Four weeks may not make a trend; investors could change their minds later this year and turn on stocks once again. But a perceived lessening of risk, a lack of investment alternatives, and a view that the global economy, particularly the U.S., is getting better may combine to herald the return of the individual to the markets.
“It’s a sentiment issue, and it just seems like sentiment is starting to turn,” said Greg Holohan, senior wealth adviser at ScotiaMcLeod in Markham, Ont. “People are in a position now where they feel certain stocks are worth the risk.”
The big question is: Are they right?
THE ‘RECENCY‘ EFFECT
It’s easier, first, to examine what is happening to cause a brighter mood. And that is as much a story about the human brain as it is about the euro zone crisis or the U.S. debt ceiling.
Human beings tend to make decisions based on what they remember most vividly. In psychology, this is called the “recency effect” – we tend to remember newer information better, and it influences behaviour more strongly than older information, which gets hazier over time.
Meir Statman, author of the book What Investors Really Want and a behavioural finance professor at Santa Clara University in California, describes investors’ post-crisis approach to stocks as similar to a bad road trip.
He paints this scenario: You’re driving down the highway when the truck in front of you suddenly slams its brakes. Your heart jumps into your throat, but you stop just in time. Naturally, your nerves are going to be on edge until you get out of the car.
But the market crash in 2008 and 2009 “is a case where we plowed into the truck,” Prof. Statman said.
Any driver who has ever been in a bad car accident knows it takes a while to get back on the road. But eventually, the mental scars heal. It’s the same for investors who lose money. “They see the future as being more positive [now], and they see stocks as being more positive,” Prof. Statman said.
The market has lurched from one apparent crisis to another over the past several years. Once the financial crisis had eased in 2009, it was replaced by worries of a collapse in the euro zone because of the unsustainable debts of member countries such as Greece and Ireland. Then, in 2011, that was coupled with concerns about U.S. political leadership, which brought the world’s largest economy to the edge of a debt default in an argument over taxes and spending.
Now, with the Jan. 1 resolution of the U.S. “fiscal cliff” and the euro zone crisis receding, many of the negative headlines have been removed – or investors have simply tuned them out.
After all the dire warnings, the sky hasn’t fallen and people have stopped reacting reflexively, said Michael Obuchowski, a portfolio manager with North Shore Asset Management in Cold Spring Harbor, N.Y., who holds a doctorate in clinical psychology.
He calls it “systematic desensitization.” In other words, “when you repeat it [the fears of economic calamities] 200 times over two years, people really stop paying attention to it. They become desensitized to that type of information.”
Or, perhaps, we have reached a point where there truly are fewer risks investors need to worry about.
“There are no ‘known unknowns’ right now,” says Pierre Lapointe, the head of global strategy and research at Pavilion Global Markets Ltd., using a phrase made famous by former U.S. defence secretary Donald Rumsfeld. “It’s the first time since the beginning of 2007 that we see much less uncertainty.”
That allows market watchers to turn their attention to economic news, which has generally been positive for several months, as well as corporate profits, which have been at record levels for two years.
The tangible numbers of people buying cars and homes and finding jobs have been improving since the second half of last year. Now that the risk-driven headlines are disappearing, investors like what they see.