This special guest commentary was written by our friend Richard Peterson M.D., MarketPsych. This piece was originally published on April 13th.
“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."-Chuck Price (then CEO of Citigroup) to the Financial Times on July 9, 2007.
How Will We Know When to Stop Dancing?
According to TD Ameritrade's investor movement index (IMX), individual investor stock purchases broke their all time high in February 2017. Despite large gains already, the U.S. stock market's "Trump rally" may continue, fueled by anticipation of lower tax rates, repatriation of overseas corporate cash, and U.S. fiscal stimulus on infrastructure.
But just as easily as we can cite reasons for the rally to continue, we can find evidence that it's a good time to sell. Some experts (including Nobel laureate Robert Shiller) believe U.S. stocks are overvalued. Rising interest rates may slow the economy. A stronger dollar is hurting U.S. companies' profits. Trump creates a unique level of uncertainty.
It can't be both ways. In this environment of both historically high stock prices and high uncertainty, two prevalent behavioral biases exert their influence over investors. Today's newsletter will explore research reported at last week's neurofinance conference at Lake Lucerne, Switzerland. It then examines how the biases called the Disposition effect (Cutting Winners Short) and the Repurchase Effect distort our thinking in market environments such as this one. Finally, we look for guidance on the stock market going forward.
Neurofinance in Practice
Switzerland-based hedge fund manager Peter Pühringer (German language wiki page) is a generous sponsor of neurological research, including neurofinance. In the markets Pühringer has profited - in part - from a keen understanding of the psychological nature of the interest rate cycle, and Pühringer is now one of the wealthiest men in the region (his personal 70% return last year didn't hurt).
He didn't start out wealthy - he was born in East Germany and emigrated to Austria in his early 20s. In his career as an investor, his early successes came from bucking the trend with Saudi real estate development and buying East German real estate in Berlin just after the Wall fell. Last week his firm was one of only two to bid on Ghanian debt during that country's first debt auction.
Pühringer's enthusiasm for market psychology has driven him to become personally engaged with brain research. He renovated the Vitznau Health and Wealth Residence on Lake Lucerne (photo below) which may be the only resort to double as a neurological rehabilitation facility complete with a MRI scanner in the building's basement....
Pühringer's interest in market psychology and economic cycles is evident in the resort's signature statue, depicted below. And on at least one floor, suites at the hotel are named after influential economists and behavioralists including Robert Shiller.......MORE
...I could write many pages about the fascinating implications of the neurofinance research underway. Given it's relevance to how investors feel after a significant bull market, today's newsletter will examine the neuroscience research of USC finance professor Cary Frydman (see extensive citations below).
In a 28-subject study that combined investment decision making with neuroimaging (fMRI), Frydman found that all participants were susceptible to two common biases - the Disposition effect - in which investors sell their winning investments too soon and hold their losers too long - and the Repurchase effect....