Human behavioral biases often get in the way of making rational decisions. These articles discuss how biases influence how we make everyday and financial decisions.
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Dr. G. Kevin Spellman, CFA
March 18, 2020
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So much is happening, and quickly. The S&P 500 is down almost 30%, schools and businesses are closing, people are beginning to panic, and the financial markets are not functioning smoothly (stocks and safe assets are both declining). Monetary and fiscal policy are coming to the rescue, but maybe we just all need to stay home.
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- Human behaviors are following predictable patterns in response to coronavirus
- Markets are not functioning correctly – is Financial Crisis 2.0 brewing?
- Expectations started high, so the sharp correction is not surprising
- A recession could be needed to rid of excesses
- Maybe we should just stay home and watch Netflix
Does the Trade War Matter? Can the US Win It?.
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Dr. G. Kevin Spellman, CFA
July 30, 2019
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The title of this paper has two questions that may have obvious affirmative answers to many or even most readers, but this paper questions common beliefs. Given media and policy attention on the US-China trade war and how the market seems to react to every bit of news, “yes” may be the answer for many people to the first question, “Does the trade war matter?” The answer to the second question, “Can the US win the trade war?” will also be “yes” if one bases the answer on President Trump’s early explanation that the war will be easily won simply because China exports more to the US than the US exports to China so China has the most to lose by tariffs. However, the US has discovered that this war is not so easily won, and herein I explain why. I also argue that the trade war would not matter to the aggregate economy if it were not for the fact that most people behave based on their belief that it does. Beliefs cause actions, even if they are faulty.
Behavioral Biases, Trump, and the Paris Agreement
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Dr. G. Kevin Spellman, CFA
June 21, 2017
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The uproar in the US and around the world associated with President Trump pulling out of the Paris Agreement will be felt for some time. The decision may not be entirely rational, so it gives us an opportunity to discuss some of his perhaps – “perhaps” to be nice – behavioral biases, as well as – to present a balanced argument – biases that may influence people who believe in the global warming idea. It is well-known that humans have biases in their decision-making process. Some of the many behavioral decision flaws are associated with humans’ natural tendency to be overconfident. People also use short-cuts to speed the pace of making choices. Other biases may be due to human’s resistance to change and recognizing mistakes. People may also be rationally irrational – they may do something irrational to protect their jobs (a rational move). These pressures and decision errors are compounded if one’s thoughts are made public (like a president’s) since, unfortunately, society frowns upon one changing his/her opinion even when new information which refutes a prior position is robust.
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This piece may cause an emotional reaction from people on both sides of the global climate change debate as it picks on decision-making processes of the opposing parties. Given this, let me start by reminding you that biases in decision-making are just part of being human. It is only natural to have decision-making flaws. To overcome biases, one needs to be aware of them and the troubles associated with them. Also, since what is forthcoming is reasonably critical of Trump’s decision, I start this piece by discussing biases associated with proponents of global warming. I attempt to stick to facts and be fair to all parties..
The Expectations Clock: A Model for Cycles and Sentiment
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Dr. G. Kevin Spellman, CFA
May 2, 2017
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The Expectations Clock provides a framework for modeling performance, expectations of future performance, and human behaviors during phases of the performance cycle. It is a model of human over- and under-reactions to the environment.
Success in investments (and business in general) is highly dependent on effectively forecasting future fundamentals (e.g., sales, earnings, etc.); however, these projections are influenced by human interpretation of events which are impacted by behavioral biases. Further complicating forecasts, human reactions (such as investments) to current and recent fundamentals also influence the fundamentals being forecasted. Thus, to predict performance, one must project the underlying cycle and how people interpret and respond to it.
Sentiment Rises: Modestly Cautious Readings
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Dr. G. Kevin Spellman, CFA
March 26, 2017
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Sentiment has risen strongly over the last six months to a high level while earnings growth has accelerated, a perfect environment for the stock market which posted strong gains (up 8.9% over the last six months). Consensus estimates call for earnings growth to continue to accelerate, but sentiment already implies this so the odds of negative surprises and declining expectations has risen. Over the last month, the market has rotated to growth and defensive sectors, which implies that investors are beginning to realize that financial markets may be ahead of fundamentals.
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Level of sentiment is positively correlated (R2 = 0.63) with historical 1-year returns (figures 2-3, top charts below). Furthermore, even short-term changes in sentiment are correlated with short-term returns (figures 4-5, bottom charts). The stock market is a gauge for expectations of earnings and risk, so predicting sentiment is useful for predicting returns. Sentiment is likely to decline from these levels (sentiment declined in 53 of 72 months since February 2000 when sentiment was over 60%), and falling sentiment from these levels is associated with muted (slightly positive) returns.