I read a headline on Bloomberg this morning that made me chuckle. It’s a great example of why you should be suspicious of all day-to-day explanations of market movements.
The headline read ‘US Stocks climb to record as Irma threat recedes’.
This suggests that US stocks were held back by the ferocity of Hurricane Irma, despite the fact everyone knows the strength of a hurricane recedes once it makes landfall.
Maybe the damage wasn’t as bad as expected. But pinning market moves on the direction and impact of a hurricane just tells you the journalists writing the story didn’t know what else to write.
After all, you can hardly say that the S&P 500 hit new all time highs today just because it was bound to happen at some point. Or that gold retreated because it had been rallying for weeks, and it was only a matter of time before it changed direction.
That’s not much of a story, is it?
No, people would rather make stuff up, because it sounds better than admitting we don’t really know.
I’m sure the fact that Irma wasn’t as bad as expected led to some positive sentiment in the US market. Throw in the fact that North Korea didn’t launch another missile over the weekend (which was expected, apparently) and you have a good reason for ‘risk-on’ trades to do well.
The reality is that no one really knows what’s going on from day-to-day. But humans hate uncertainty, so we construct narratives to make an intrinsically uncertain world more certain.
In his book, Thinking, Fast and Slow, Daniel Kahneman said that we have two systems for how we think. System one is fast and reactionary, while system two is slower and more considerate.
When coming up with a quick explanation for why the market did this or that, we engage our system one. As Kahneman writes in a chapter entitled, ‘The Illusion of Understanding’:
‘The sense making machinery of System 1 makes us see the world as more tidy, simple, predictable and coherent than it really is. The illusion that one has understood the past feeds the further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence.’
Consider the creation myth as it appears in The Bible. That fits the bill, as described above, quite nicely. We’ve been telling ourselves stories to make sense of the world ever since we developed language skills.
We’re hardwired to make stuff up.
What’s the point of telling you this? What’s the benefit of telling you that the things you read about the market on a daily basis are mostly guesses in the absence of any concrete facts?
Well, if you’re conscious of this ‘illusion of understanding’, you’ll be less inclined to get sucked into a narrative that suits your particular biases. When a market narrative plays to your bias, you’re more likely to get sucked into making a poorly timed investment.
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For example, gold is probably one of the most biased investment narratives people get sucked into. The recent rally has been great for gold and gold stocks. But if you bought into it, and believed the hype, you may have made some investments at exactly the wrong time.
Last week, I updated subscribers of Crisis & Opportunity on the gold price action. We’ve got a couple of gold stocks in the portfolio, and are looking to add a few more at some stage.
I showed the following chart and said that the breakout from the trading range was bullish. But instead of getting all worked up about the rally and going full gold bug, I urged caution.
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Here’s what I wrote:
‘This is a strong move for gold. I wouldn’t be surprised to see the rally extend higher in the short term. But what often happens after breakouts like this is that prices come back to the breakout point.
‘That could happen should tensions in North Korea subside.
‘Should gold correct in the weeks or months to come, it might be worthwhile adding a few more gold plays to the portfolio. I’ll keep you updated on this front.’
Gold subsequently rallied to around US$1,360 an ounce. But it has since retreated sharply, and it now trades around US$1,327 an ounce.
In my view, the worst thing you can do at this point is to listen to the daily narratives about why gold is doing this or that. It’s far better to plead ignorance about the whole thing and just play what’s in front of you.
As I told my subscribers, the recent breakout for gold is bullish. It sets up the precious metals for higher prices longer term. But instead of buying into all the reasons why gold will go higher long term, it’s better to not even know. Ignorance is bliss.
So the prudent thing to do is wait for the inevitable correction after the breakout, and then plan your investment strategy from there.
Which is exactly what we’ll be doing.
If you’re interested in learning more about this investment approach, click here.
Editor, Crisis & Opportunity