Whichever way you voted in the Brexit referendum, it’s been emotional. But powerful emotions and rational decision-making rarely go hand in hand. As people—and as investors—we’re instinctively drawn to popular decisions, seizing on that popularity as confirmation of our choice. After all, if our decision turns out to be wrong, at least we’re not on our own.
The four types of behavioural bias
This behavioural bias comes in four classes types. The first is anchoring. When analysts make an earnings estimate, they tend to stick to it, even if new information changes things. The second is herding, where analysts follow the crowd on consensus and guidance. The third is overconfidence. We sometimes see this when management teams allow their peripheral businesses to divert focus away from their successful core business. And fourth there’s loss aversion. When negative newsflow causes a company’s share price to underperform, the fear of locking in losses often prompts investors to cling on in the hope that the stock will bounce back, rather than getting out quickly.
The path of least resistance
So how do herding and anchoring work in practice? Take sell-side research analysts, who cluster around consensus estimates for profit figures. If one analyst believes the true figure lies nowhere near the estimates of his peers, the easiest option is to rein back his numbers closer to consensus. This means that if he’s right, he looks clever; and if he’s wrong, he’s not that wrong. So analysts tend to gradually revise up their estimates—over and over again—with experience teaching us that once an upgrade happens, there’s a 70% chance of another one.
At a sector level, if we compare the number of houses built since 2008 against the average number of houses needed based on household formation growth rates, it’s clear to see that we have created a structurally undersupplied market. The introduction of the Help to Buy scheme has also introduced greater certainty of mortgage availability for first time buyers, providing a steady stream of buyers for product regardless of short-term market conditions. But the planning process is time-consuming and complex, making it difficult for new entrants to break into the market, despite the high margins to be made.
A huge sell-off based on emotion, not fact
So how did the Brexit vote affect housebuilders? In the immediate aftermath of the referendum, there was a significant sell-off: for example, Redrow was down over 75% intraday [Source: Bloomberg as at 30 September 2017] - a purely emotional price that had nothing to do with the actual market. Gradually, people became more comfortable with the reality of the market and began to see it as a buying opportunity. Meanwhile, the big developers continued to grow volumes and increase selling prices, resulting in better than expected earnings and a recovery in their share prices. Around Brexit, analysts were slashing their numbers because they were scared, but then had to revert to their original numbers after Bellway’s reporting showed that nothing had really changed.
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