What is Driving Today’s Investors?

CFA Society of Saskatchewan 21st Annual Forecast Dinner January 24, 2013

Market Cycles, Behavioral Economics & Post Credit-Crisis Investor Psychology
Presentation by Barry Ritholtz CEO, Fusion IQ

Conexus  Arts  Centre,  Regina   200  Lakeshore  Dr,     Regina,  SK  S4S  7G4  

Today’s Powerpoint Presentation:

10 Steps To a Financial Crisis

Tonight’s Agenda Agenda

  Macro View: Housing & Employment   Understanding Long Term Secular Market Cycles   Behavioral Economics & Today’s Investors   10 Key Trends to Watch

  Factors of Employment Overhang
–  –  –  –  –  Structural Demographic Global Costs Skillsets

NonFarm Payrolls Post-Recessions (1948-2007)

Source:  Ritholtz.com,  TheChartStore.com  

NFP Post-Recessions (Composite versus 2007)

Source:  Ritholtz.com,  TheChartStore.com  

NFP Post-Recessions (Composite versus 2007)

Post  WW2  Job  Losses  During  Recessions    

Source:  Ritholtz.com,  Calculated  Risk  

NFP Post-Recessions (Composite versus 2007)

Post  WW2  Job  Losses  During  Recessions  

Source:  Ritholtz.com,  Calculated  Risk  

Residential Real Estate

  Drivers of Housing Recovery:
–  –  –  –  Huge Gov’t Support Affordability Credit Availability Underwater Homeowners Cannot Put houses up for Sale –  Deleveraging of Household Balance Sheets –  Constrained Supply –  Foreclosure Abatements

Residential Real Estate Boom Was Global

Source:  Ritholtz.com,  McKinsey  

Existing Home Sales

Source:  Ritholtz.com,  Calculated  Risk  

New Home Sales

Source:  Ritholtz.com,  David  Rosenberg,    Calculated  Risk  

Excess Mortgage Debt
1990: $6 trillion of housing collateral could support $2.5 trillion of mortgages 2006: $23 trillion of housing collateral could support $10 trillion of mortgages 2010: $16 trillion of housing collateral could support $6 trillion of mortgages. Problem is, mortgage debt has remained at $10 trillion – $4 trillion too high.

Source:  Ritholtz.com,  RAB  Capital  

Part II: Long Term Market Cycles

  Understanding the Drivers of Secular Cycles   P/E Multiple Compression & Expansion   “100 Year Floods” Occur Every Decade   Composite of 19 Secular Bear Markets   The Bond Market as Safe Haven   Sentiment Cycle   The Upcoming Generational Bull Market

100 Years of Secular Markets, P/E Expansion & Contraction

Source:  Ritholtz.com,  Crestmont  Research  

100 Year Dow Industrial Chart

Source:  Ritholtz.com,  Bloomberg  

1966-82 Cyclical Markets

Source:  Ritholtz.com,  Bloomberg  

“100-Year Floods” seems to come along far more often than their name implies

Source:  Ritholtz.com,  TheChartstore.com  

Composite  19  Secular  Bear  Markets  

Source:  Ritholtz.com,  Morgan  Stanley  Europe  

US Bonds Are A Safe Haven During Crises  

Source:  Ritholtz.com  

Pension Funds Have Too Many Bonds, Too Few Stocks  

Bonds were 34% of pension fund assets in 2012 versus 20% in 2006. Stocks were 61% versus 39% UK 75% of pension-fund assets in 1999; Insurers have less than 10% of assets in stocks.
Source:  Ritholtz.com,  Société  Générale  

Sentiment Cycle

Source:  Ritholtz.com  

Part III: Behavioral & Cognitive Issues

  Herding, Groupthink   Experts: Articulate Incompetents   Optimism Bias   Confirmation Bias   Recency Effect   Emotions change the way we perceive events (e.g., Sports, Politics)

This is your brain

Your brain weighs 3 pounds, and is 100,000 years old. It is a “dynamic, opportunistic, self-organizing system of systems.” MRIs have revealed to Neurologists what our brains looks like when making decisions . We can observe it 1) in real time; 2) under actual conditions, and 3) in reaction to financial risk/reward stimuli. Once we begin trading stocks, however, our brains begin to undergo subtle physical change that we can actually see in the MRIs of Traders . . .

This is your brain on stocks


Mutual of Omaha “Lone Gazelle”

Source:  Kal,  Economist  

Wall St. Groupthink: Buy Buy Buy!  
1.  Only 5% of Wall Street Recommendations Are “SELLS”
-NYT, May 15, 2008


Why Analysts Keep Telling Investors to Buy
-NYT, February 8, 2009


Equity Analysts Too Bullish and Bearish at the Exact Wrong Times
-McKinsey, June 2nd, 2010


None of the S&P 1500 have a Wall St. Consensus “Sell” on them
-Robert Powell, Editor, Retirement Weekly, August 2011

It is better for one's reputation to fail conventionally than to succeed unconventionally. -John Maynard Kyenes

Sources:  Ritholtz.com,  NYT,  McKinsey,  Marketwatch  

Optimism Bias
“Here, Kitty, Kitty, Kitty”

Dunning Kruger Effect: DK is a cognitive bias in which unskilled people make poor decisions and reach erroneous conclusions, but their incompetence denies them the metacognitive ability to recognize these mistakes. Metacognition: The less competent you are at a task, the more likely you are to over-estimate your ability to accomplish it well. Competence in a given field actually weakens self-confidence. This has devastating consequences in the investment world.

“Expert” Forecasting versus Ambiguous Uncertainty
Bennett Goodspeed, The Tao Jones (1984) discussed “The articulate incompetents:” • Expert forecasters do no better than the average member of the public; • The more confident an expert sounds, the more likely he is to be believed by TV viewers • Experts who acknowledge that the future is inherently unknowable are perceived as being uncertain – and therefore less trustworthy. (Isaiah Berlin: Hedgehog vs Fox) • The more self-confident an expert appears, the worse their track record is likely to be. • Forecasters who get a single big outlier correct are more likely to underperform the rest of the time.
Source:  Zweig,  Your  Money  &  Your  Brain;  Grants  Interest  Rate  Observer,    

Analysts: Over-Optimistic GroupThink  

“Analysts have been persistently overoptimistic for the past 25 years, with [earnings] estimates ranging from 10 to 12 percent a year, compared with actual earnings growth of 6 percent… On average, analysts’ forecasts have been almost 100 percent too high” -McKinsey study

Source:  Ritholtz.com,  McKinsey  

Confirmation Bias  
Selective Perception & Retention  
1. We tend to read that which we agree with; We avoid that which disagrees with our preconceived biases, notions or ideologies; 2. Our biases change the way we perceive objects – literally, the way we see the world. 3. The same biases affect our memories – we retain less of what we disagree with . . . 4. Expectations Affect Perception

Beware the Recency Effect
WSJ:  2007     WSJ:  2010    

Source:  Ritholtz.com,  WSJ  

What Just Happened vs. What is Going to Happen
Time, June 2005 Fortune, June 2005

Source:  Ritholtz.com,  Fortune,  Time  

2003: Politics and Asset Management Don’t Mix
These are poorly designed tax cuts - Stay Out of Markets!

Source:  Ritholtz.com  BigCharts.com  

2003: Politics and Asset Management Don’t Mix
2003 Tax Cuts > $1 Trillion   How did that political trade – up over 90% over 4 years – work out for you . . . ?  

Source:  Ritholtz.com,  BigCharts.com  

2009: Political Investing  
Obama is a Socialist! Stay Out of Markets!

Source:  Ritholtz.com,  BigCharts.com  

2009: Politics and Asset Management Don’t Mix  
FASB 157, ZIRP, QE +VERY Oversold Markets The political trader missed the best rally in a generation – Up 108% over 36 months  

Source:  Ritholtz.com,  BigCharts.com  

A brief intro to

Neuro Finance

If u cn rd ths  

This animation . . .  

. . . is not an animation  

When it absolutely positively has to deceive your eyes overnight  

A Species of Dopamine Addicts  

What does this mean for investors/traders? • We have an Optimism bias (helps our survival). • Our brains are better at processing good news about the future than bad. • Anticipation of financial reward > than actual benefits (Buy Rumor, Sell News) • Gamblers, Alcoholics, Sex Addicts, Junkies, OA, Hyper-Traders = Dopamine High.

Monkeys Love a Narrative

We prefer stories to data – Pre-writing, story-telling is how Humans evolved to share information We are vulnerable to anecdotes that mislead or present false conclusions unsupported by data

“We have met the enemy, and he is us.” -Walt Kelly, Pogo, 1971

The Upcoming Generational Bull Market

  Drivers of Long Cycles   Factors   Key Areas

What  Drives  the  Long  Cycle  ?  

  Drivers of Long Cycles
–  –  –  –  –  Major Societal Shifts Technology Public Works Innovation Sociology & Lifestyle


Coming  Genera>onal  Bull  Market    

  Factors
–  –  –  –  –  Creative destruction wrought by Youth Post Gen-Y think of themselves as their own brand Expanding beyond traditional technology regions Every generation seeks to bypass their elders No longer a Left vs Right debate, but small & nimble mammals versus slow-witted Dinosaurs –  Attracting skilled immigrants to North America will remain key competitive advantage

Coming  Genera>onal  Bull  Market    

  Key Areas
–  –  –  –  –  –  –  Mobile Cloud, Software, Social Web 3.0 Cheap energy driving US manufacturing renaissance Nano technology, Materials Science Biotech, Genome Design, 3D Printing


Source:  Ritholtz.com,  Stock  Trader’s  Almanac  

10 Finance Trends to Watch
1. ETFs are eating everything. 2. The financial sector continues to shrink; advisers continue to leave large firms for independents. 3. Increased pressure on fees and commissions. 4. Hedge fund troubles. 5. Dispersal of financial news. 6. Demographics are a huge driver. 7. The death of buy-and-hold has been greatly exaggerated. 8. What hyperinflation? 9. The bond bull market has ended/interest rates are spiking. 10. Central Bankers are still holding the system together.
Source:  Washington  Post,  January  12,  2013    

for more information, contact

Barry L. Ritholtz
CEO, Director of Equity Research Fusion IQ 535 Fifth Avenue New York, NY 10017 212-661-2022 x7104 516-669-0369 The Big Picture http://www.ritholtz.com/blog