After the 2008 market debacle, a couple of professors devised a Financial Trust Index to gauge how Americans were feeling about things. The idea was that a large sample would be surveyed every quarter and then the data tabulated. (You can see their website here.) My specific interest here is an article on the Financial Trust Index that appeared in the Wall Street Journal on July 20, 2010. This was a little more than one year from the market bottom in 2009. Prices had already advanced nicely, but this is what the article had to say:
About 45% of people think the stock market will drop by more than 30% in the next year, according to a survey by economists at the University of Chicago and Northwestern University. That’s even worse than the 42% a year ago who thought such a sharp decline in stocks was likely. (In December 2008, the share stood at 56%.)
And they’re not counting on much of a payback, either. The average expected return on investment in the next year was just 1.4%, versus 3.5% three months ago.
A huge percentage of investors were expecting another market drop of severe proportions. Why? Well, a big drop had happened in the not-too-distant past and like most forecasters, they were extrapolating more of the same into the near future. We’ve written a lot about the folly of forecasting before, so poor forecasting technique isn’t really surprising. Given the well-documented dismal performance of retail investors, why would the Wall Street Journal even run an article highlighting their forecasts?
Media is a business. Like all businesses, they are trying to maximize their revenues. Especially in this digital age, they can see which stories get the most clicks. Some websites even have a “most popular articles” list. The most popular stories are often stories that create fear. Fear is a much more powerful emotion than satisfaction. In fact, prospect theory shows that people react twice as strongly to negative outcomes as they do to positive outcomes. Therefore, many stories in the media are going to have a negative slant. And, of course, stories with a negative slant are most believable and appealing to us when things currently are going badly.
Ignoring forecasts in the media is a necessity for good investment performance. You’ve got to have a thoughtful investment process—and stick to it, especially when conditions are terrible. That was a good policy also when this article came out in 2010. Rather than the forecasted investment return of 1.4% for the following year, the S&P 500 was up more than 22%. That’s more than double the average annual return: it wasn’t just a decent year, it was a great year. Reflect on that before you deviate from a reasonable investment policy.
