For investment managers, that means focusing on company fundamentals rather than giving subjective views on an uncertain and unpredictable future.
It’s all too easy to be emotional about the views of Donald Trump, the rights and wrongs of Brexit or the refugee crisis unfolding across vast swathes of Europe. Indeed, some feel so strongly that they regularly vent their spleen by taking to social media, the airwaves or, increasingly, to the streets in protest.
Few of these people are likely to make good investors. Why? Because investors who make decisions based on emotion generally make the wrong decisions.
The stock market is an unemotional beast, concerned with such dry data as balance sheets, cash flow statements and the minutiae of analysts’ forecasts. When operating in such an environment, it’s important to stay equally unemotional, ensuring that decisions are based on evidence alone.
That is what we strive to do each and every day. It is not easy, but past data tells us that this kind of disciplined approach adds value. Thankfully, few other investors are so disciplined: they let emotion—not facts—influence their decision making. This leads them to make cognitive errors which we can then turn to our clients’ advantage.
It’s worth noting that equity markets went up at each of the major surprising events of the past 12 months: Brexit, the resignation the UK Prime Minister, the resignation of the Italian Prime Minister, the election of Donald Trump and the announcement by Prime Minister Theresa May that she is to pursue a “hard” Brexit. Emotion could have easily led us to expect the opposite outcome—and our instincts would have been wrong and costly on each occasion.
That’s why our Behavioural Finance process is designed to use facts—not emotion—to find good-quality, reasonably valued companies with improving prospects, as demonstrated by analysts’ upgrades.
When it comes to the economy, the following facts are relevant:
- GDP forecasts for advanced economies are rising (now around 2.8% for 2017)
- Inflation forecasts in developed markets are also rising on the back of improved economic activity (GDP), rising commodity prices and in the UK the recent sharp fall in sterling.
- There is also evidence of some early signs of real wage growth returning to many Western economies.
The rhetoric of both the Trump administration and the new May government points towards looser fiscal policy. There may be a couple of small rate rises in the US this year, but generally monetary policy shows no sign of tightening significantly in the near term. This is a good backdrop for equities.
There is also the possibility that the fiscal stimulus from one or both administrations may be larger than expected and coupled with radical, corporate friendly tax reform. Again, we will wait for evidence of this before acting, but this would give a further boost to an equity bull market that is now approaching eight years in length.
In addition, the latest Bank of America survey* indicates that cash levels among fund managers is high (perhaps driven by emotion), which should provide support in the event of any setback in markets.
However, the future is clearly more uncertain than usual. Trump is a maverick, the refugee crisis continues unabated and the full impact of our departure from the EU will remain unclear for some years to come. The established global order feels under threat, but there will, as ever, be winning and losing investments. As a result, we must stay vigilant and watch company and economic data more closely than ever before. Others may continue to make investment decisions driven by emotion. We’ll continue to make ours driven by cold, hard facts.
*BofA Merrill Lynch January Fund Manager Survey
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