The Recency Effect & Investors

What do gold prices, a stock-market plunge and a credit crisis have in common? The way investors tend to see them are examples of the “recency effect.

A brief description first: In human psychology, people who are asked to recall items on a long list tend to have a sharper memory of the items toward the end. This is a function of finite memory capacity — you can’t remember everything, so you recall the more recent items.

From an evolutionary perspective, this makes some sense. Focusing on what happened some time ago while imminent threats exist probably isn’t the ideal survival strategy. The most recent threats are likely the more dangerous ones to your ability to procreate and pass on your DNA.

We see this manifest itself in investing in a related, albeit more nuanced way. Just to cite a few examples: Puerto Rico’s default is the new Greece; auto loans are the next subprime credit collapse; student debt is the next economic crisis.

All of these are demonstrably untrue (“So far!,” go the cries from the peanut gallery, where the recency effect is in full bloom). The issues resonate, because these events are a) recent and b) they traumatized many investors.

Trauma may be the key to understanding investment-related recency effects. In investing, it isn’t just the most recent events that stand out; it’s events of greater psychological or emotional weight that leave the more lasting mark.

Perhaps this emotional component is why so many people tend to make grotesque exaggerations and extrapolate in ways that lead to some truly awful forecasts. The credit crisis of 2008-09 means another, bigger market crash is just around the corner. The 41 percent drop in the value of the dollar from 2001 to 2008 means the end of the fiat currencies is nigh. Hyperinflation is coming! Buy gold!

 

Continues here: Confusing What Just Happened With What Happens Next

 

 

 

Category: Cognitive Foibles, Psychology, Trading

10 Tuesday AM Reads

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Jon Stewart: You Can’t Prove That on TV

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Category: Think Tank

Campaign Cash

click for interactive graphic Source: Bloomberg  

Category: Legal, Politics, Really, really bad calls

When do scientists believe computers will surpass the human brain?

Source: Mic

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Category: Data Analysis, Economy

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Welcome to August! Earnings season is in full swing, and we have a month of data to move the FOMC off their intended path. Oh, and the finest curated morning train reads in the land: • Win or Lose, U.S. Stocks Getting Biggest Earnings Bang Since ’12 (Bloomberg) but see King dollar has cost S&P 500 companies $244 billion of…Read More

Category: Financial Press

Six-Year Checkup

Source: WSJ

Category: Economy

It’s official. Puerto Rico defaults

Puerto Rico Defaults – Our new Muni Book Davd Kotok Cumberland, August 1, 2015   It’s official. Puerto Rico defaults. Here is a full list of discussions. As my colleague and co-author, Michael Comes, has described in detail, this is a default on a “moral-obligation” bond. Litigation will certainly start next week. A moral ob….Read More

Category: Books, Fixed Income/Interest Rates, Think Tank