Bearish State of Mind

Recently a Hidden Brain podcast delved into how mindset shapes our expectations. The presenters made the point that our brains are wired to predict future events so we can identify our options for a way forward and make choices. This is called “prediction processing,” something we all do without really realizing it. They went on to say that once we’ve identified our preferred path, we look for data to confirm we made the right decision—something called “confirmation bias.”

I was listening to this while stuck in traffic. I thought about how different a traffic experience is now, with Google Maps. I used to consider my departure time, have a couple of options regarding how to get to work and mentally prepare for a long drive if my timing was bad. I relied on 60-second traffic updates from the radio. Now, I have artificial intelligence-driven technology pulling data from many other drivers feeding me alternatives on how to get to work, which usually makes the drive shorter.

However, my mindset has been built up over 25 years of commuting, so I sometimes don’t realize how beneficial the new tech is. Also, I’m sure we’ve all been exposed to the less than perfect routes given by Google or Apple Maps, so nothing is foolproof.

So, what does this have to do with investing?

Over the last three years, we have been faced with a pandemic and a pandemic recovery fueled by unprecedented government spending and central bank liquidity. That’s led to high inflation. We’ve seen the start of a war very near Europe, the next phase of China’s plan to be the largest economy in the world, and economic growth slowing. In the markets, we’ve seen volatility featuring a tripling of interest rates, from near 0%, and a rally in stocks of over 100%...followed by a sell-off of nearly 25%.

As investors, our mindset is often to gather information taking place in real time and then attempt to react accordingly, changing our investments to appease our emotional reaction to the bad news. In other words, the more negative news we get, the more negative investor sentiment becomes.

You can see what has happened in this chart from AAII (American Association of Individual Investors). The chart below looks at the difference between those investors who identify as bullish and those who are bearish.

The more negative the number the more bearishness there is. On June 23, the reading was negative 43%, the lowest reading we’ve seen in some time. Recently, it has rebounded a bit.

Our brains are wired to take this incoming negative data as confirmation that our fears are being realized. That’s an invitation, then, to choose a less risky path forward with our investments. As sentiment grows more negative, the more negative the information becomes.

It is why our advisors work so hard to remind clients that they are working from a financial plan that incorporates both good and bad market environments and anticipates their need for growth and income over a long period of time. Our mindset needs to shift away from confirmation biases and bad news. We need to instead focus on the outcome we’ve planned for.

The planning process

Stock investing is difficult because volatility is unavoidable—and volatility can create an emotional reaction. But on the other hand, that risk has historically meant higher returns than less risky assets. The planning process is meant to provide insight into what kind of return is required to meet long-term objectives and over what time horizon.

If the environment changes for investments, as it has now, the question should be: “Has my return requirement or time horizon materially changed?” If so, then revisiting the plan makes sense.

Recently, investor sentiment has improved from the June low—though it remains decidedly bearish. The confluence of events we’re experiencing will keep sentiment lower for some time. In that context, it’s especially important to keep our mindset focused on planning rather than letting emotional biases—amplified by negative sentiment that leads to confirmation bias—take charge of our thinking and our actions.