Objectivity versus emotion in the stock market

Fear and loathing interferes with our good judgment. The MoneyLetter’s regular contributing columnist Ken Norquay applies lessons learned observing the recent U.S. presidential election to help us become objective investors.

What lessons can investors learn from the venom-filled campaign now that the U.S. election is over? In my stock market book, Beyond the Bull, I expound on the many benefits of being objective in assessing any investment situation. Objectivity gives us judgment and helps us prevent loss. Objectivity helps us see past short-term drama. During the recent election campaign, it was easy for Canadians to remain completely objective. After all, we were not voting and our opinion was completely unimportant.

I chuckle as I write these words, tongue firmly planted in my cheek. The exact opposite was true! Most Canadians felt overwhelming emotion for one side or the other. My left-leaning friends still have not gotten over Donald Trump’s surprise come-from-behind victory. They were completely nonobjective. They were emotional and 100 per cent biased. Consequently, they were totally shocked by the results.

How to become a better investor

Our goal is to become better investors. In order to achieve this goal, we need to remain as objective as possible, no matter how emotional the situation becomes. Let’s examine the election from the perspective of elector psychology.

If we were devout Democrats, we would be programmed to believe everything negative said about Mr. Trump and to NOT believe everything negative said about Hillary Clinton. If we were devout Republicans, we would have endorsed anything negative said about Mrs. Clinton and dismissed anything negative said about Mr. Trump. That’s how the human mind works when it gets emotional.

We are egocentric; our view is important, yours is not. We filter our information through our belief systems. When we are opinionated, we believe the data that support our beliefs and disbelieve the data that deny our beliefs. We live in a world dominated by our own beliefs. And the news flow around the election precisely illustrated that human character flaw.

When the FBI announced its investigation of Mrs. Clinton’s erased emails, supposedly about illegal arms sales, the Democrats dismissed it as an election gimmick by Trump supporters. Hillary would never do such a thing! Mr. Trump was accused of being against immigration because he spoke about building a wall between Mexico and the United States. Republicans dismissed it as a gross misinterpretation of fact by Clinton supporters and pointed out that Melania Trump herself is an immigrant.

There were many other emotional misjudgments and counter misjudgments, and we Canadians became involved as if we were Americans.

How does it feel (really)

Just for fun, take a few minutes to reflect on your own emotions during the election. As investors, we need to learn about ourselves. As you reflect on the news of the past six or eight months, try to remember how often you have been fearful. Some political analysts told us that Americans were choosing between two negative candidates. They said it was a campaign of fear. Please ponder this.

Both political parties tried to make the electorate afraid of the other candidate; some disaster will come to America if you vote for THEM.

Try to remember how easily you became afraid during the past few months. Media-backed fear mongers tried to persuade us that Hillary was a warmonger and that Donald was a sexist, racist bigot.

Why think about feeling fearful? Because fear is an important emotion in the investment business.

When a biased, fearful mind encounters any news story, it works from its bias. For example, “I support the X Party” or “I am against the X Party”. If the news is critical of the Y Party, the biased mind automatically focuses its attention on the negative qualities of the news story and ignores any positive qualities. Then it exaggerates those negative qualities. Then it develops a desire to harm the Y Party. Objectivity and truth are long forgotten. Our biased beliefs are in charge.

The bull and the bear game

In the stock market, whenever the market goes down for an extended period, investors become increasingly fearful. Investor fear makes us sell near the bottom. From the point of view of stock market psychology, a bear market is a time when the average investor’s emotions change from expectation of profit to fear of loss. Fear is what prevents us from buying into the stock market near the bottom of its cycle. In investing, fear is the enemy.

Fear of loss affects our investor mind in the same way as political fear affected the minds of voters and onlookers in the U.S. presidential election. From our bias, we think, “I will lose even more money”. Then we focus only on the negative news: corporate earnings are dropping, unemployment is increasing, etc. We ignore any positive facts (e.g., stocks selling at much lower prices could be bargains or that governments are bringing in aggressive stimulus packages). Then the fearful mind exaggerates the negative news: “OMG there might be a depression!” Then they wish to harm the perpetrator of their demise: Some financial advisor, some politician, whoever they blame for their losses. Any scapegoat will do. Then, in disgust, they will sell their stocks near the bottom of the cycle.

Always be objective about the stock market

Ordinary investors must remain objective about the stock market. How? By relying on a sound investment strategy based on objective data and stock market logic. Invest in securities that are in up trends. Sell stocks that are not in up trends.

It is natural for the human mind to get caught up in the heat of current events and to spin the facts through our bias of our personal beliefs and opinions. Objective investment judgment evaporates because our subjective, emotional view is so strong. Our sense of self is our biggest obstacle in investing. We must objectively observe the market and objectively assess our situation. Our personal opinions and emotions interfere with our objectivity.

With this in mind, let us objectively review the financial trends to see if Mr. Trump’s election has changed anything.

There were two strong up days in the U.S. stock market before the announcement of Mr. Trump’s win and two strong days after. Then the market stabilized. The U.S. market remains in a trendless sideways shift. The Canadian stock market peaked in September 2014 and is currently in a long-term down trend. The Trump rally lasted only four days, and the subsequent down days erased all the gains made in the short-lived rally.

The U.S. dollar has been in a trendless sideways drift since spring 2015. The short term Trump-rally has just broken through the previous highs. We will monitor this closely.  The Canadian dollar continued its long-term down trend vs. the U.S. dollar. There is no reason to change our opinion on either of these trends.

Interest rates are more interesting. Following Mr. Trump’s election, there was a sharp drop in U.S. bond prices. This equates to a sharp rise in long-term interest rates, which touched a low in winter 2015 and then bounced higher. Earlier this year, long-term rates touched a new low. The Trump inspired drop in the bond market was very sharp, indicating that perhaps interest rates are in an up trend again. It’s too soon to say right now. We will keep you informed.

Oil and gold prices continued their short-term down trends.

Notes to gold stocks traders

Emotional events sometimes produce good trading opportunities.

In our last column we cautioned traders that some gold stocks had had significant run ups. As of mid-November there has been an emotionally charged decline in many gold stocks. Good trading opportunities lie ahead when the current ‘correction’ ends. Consider trades in Detour Gold (TSX—DGC), Franco Nevada (TSX—FNV), Nova Gold (TSX—NG; NYSEMKT—NG), OceanaGold (TSX—OGC), Semafo (TSX—SMF), Silver Standard (TSX—SSO) and the iShares S&P/TSX Global Gold Index ETF (TSX—XGD). These stocks are in up trends, but have had significant short-term declines. Use your trading rules to time your entry and exit.

On another note, we saw a significant rally in oil following the sharp drop in prices from June 2014 to February 2016. We postulated that there would be another sharp decline toward the February 2016 low of $26.10 (U.S.) per barrel. Right now the price of oil is in the second sharp decline. If the February 2016 low is not undercut, there could be an important buy point for energy stock traders and investors. I will keep you informed.

Ken Norquay, CMT, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance.

 

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