Tag Archives: SPACs

Timeless Financial Tips #4: How to Manage your Financial Behavioural Biases

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By Steve Lowrie, CFA

Special to Financial Independence Hub

There are countless external forces influencing your investment outcomes: taxes, market mood swings, breaking news, etc., etc.

Today, let’s look inward, to an equally important influence: your own financial behavioural biases.

The Dark Side of Financial Behavioural Bias

Having evolved over millennia to secure our survival, our deep-seated behavioural biases precondition us to frequently depend more on “gut feel” than rational reflection. Sometimes, our instincts are life-saving, like when a car brakes hard right in front of you. Chemical reactions in the lower brain’s amygdala trigger you to brake too, even as your higher brain is still enjoying the scenery.

Unfortunately, these same rapid-fire triggers often hurt us as investors. When we make snap financial decisions that “feel” right but are rationally wrong, we tend to sabotage our own best interests. By recognizing these reactions as they occur, you’re more likely to stop them from ruining your financial resolve, which in turn improves your odds for better outcomes. Let’s explore some behavioural finance examples that you’ll want to prepare for…

Behavioural Finance Example #1: Fear and FOMO

The point of investing is to buy low and sell high. So, why do so many investors so often do the opposite? You can blame fear, as well as Fear of Missing Out (FOMO investing). Time after time, crisis after crisis, bubble after bubble, investors rush to buy high by chasing hot holdings. They hurry to sell low, fleeing falling prices. They’re letting their behavioural biases overcome their rational resolve.

Behavioural Finance Example #2: Choice Overload and Decision Fatigue

Our brains also don’t deal well with too much information. When we experience information overload, we may stop even trying to be thoughtful, and surrender to our biases. We’ll end up favouring whatever’s most familiar, most recently outperforming, or least scary right now. When choosing from an oversized restaurant menu, that’s okay. But your life savings deserve better than that.

Behavioural Finance Example #3: Popular Demand and Survival of the Fittest

Inherently tribal by nature, we humans are susceptible to herd mentality. When everyone else gets excited and starts chasing fads, whether it is cryptocurrencies, alternative investments, or the other financial exotica-du-jour, we want to pile in too. When the herd turns tail, we want to rush after them. It’s like that old joke about escaping a bear: you don’t need to run faster than the bear; you just need to run faster than the guy next to you. In bear markets, this causes investors to flee otherwise sound positions, selling low, and paying dearly for “safer” holdings, rather than holding their well-planned ground.

Behavioural Finance Example #4: Anchor Points and Other Financial Regrets

Successful investors look past their occasional setbacks and remain focused on capturing the market’s long-term expected returns. But that’s hard to do, as we are often trapped by financial decisions regret. For example, loss aversion causes the average investor to regret losing money approximately twice as much as they appreciate gaining it. Similarly, anchor bias causes us to cling to depreciated holdings long after they no longer make sense in our portfolio, hoping against hope they’ll eventually recover to some arbitrary, past price. Ironically, you’re less likely to achieve your personal financial goals if you’re driven more by your financial regrets than your willpower.

Taking Charge of Your Financial Behavioural Biases

We’ve now looked at some of the damage done by behavioural biases. Once you know they’re there, you can at least minimize your exposure to them. Better yet, by using what behavioral psychologists call “nudges,” you can even harness your biases as forces for financial good. Following are two examples. Continue Reading…

Stock Valuations: Are the lunatics running the asylum?

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By Noah Solomon

Special to the Financial Independence Hub

The Buffett indicator is a simple ratio that compares the market capitalization of the U.S. stock market to its GDP. Buffett himself warns that if this ratio reaches 200%, “you are playing with fire.” At its current level of approximately 234%, this indicator is higher than it has ever been, including at the peak of the dot-com bubble in the early 2000s.

The cyclically adjusted price/earnings (CAPE) ratio is a well-known metric invented by economist and Nobel Laureate Robert Shiller. The S&P 500 Index’s CAPE ratio currently stands at 36.6, which is higher than 98% of monthly readings since 1881, and more than double its 140-year average.

To be fair, the current nosebleed levels of the Buffett indicator and the CAPE ratio can be partially explained by today’s record low interest rates. Furthermore, equity markets have become increasingly dominated by technology-driven and/or software-as-a-service (SaaS) companies with above average profitability. This shift may render current valuations less comparable to those of the distant past.

Regardless of the valuation metrics you use or whichever “this time it’s different” adjustments you make, stocks today range anywhere from somewhat expensive to obscenely overvalued.

What Did You Think Was Gonna Happen? Money Makes the Mare Run

Since 2008, financial markets have benefited from an unprecedented period of low-interest rates. When the pandemic began to ravage the globe in early 2020, the Fed cut interest rates to near zero and began pumping hundreds of billions of dollars into financial markets. By purchasing Treasury bonds and government-backed mortgages, the Fed has continued to inject approximately $120 billion into the economy each month.

Leaving interest rates at levels below inflation for an extended period is like putting a giant hose in the ground – water will come up somewhere. In the case of monetary stimulus, the “water” manifests itself in rising asset prices. According to legendary investor Marty Zweig:

“In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major direction.”

In today’s markets, you don’t have to look very hard to find strong evidence of Zweig’s theory, which explains why stock markets were making fresh highs during successive outbreaks of Covid-19 and spiking unemployment. It also explains why approximately two thirds of stock returns over the past decade are attributable to multiple expansion rather than earnings growth.

Those who think that the huge gains in everything from stocks to art to cryptocurrencies to real estate over the past 12 years are solely the result of economic growth and corporate ingenuity should avoid anyone selling GameStop options! The market’s dependence on low rates cannot be overestimated. Interest rates giveth and taketh away. Should the central banks succeed (or over succeed) in getting the inflation genie out of its bottle, equities could be in for a nasty ride.

Stretching A Rubber Band Until It Snaps

Extreme valuations are only one of the features that have historically accompanied asset bubbles and subsequent busts. Another harbinger of future misery has been accelerating gains. Prior to both the tech-wreck of the early 2000s and the global financial crisis of 2008, market returns had shifted from normal to worryingly unsustainable. Accelerating gains can be thought of as a rubber band that is being stretched further and further. The more you stretch the band, the greater the likelihood that it will snap.

As the following chart demonstrates, average equity market returns have been accelerating to the point where they are at their highest levels in five years.

Are the Lunatics Running the Asylum?

Excessive speculation is another common ingredient in the recipe of historical bubbles. Whereas it’s never precisely clear what percentage of market activity is driven by short-term speculators (i.e., gamblers) as opposed to long-term investors, there are some clear signs that the lunatics are at least helping to manage (and possibly running) the asylum.

Short-Dated Call Options: A Canary in the Coal Mine?

If you think information may surface that will cause people to recognize that a company is worth much more than its current value, then you would either purchase its shares or buy long-dated call options. By contrast, short-dated call options represent speculation in its purest form. Buyers of five-day options have no reasonable expectation that meaningful new information will emerge over that period – they are simply gambling. Continue Reading…

SPACs, NFTs and another Tech-inspired Silly Season

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By Steve Lowrie, CFA

Special to the Financial Independence Hub

Is it just our imagination or has there been an uptick lately in exciting “new” trading tactics for seizing riches from exotic new markets?

After a year of sitting at home, an excitable generation of do-it-yourself traders has replaced traditional leisure-time activities with online pursuits: including aggressive, Tweet-worthy trading for fun and profit.

The result? Waves of volatile financial feeding frenzies and overnight sensations, egged on by a brood of freshly hatched social media stars and a spate of flashy new trading platforms with captivating names like Robinhood.

All this might seem new and different, if I hadn’t already seen such eerily similar circumstances so often before, with so many unhappy endings. I suppose that puts me in the same curmudgeonly camp as 97-year-old billionaire Charlie Munger (Warren Buffett’s long-time Berkshire Hathaway partner). He pulled no punches in this recent interview about Robinhood:

“[Some] may call it investing,” he said, “but that’s all bulls**t. It’s really just wild speculation, like casino gambling or racetrack betting. There’s a long history of destructive capitalism, these trading orgies whooped up by the people who profit from them.”

Speaking of Warren Buffett, a recent Financial Post article asked the question: “What would Warren Buffett make of this stock market silly season?”  The answer was that he already has weighed in on the matter many times before, including one of my favourite “Buffettisms”:

“The stock market is a device for transferring money from the impatient to the patient.”

Impatience in Action

But maybe this time is different after all? Let’s take a closer look. The current wave of “get rich quick” mentality launched in January 2021, when a Reddit-driven rally abruptly sent the prices of several unloved stocks like GameStop through the roof.

More recently, special purpose acquisition companies (SPACs) have captured a lot of attention. “When SPAC-Man Chamath Palihapitiya Speaks, Reddit and Wall Street Listen,” observed a recent Wall Street Journal column. “Amateur traders hang on [Palihapitiya’s] every word for clues about his next target: and for the insults he hurls at the high-finance elite.”

Non-fungible tokens (NFTs) have also been taking the trading world by storm. If you think of an NFT as being like a collectible — say, an autographed baseball card — but in digital format, you’re getting close to envisioning its worth. Similar to playing cards, people are collecting these pieces of code, typically exchanging them in cryptocurrency such as bitcoin.

How much can an NFT be worth if the collectible attached to it is in high demand?  However much the market decides.  In this recent extreme case, “NFT Mania” garnered $69 million for a piece of digital artwork.

Innovations vs. Investments

At least on paper, some have amassed rapid fortunes by trading into these sorts of innovations to catch a wave of risk-laden opportunity. But will these brave speculators manage to convert their good fortune into lasting wealth once today’s trends fizzle or fly? Continue Reading…

4 Investing lessons from 2020

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By Steve Lowrie, CFA
Special to the Financial Independence Hub
Sometimes, it takes years for key investment lessons to play out to the point we get to say, “See? Told you so.” 
Not so in 2020. Now that this excruciating year is behind us, we can at last appreciate the remarkable crash course it offered in nearly every principle inherent to successful long-term, goal-focused investing.

Where to begin?  Let’s start with the power of planning.

Lesson #1: Planning beats reacting

“Short-term thinking repeated again and again doesn’t lead to long-term thinking.” — Seth Godin

You were there, so you probably remember:  Major global stock markets declined from near all-time highs in mid-February to a low on March 23rd (34% in 33 days).

Few of us saw that coming.  Fewer still might have guessed things would so abruptly reverse, to end 2020 with new highs, well into positive territory.  The U.S. stock market reached new heights last summer, even as the pandemic and its economic devastations raged on.  The Canadian stock market reached a new high recently on January 7, 2021.  Europe and other global stock markets still have a way to go.

The lifetime lesson here, and my key, repeated observation for 2020, is simply this:

The economy can’t be forecast, and the market cannot be timed.  Instead, have a long-term plan and stick to it during dramatic turning points.

Planning as opposed to reacting: this is your and my investment policy in a nutshell, once again demonstrating its enduring value.  Consider these points:

Much ado about nothing:  The velocity and trajectory of the equity market recovery nearly mirrored the violence of the February/March decline.  For those who like to relate letters of the alphabet to economic or market performance charts, the 2020 stock market chart was a pretty pronounced V.

Patience is a virtue:  In volatile markets, it’s tempting to “wait for the pullback” once a market recovery is underway, and/or wait for the economic picture to clear before investing.  Either or both formulas are more likely to underperform compared to simply sticking with your disciplined plan.

Lesson #2:  In investing, “shiny and new” often isn’t

“Modern portfolio management tools give today’s investors control over their own savings, insight into fees and performance, and the luxury of watching their money vanish in real-time when markets plunge.” — Tim Shufelt, The Globe and Mail

The most significant behavioural mistakes investors make (individuals and institutions alike) are panicking in a down market or getting caught up in the allure of a hot market fad.  While both can be severely hazardous to your financial health, my experience is that chasing hot new trends is often the most damaging.

Today’s trends may be new, but the lesson is all too familiar:  A hot new investment trend is wonderful and exciting … until it’s not.

For example, reading today’s financial news, I sometimes wonder if I have been asleep for the past 20 years, like Rip Van Winkle.  Have I just woken up in the tech boom of the late 1990s, when there was more than an average number of hopeful investors trying to score big on the latest tricks of the trade?  If you’ve been around as long as I have, you know that didn’t end well.  A lot of investment portfolios were left woefully deflated once that bubble burst.

From the adventures of day-trading brokerage accounts, to chasing the latest hot IPO, to piling into large technology companies (regardless of their bloated valuations), the similarities between then and now are uncanny.  Today, we could add record-busting bitcoins and blank-check SPACs to the mix.

Then and now, rising markets often tempt the uninitiated to abandon their well-diversified portfolios to chase after the “easy” money.  Then and now, your best move remains the same: stay diversified.  Concentrated bets on hot trends generate wildly unpredictable outcomes, which makes them far closer to being dicey gambles than sturdy investments.

Put another way, if investing were a school, the markets charge a steep tuition to those who don’t heed their history lessons.  I wonder if 2021 could be an expensive year for those chasing the latest hype?

Lesson #3:  Be selective in your media diet

“Wow. If I’d only followed CNBC’s advice, I’d have a million dollars today … provided I started with $100 million dollars. How do they do it!?” — Jon Stewart, The Daily Show

This is a topic for deeper discussion, but it’s worth including in our 2020 reflections:  Investors should remember that popular and social media is much better at hyping extreme news than offering calmer views. Continue Reading…