Markets Move in Cycles

June 8, 2018

Availability Bias: an information-processing bias in which people take a heuristic (mental shortcut or rule-of-thumb) approach to estimating the probability of an outcome based on how easily the outcome comes to mind. Easily recalled outcomes are often perceived as being more likely than those that are harder to recall or understand. People often unconsciously assume that readily available thoughts, ideas, or images represent unbiased estimates of statistical probabilities. People decide the probability of an event by how easily they can recall a memory of an event. The basic problem is that there are biases in our memories. For instance, recent events are much more easily remembered and available. [1]

 

When I started with SEM 20 years ago, Rick Gage explained this phenomenon as "recency" bias. At the time there was no such thing as Behavioral Finance. Over the last two decades I've witnessed far too many times the damage Availability Bias does to investment portfolios. Both advisors and investors are subject to these biases. The best way to overcome an "information-processing" bias such as this is to take a step back and look at the data. The market moves in cycles. Always has, always will.

 

Right now I see advisors and their clients making decisions based on the most available information. Over the last 9 years, investors have enjoyed significant rewards by buying the dip. That works -- until the bull market cycle is over. In the same way, I've heard too many times advisors and clients say, "[Fill in fixed income fund name here] has done a good job for [10, 20, 30] years". What they do not realize is these funds have only managed money in a bond bull market.

 

I saw this chart earlier this week from Ned Davis Research. Nobody knows until we have the benefit of hindsight when the market cycle has shifted, but it is interesting to remember there are long periods of time where stocks & bonds have significant declines. It's been a long time since we've had a bond bear market, but it can and will happen. The funds you think will provide downside protection because they did last time may not provide the same protections this time around.

The only answer, in my opinion is to use a data driven approach that is designed to adapt to whatever the market has to offer. Focusing on shorter-term trends allows us to take advantage of opportunities that will develop regardless of the market environment. We've been doing this along time and have seen Availability Bias rear its ugly head far too many times. If you would like help developing a portfolio that is designed to adapt to whatever market environment we are in, drop me a note.

[1] SOURCE: The Behavioral Biases of Individuals; Behavioral Finance, Individual Investors, and Institutional Investors, 2016 CFA Level III Program Curriculum, CFA Institute, pg 67

Please reload

Featured Posts

Investment Grade Junk

September 11, 2019

1/10
Please reload

Recent Posts

December 10, 2019

November 25, 2019

November 13, 2019

November 6, 2019

Please reload

Connect
  • LinkedIn Social Icon
  • Twitter Social Icon
  • Facebook Social Icon
  • RSS Social Icon

Related Posts

Please reload

This site is for INFORMATIONAL PURPOSES ONLY.  The comments and posts published in the SEM Trader's Blog ARE NOT investment recommendations. They can NEVER be considered as trading calls or advices. If you decide to use the information offered here for your real trading it is at your own risk.  CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute

Investing in the stock or bond markets involves risk and may not be suitable for all investors. Before making any investment decisions you should carefully consider your investment objectives, level of experience and risk appetite. The possibility exists you could sustain a loss of some or all of your initial investment and therefore you should not invest money you cannot afford to lose. You should be aware of all the risks associated with your investments and seek advice from an independent financial advisor if you have any doubts. All investments involve risk including those managed by SEM Wealth Management.

Opinions expressed at www.stratequity.com, www.semwealth.com and semtradersblog.com or the previous Trader's Blog site are those of the individual authors and do not necessarily represent the opinion of SEM Wealth Management or its management. Any opinions, news, research, analysis, prices or other information contained on this website, by SEM, its employees, partners or contributors, is provided as general market commentary and does not constitute investment advice. SEM will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

 

The use of this website constitutes acceptance of our user agreement. Past performance is NOT indicative of future results.

***Anywhere performance of SEM's Investment Models is used, please refer to our Performance Snapshot  which contains details of the performance calculations for each of our investment models.***

 

There is no representation made as to the future results of SEM’s programs or if they will be profitable.

For additional information on the author and SEM Wealth Management, please see our DISCLOSURE DOCUMENT (ADV Part 2).