Stock brokers at the New York Stock Exchange on October 25, 1929: Pity they were not more skeptical. Richard Drew
Sharemarkets are at record highs, yet professional investors around the world are scared.
So scared that in July a record proportion of them put money into investments that hedged against the risk of a potential crash, according to Bank of America-Merrill Lynch’s latest fund manager survey. That sounds entirely reasonable – there’s a lot to be worried about, after all.
But keep in mind that over the period those masters of the universe were filling in their questionnaires, the S&P 500 index was making new record highs.
Presumably, then, many of those individuals were upping protection against a nasty turn for the worse while simultaneously putting money into the US sharemarket – an unusual marriage.
Sign of a tantrum
Of course central banks help explain the paradox. Faced with little yield from bond and cash markets, many investors are forced into riskier assets such as shares and property. There’s also the understanding that at the slightest sign of a tantrum, central bankers will reach for the bottle. Brexit is a classic example, but equally abrupt was the turnaround in US Fed rhetoric after markets dropped sharply at the beginning of this year. The message is clear: investors, we have your back. The market is well trained to treat bad news as good news, as it extends the lifespan of ultra-loose monetary policies.
But new research shows how in one important way bad news will always remain bad news, and it could help explain why this has been the most reluctant bull market in memory.
The paper Crash beliefs from investors surveys is by Robert Shiller and William Goetzmann, both of Yale University, and Dasol Kim of Case Western Reserve University. They find that investors on average overestimate the chance of an imminent sharemarket collapse by a factor of six. They are primed to do so, the authors say, by the financial media’s preference to report bad news over good news.
The research makes use of Shiller’s investor survey which has been running since 1989. Questionnaires are sent to about 300 high-net-worth and institutional investors. Respondents are asked what they think is the probability in the coming six months of a “catastrophic stock market crash” on par with Black Monday of 1987 or the similarly hued Tuesday of 1929.
The paper’s authors note that the statistical probability of a meltdown of that magnitude occurring is one in 60, based on historical data between 1929 and 1988. But over the 26 years of surveying, investors on average put the likelihood at one in 10. That’s a big difference, particularly if you think that investors should inherently be more optimistic than the average person on the street – after all, isn’t investing essentially an exercise in betting on a brighter future? (Except for those gloomy shorters, of course.)
This is where the doom-mongering banshees of the press come in. Every journalist knows that bad news sells better than good news, and that extends to the financial pages. The economists studied the Wall Street Journal over the period of the surveys, searching for words and phrases associated with a stock market boom or crash. They found, unsurprisingly, that good or bad days on the market were followed by positive or negative news coverage. But it wasn’t equal. While a good day typically made for one day’s upbeat headlines, a bad day appeared to trigger several days of downbeat coverage.
“These findings are generally consistent with a negative bias in the financial media,” the researchers write. In our defence, the economists also note that “there is considerable evidence that negative news garners more attention and reflection” and as such “the asymmetry” in reporting positive versus negative news “may be a response to rational reader demand”.
In any case, turning back to the survey results, they find that poor recent returns and the negative news it generates leads to investors upping their estimates of a crash happening in the coming six months. It’s a mental quirk that behavioural economists call “availability bias”: a tendency to give more weight to information that is top of mind.
And there are plenty of “top of mind” worries filling these and other financial news pages: Brexit, China’s debt problem, secular stagnation, Donald Trump, even terrorism.
If the researchers are right, and bad news is overreported and has an outsized effect on investors’ expectations of a coming crash – perhaps we are all worrying too much? That’s one possible conclusion, although it’s a hard sell.
But, paradoxically, if you subscribe to the school of thought that bull markets only die amid a frenzy of over exuberance, then it’s only on the day we all believe everything is OK that this bull market is likely to expire.
If that’s true, outside of a true catastrophe, sharemarkets can stay high only as long as people stay worried.
Maybe bad news really is good news after all.