By Michael Aroesty
“Our comforting conviction that the world makes sense rests on a secure
foundation: our almost unlimited ability to ignore our ignorance.”
― Daniel Kahneman, Thinking, Fast and Slow
The extraordinary panic and unprecedented sell-off at the end of March abruptly shifted to a relentless relief rally in April. What changed? Which side – the bears in March or the bulls in April – is right?
Over the past six weeks, nothing in the reported data suggests a buying binge to be prudent.
There are now 33 million more unemployed workers today than there were in February. All the employment gains over the last decade have been erased, leaving the unemployment rate at 14.7%, the highest reading in the post-World War II era.
The best we can say about the high frequency diffusion indices, key measurements of economic activity, is that the data has moved from depressionary to recessionary. Not exactly a ringing endorsement of bullishness.
Given the stark contrasts in economic data and the equity market’s performance, especially given unparalleled uncertainty regarding the future path of the disease and responses to it, we suspect another element to be in play.
Extreme Thinking During Extreme Times
Investor psychology can move markets as much or more than any data release. What market participants believe the future to look like can diverge significantly from the current reality, and also from what that future will actually look like.
An inevitable consequence of our human brain during periods of high uncertainty is a tendency to think in ‘extremes.’
Our “fast-thinking” brain, as behavioral economist Daniel Kahneman describes it, once activated, searches the world for dangers and subsequently builds an increasingly negative worldview. Psychologists call this “catastrophizing:” seeing the future in a profoundly negative light. Catastrophizing reduces our ability to sort available information.
The other extreme is denial. Being continually exposed to negative information (sound familiar?) causes our brain to be repelled by all the danger, instigating more positive thoughts.
For investors, each false extreme is dangerous – each obscures our ability to achieve clarity of thought. Though complete purity of thought may be impossible in good times let alone highly fluid times, we can at least recognize our inherent biases to avoid becoming our own worst enemy.
Simple Steps Toward More Effective Thinking
In his book The Number, Lee Eisenberg explains there is a number that represents the amount of money and resources that people need to enjoy the active life they desire, especially post-career. According to Eisenberg, “Those who say that this is either (a) the Apocalypse or (b) the Golden Age are both wrong. Most experts who look into our financial future can be classified as hawks or doves. The hawks screech that the future is terrifying, worse than you think. The doves see mostly blue skies ahead.”
Because we cannot be sure if the near future holds another wave of COVID-19 cases and further economic contraction, or the first hints of economic recovery and a return to something like business as usual, we scan the news attempting to achieve a version of divine intervention. Unfortunately, that epiphany rarely arrives, leaving us to regurgitate the views purported to us.
Here are some ways to pull back from extremes and re-center your thinking.
1) How Do You See the World? Are You a Pessimist or an Optimist?
A great starting point for reconditioning our thinking patterns is self-awareness. Our brain likely leans toward one extreme, observe your personal history of decision-making for important clues about your natural tendencies. Counterbalance these tendencies with more intentional research that supports the other side.
2) Be Sensitive to Your Natural Tendency Toward Confirmation Bias
Writer Dean Yeong sums up a key concept from Rolf Dobelli’s The Art of Thinking Clearly: “The confirmation bias is the mother of all misconceptions. It is the tendency to interpret new information so that it becomes compatible with our existing theories, beliefs, and convictions. In other words, we filter out any new information that contradicts our existing views.”
Research has revealed that confirmation bias is one of our most pervasive vulnerabilities. We are wired to see things the way we always have, even when there is compelling contradictory evidence. During times of crisis, this tendency is exaggerated, moving us toward an extreme point of view and then locking us in. When navigating crucial decisions about investments during the next phase of the pandemic, challenge yourself to understand what is actually happening rather than what your brain is seeking to believe.
3) Engage Your “Slow-Thinking” Brain with High-Quality Questions
A good practice to protect your thinking is to write down your analysis of a situation. Benjamin Franklin’s simple two-column pros-and-cons is a useful approach to laying out your thoughts.
On the left side of a sheet of paper, write “Current causes for concern.” On the right side, “Rational reasons for hope.” Doing so balances your thoughts, activating the “slow-thinking” part of your brain and forcing you to be more receptive to new information.
4) Question and Expand the Voices & “Experts” You Follow
As Dobelli reminds us, “Authorities crave recognition and constantly find ways to reinforce their status.…Whenever you are about to make a decision, think about which authority figures might be exerting an influence on your reasoning.”
Question the experts making projections about the future, especially those in the financial news media. No one has a crystal ball, and if they did, they would not be explaining the future for free to everyone who will listen.
Ignore Ignorance at Your Own Peril
Though difficult, it is critical to analyze how you make decisions during challenging times. Slow down. Pay attention to your natural patterns and your tendency to drift toward an extreme, and to whom you are listening. By spending some time writing down and analyzing your thoughts, you will wisely refine the quality of your thoughts.
The “truth”, as with most things, tends to reside somewhere in the middle. By being aware of your fears and your tendencies, you can protect yourself from the mistakes made by giving into the extremes.
This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as “anticipate,” “expect”, or “believe” that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views and opinions expressed in this document will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.