Psychology Overwhelms Fundamentals in the Short Run

In discussing market changes, Howard Marks, remarks that psychology overwhelms fundamentals in the short run as the reason why markets can appear irrational. This is a neat way of holding both the idea that investors are rational and markets are irrational simultaneously.

See also:

• The Robinhood momentum algorithm might be perfectly suited to capture the psychology in the short-run
• The stock market boom during the pandemic appeared irrational (how could the market do well when there is so much unemployment and businesses failing?) yet it was largely due to rational fundamentals (increased savings and low interest rates resulted in investors moving from bonds to stock to get the same level of returns).
• Tournament like fields with asymetric and convex payouts favor high-variance strategies amplifies this short-run psychology.
• People are bad at long-term thinking

Links to this note

• The Stock Market Is More Volatile Than the Businesses Listed

  The annual percentage changes of the stock market go up and down more than the actual businesses in it. Similarly the profits of the businesses go up and down more than the economy of which it’s comprised.

• Clarity Is One Number

  Making complicated things seem simple involves abstracting over reality in such a way that is clear and actionable. Often times, that means reducing things down to one number going up or down. People are drawn to (fixated even) clarity of a single number going up or down.

• Default Optimism Is Rational

  Optimism is the most rational viewpoint to have by default. Unlike pessimism or negativity, optimism is helpful even when faked because we find evidence for whichever mindset we have. As Earl Nightingale said, “we become what we think about.”

• Skepticism and Optimism in Markets

  When it comes to markets, skepticism is warranted when optimism is excessive and optimism is warranted when skepticism is excessive.

• What’s the Trade?

  When you see something absurd in the market, it’s helpful to ask, “What’s the trade?” How would you make money from it if it truly is absurd? Oftentimes, it’s not that straightforward and there is more to it than you think. This is a good check against biases and, if you truly believe that something is wrong, would you be willing to make the trade?