In December 2018 US equities fell by 16%. On Christmas Eve alone, they lost 4%. Little had changed in the global economy over the past month – but investors turned negative in droves.
After Christmas and through the first two months of 2019, the US equity market rose by nearly 20%. On 4 January alone, it gained 3%. Again, little changed in the economy but investors became excited again. Emotions move markets.
Emotions move markets because markets are made by humans. The human brain isn’t a cool, calculating, analytical machine – it’s more like a warzone where various parts of the brain battle for control. The biggest fight is between the neocortex and the reptilian complex: the ‘reasoner’ and the ‘lizard’."The human brain isn’t a cool, calculating, analytical machine – it’s more like a warzone where various parts of the brain battle for control."
The reasoner wants to take time, analyse issues and think about potential options before calmly committing to a course of action. The lizard sees every decision as fight or flight, life or death – needing an immediate, emotional, instinctive reaction. We all know people whose lizard tends to win out, and others whose reasoner dominates the contest.
Financial markets can sometimes get… lizard-y. They jump around and overreact. It’s useful to ask if lizards are driving the market when it falls. Is there something wrong with the economic fundamentals, or is an emotional overreaction on the go?
Late last year the world’s equity markets were infested with lizards. In December, investors became petrified and started to panic-sell. What made them rush to the exit at a time when they should have been doing last-minute shopping? Nothing. No key numbers were released, no company suddenly went bust and no government was overthrown. Christmas Eve, in particular, was pure lizard.
Two months into 2019, equity markets have bounced back to around their November levels. There are plenty of stories to explain this, with the shift in policy from the Federal Reserve getting most of the credit. Chair Jerome Powell’s pause in the interest hiking cycle has surely boosted investor confidence.
So, does this mean that reasoners are in charge of the markets again? We’re not convinced. The Federal Reserve meeting was late in January, and markets had already risen 14% in the month before that. A sharp market rally based on no real change in the fundamentals is just as lizard-like as an unprompted plunge. Joy has replaced fear in the markets – but we’re still in an emotion-driven environment.
Fear and joy on the S&P 500
- The S&P 500, usually the world’s most stable market, has been suffering from a lizard infestation recently.
- The double-digit fall then double-digit rally between November and February have left the market basically unchanged. The journey, though, has been wild, and many investors who panicked and sold in December have been burnt. Timing markets is tough, especially when emotions are running the show.
- If you’re investing for the long term it’s often good to look away from the markets and not react to their short term ups and downs.