Market Highs and Herding

The U.S. has low inflation combined with monetary and fiscal stimulus which has led to a bubble in stocks. This occurred in December of 2017, followed by a near 20% decline just two months later. We saw it again in February of this year. With overly confident investors, the risk of a decline is extreme..As Benjamin Graham said, “The investor’s chief problem — and even his worst enemy — is likely to be himself. ”

The reason is uncertainty. So how does our mind interpret uncertainty?Robert Prechter and Wayne Parker, co-authors of the paper, ”The Financial/Economic Dichotomy in Social Behavioral Dynamics: The Socionomic Perspective” (Journal of Behavioral Finance, Vol. 8, No. 2, pp. 84-108, 2007) explain very different regions of the brain are involved. When we act as consumers, the neocortex of the brain, drives reasoning. But when we buy stocks, our brain relies on the more primitive region — the basal ganglia — which drives unconscious behavior such as herding. An investor buys with uncertainty with the hope that it will be worth more tomorrow. In the decision making process the brain defaults to herding. The solution, see the markets objectively — and separate yourself from the herd.