Your fixation on short-term data may be costing you money
Jeremy Siegel preaches perspective but investors don’t appear to be listening.
People have a tendency to put a large emphasis on the present. The stresses of day-to-day life seem harsh. The rush of life seems fast. The project at work seems more important than any other. Over the short-term, we fixate on things and exaggerate their long-term importance.
Take a step back. Many of these fixations are just tiny blips. They do not have outsized impacts to the long-term trajectory of our life. There are people and events that will shape our lives, and there are insignificant daily occurrences that will fade with time and perspective.
Markets are the same way. We obsess over every data point. Our current fixation is on interest rates and the timing of potential rate cuts. We speculate endlessly on how many there will be and when they will happen.
For the last two years the market has surged on optimism that cuts are imminent. Those hopes get dashed and the market retreats. What matters over the long term is whether interest rates are going to be closer to zero or closer to their current level. Over the long-term, economic growth will provide a tailwind to companies or hold them back.
Siegel’s comments on market noise
Jeremy Siegel, Author of Stocks for the Long Run and renowned financial markets commentator has fiercely advocated for long-term investing.
His recent appearance on CNBC was no exception. He detailed the hypersensitivity of the markets to inflation data as an example.
The US inflation data reported on April 10th is an example. Reported CPI increased 0.4% which was above the market expectation of 0.3%. Share markets in the US and Australia have fallen close to 3% since the new data. Siegel observed that if the data had come in 0.1% less the reaction from the market would have been starkly different.
He cites another example. The Federal Open Market Committee (FOMC) has 19 members and meets 8 times a year to determine the appropriate monetary policy stance given the economic and financial conditions. Their December inflation estimate moved the market significantly. Siegel points out that if one of the 19 FOMC members had raised their inflation estimate by 0.1% it would have changed the median estimate of three rate cuts to two rate cuts. Siegel believes the market would’ve collapsed.
These two examples demonstrate the hypersensitivity of the markets and the ease in which news can swing the markets in both directions. Siegel believes the information that the market is acting upon isn’t representative of wider economic conditions.
Siegel calls out two points from the US Bureau of Labor Statistics (BLS) report that was released on the 10th of April. The report that the Shelter index increased 5.7% over the last year which accounted for over 60% of the total 12-month increase. Another notable increase was motor vehicle insurance which increased by over 22%.
These components of CPI are some of the most backward looking and not representative of the current conditions. The BLS uses an 18-month moving average that lags the market. Zillow (a US real estate website) measures monthly rentals which shows that rents have not moved year on year for almost two years.
Motor insurance is similar. Insurance premiums follow 12-15 months after increases in the price of motor vehicles. Again, this is not indicative of current conditions. Siegel thinks that the FOMC are ‘overstating and overthinking’.
And the market has moved significantly based on these forecasts. He thinks there will be two rate cuts by the end of the year, instead of the three predicted by the FOMC.
This is not a unique scenario. Paying heed to market noise has usually been to the detriment of investors. Our Mind the Gap study looks at the hard data behind this. In Australia, investors have lost 7% of their total return to poor decisions. These often arise when investors react to short-term performance and speculate on short-term movements. Other countries fared worse.
Another insight from our research is that generally, big pivot years for the markets lead to more timing mistakes by investors. Investors generally sell after a bear market and buy after a bull market – even though one of the most well-known investing adages is buy low, sell high. This played out during the GFC for US investors, where the gap widened even further as panic selling occurred at the bottom. These investors missed out on a dramatic rebound.
Are you an investor or a speculator?
Investments have a tendency to gravitate towards their fair values in the long run. Benjamin Graham is often given the title the ‘Grandfather of Value Investing’. He famously said “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
What he meant is that a voting machine deals with day-to-day short-term expectations. The weighing machine refers to the longer-term drivers of share prices. Over the long run the actual performance of a company and an economy impact performance. Simply put, Graham is saying that the price and value of an equity may deviate significantly over the short term but eventually will intersect.
He also called traders speculators. Traders are trying to figure out what is going to happen in the short-term and try to position their portfolio for profit. They have certain expectations for the future. Those expectations are baked into the positions they take. Those expectations could be on what the federal budget will look like, central bank policy over the next year, or the CPI expectation for the next month. They have an expectation about the future, and once they have decided what they think is going to happen, they look for signs that they are correct or incorrect.
Much of the volatility we see day to day is based on different pieces of data coming out that is causing traders to re-think their expectations. The examples cited by Siegel are examples. This is where the term ‘priced-in’ comes from – there is consensus that an event will occur, and the aggregate position in the market reflects this consensus.
This contrasts with the behaviour of investors. An investor is focused on the inherent value of any investment and making decisions for the long-term to achieve an investment goal.
In times of uncertainty, markets can be hypersensitive to shifts in expectations. There are strategies that investors can implement to lessen the impact of market noise on their decision making.
How investors can use behavioural finance to lessen the impact of market noise
Action bias is the underlying cause of many of the poor decisions that investors make. Action bias is the tendency to want to take action. Even if those actions are to your long-term detriment. The impact is particularly pronounced in volatile markets. Sitting on your hands in the face of market swings feels wrong. You want to act – you want to do whatever you can to protect yourself and your financial goals when markets fall. When markets surge you want to do whatever you can to not miss out on the returns that others may be getting in the market.
An Investment Policy Statement can help. It stipulates what types of investments align with your goals. If you’re looking at securities outside of your investment criteria it may be a sign of speculation. In the same breath, it also outlines when you sell. This also limits poor decisions. Prematurely and unjustifiably selling assets can make it harder to achieve your goals. Understanding what you’re invested in and why you’re invested in it will build confidence and ensure your portfolio is aligned to your goals.
Understanding the direct correlation between your investment strategy and your goals is crucial to preventing poor behaviour. Defining your goals properly is the first step. Our research from our Decision Sciences team delves into how to properly define your goals, which can have a meaningful impact on strengthening the correlation between assets and goals.
Final thoughts
Just like in life our fixation on short-term economic data needs perspective. Will it matter in 10 years if rate cuts occur in November or December? Will one, two or three rate cuts in 2024 impact your chances of achieving your goals? If you can’t remember the specific actions of central banks 10 years ago and the impact on your portfolio it is unlikely any actions this year will matter.
