
Japan is already the world’s biggest creditor with its net foreign assets (Japans assets minus what they owe to foreigners) at around $3 trillion, or 60% of its annual GDP. This chart shows how since 2012 both sides of its national balance-sheet have grown rapidly as Japanese investors borrowed abroad to buy more and more assets.
Globally, Japan’s impact is felt most keenly in corporate-credit markets in America and Europe. Japan’s pension and insurance firms are in a pinch to make regular payments to retirees so they look abroad for yield. Some see Japan as a template: its path of ever-lower interest rates is one that other rich, debt-ridden economies have been destined to follow and will now struggle to escape.