Recency bias — the trick of the brain that places greater importance on current events than earlier ones — is at the root of many misapprehensions. Sports teams on winning streaks become “unbeatable”. Covid lockdowns spawned the popular view that the era of working in the office was over. The Marvel cinematic franchise was considered an iron-clad guarantee of box-office success. In these instances, the feeling that a current reality is symptomatic of a sustained trend was based purely on it being true at the time rather than on underlying fundamentals.
Financial markets are certainly not immune from recency bias. When lots of money is at stake and markets turn suddenly, it’s natural for investors to question whether the latest moves herald the beginning of something systemic. Trusting the fundamentals rather than being swayed by what can seem like unstoppable momentum can be difficult, but the latter usually leads to bad investment decisions, panic and volatility.
We definitely saw some of that last week. On Monday, various commentators were referencing a stock market “collapse”. I read several calls for the Fed to cut rates before its next meeting, a measure it would only contemplate during an extreme crisis. The term “Armageddon” was even bandied around. Fairly radical rhetoric on the strength of two trading sessions.
Post-financial crisis and Covid, the actions of central banks — the easy and cheap availability of debt — dampened a lot of turbulence that, historically, had been part and parcel of normal markets. Effectively, we’ve had a 15-year safety net underneath the financial markets. As central banks step back from supporting economies and markets and turn off the taps of quantitative easing (QE), we should expect to see more volatility.
What we saw at the start of last week was not a “collapse” but a pullback — and pullbacks are far more frequent than people may imagine, especially those prone to recency bias. Since 1980, investors have experienced S&P 500 pullbacks of more than 5 per cent on average five times a year.
I’m not saying the economic data that prompted the sell-off — specifically the slowdown in US jobs growth — is irrelevant. Clearly, it underlines that the US economy faces challenges. But perspective is required. When Goldman Sachs raised its probability of a recession from 15 per cent to 25 per cent, the 75 per cent odds of non-recession wasn’t reflected either in the headlines or the sea of red on traders’ screens.
So, if “normal markets” post-QE are more susceptible to sudden lurches, investors’ nerves will be tested. Attempting to “time the market” — investor-speak for selling out into cash in anticipation of deepening crashes — has proved a costly pastime. Over the past 25 years, investors who exited the market the day after a fall of 2 per cent or more, and then bought back in a week, month or year after, would, on average, have halved the money they would have made by staying invested through the volatility.
Although we are seeing signs of a rebound in the heaviest-hit markets of the United States and Asia, last week’s tumbles also highlighted that the UK — the ugly duckling for investors in recent years — may be more resilient than many to these sorts of pullbacks.
Britain is reassuringly boring — quite an attractive quality during volatile periods. Moreover, our dullness is pretty wide-ranging. Firstly, it’s apparent in the FTSE’s biggest sectors. While the racy tech stocks of the Nasdaq plunged, the UK index — weighted towards less-cyclical sectors like pharma, consumer staples, telecoms and utilities — held up relatively well.
Secondly, rather than being geared towards growth, investors look to UK businesses to pay them a steady income via dividends. While this might make our domestic market seem incredibly turgid during boom times, it looks a lot more appealing when stock markets appear to be running out of steam. This should stop it selling off quite so emphatically when shocks occur.
Thirdly, nowadays even our politics is unexciting. “Fiscal discipline with Rachel Reeves” is unlikely to make it to Netflix but, unlike the erratic soap opera of recent years, won’t actively repel global investors.
Unexpected and dramatic pullbacks will happen, as they always have. It’s rare they portend imminent disaster and even rarer that cashing out is the best option. That said, they make investors think about their allocations. We’ve just had a vivid reminder that being overly concentrated in high-growth geographies brings big risks.
A bit of boredom in a portfolio might come in very handy: call it the “tedium trade”. If this idea gains popularity, the UK — which, alongside being the cheapest developed market, is bucking a global trend, given our economic data is actually improving — could emerge as an unlikely winner from last week’s wreckage.
Seema Shah is chief global strategist at Principal Asset Management