Opinion: Investors are way too greedy for a stock-market selloff to really take hold
- As stocks rise, doubts and inhibitions fade, and we begin wanting and expecting higher returns -
When stocks fell 2% over Monday and Tuesday, pundits were quick to give their “explanations.”
Aha, Amazon Berkshire Hathaway and JPMorgan Chase were banding together to upend the health care market.
Aha, the 10-year Treasury note’s yield had crept above 2.7%.
Aha, the strong global economy and the weak U.S. dollar would push inflation up, forcing the Federal Reserve to raise short-term interest rates faster than expected.
But as I learned years ago, there is no reason for any short-term market move. Indeed, by midday Wednesday, the Dow Jones Industrial Average had recovered a healthy slice of the losses, while the S&P 500 showed more modest gains.
I was doing a summer internship in Reuters’ Wall Street bureau, where I churned out four market updates an hour. In each one I had to tell readers “why” the market was moving in any one direction. (No offense to Thomson Reuters, which is a great news organization, but that’s just the nature of this beast.)
It wasn’t my finest hour professionally; I scrambled to get someone, anyone on the phone who could tell me why stocks were doing what they were doing. As the day wore on, I noticed an “echo chamber” effect in which sources were repeating things I had written earlier that day.
I decided markets are often driven by traders’ whims and impulses with no real reasons for it. Without knowing it, I had embraced behavioral finance.
That’s where I turned late last week, before the selloff, for a reading of the market’s mood, specifically its level of greed. I interviewed the man who had literally written the book on the subject, “Beyond Greed and Fear” — behavioral economist Hersh Shefrin of Santa Clara University.
Professor Shefrin told me that “in the aggregate” we were seeing much more greed than fear, a huge pendulum shift from the early part of this decade, when investors were still traumatized by the financial crisis.
We’ve been moving toward the greed side of the spectrum since 2013, he said, and that has picked up steam since early 2016 and then after the election (which he linked to an acceleration in earnings growth, by the way). My take: The “Trump bull market,” like the Trump economy, is the culmination of trends that have been developing for years.
Greed and fear, Shefrin explained, are rooted in neurobiology, or brain chemistry. Fear and anxiety come from the amygdala, one of the brain’s most ancient structures. Greed is linked to the nucleus accumbens. That’s where neurotransmitters dopamine, which promotes desire, and serotonin, which enhances satiety and inhibition, operate, according to a McGill University website.
“In the market sense, we’ve come to associate greed to mean not so much wanting more than your fair share, but simply wanting more and setting high goals for your returns,” Shefrin said. “It’s not just getting the reward; it’s anticipating the reward. And it really drives a lot of our behavior.”
As stocks rise, doubts and inhibitions fade, and we begin wanting and expecting higher returns. Rising markets — especially those, like this one, that rarely correct — induce complacency and lower risk aversion. Bull-market euphoria really is a natural high. But that has a down side.
“We become vulnerable to reckless behavior [and] taking imprudent risks,” said Shefrin. Exhibit A: Bitcoin and even more exotic cryptocurrencies.
Which brings us back to today’s markets. CNN Money’s Fear and Greed index comprises seven indicators, including the spread between stock and bond returns; new highs vs. new lows; advancing vs. declining volumes on the NYSE; market momentum; and put and call options.
As of last week, that index stood at 78 on a scale of 100 — or “extreme greed” territory.
“I think that’s an accurate characterization of overall market sentiment,” Shefrin told me last Friday. “I’d say the markets are probably about 20% overvalued on the fundamentals.”
After the selloff, the Fear and Greed index fell to 62 — mere “greed” —thanks largely to a spike in one indicator, the CBOE Volatility index, or VIX. By midday Wednesday, the VIX had slipped a bit as stocks rebounded.
Will the reflex rally last? Who knows? Only a sustained correction, which is way overdue, will disabuse many investors of the notion that stocks can go only one way — up. If stocks go off to the races once again, extreme greed will be back in the saddle.
Howard R. Gold is a MarketWatch columnist and founder and editor of GoldenEgg Investing, which offers exclusive market commentary and simple, low-cost, low-risk retirement investing plans. Follow him on Twitter @howardrgold.
From MarketWatch