Tag Archive for: Dow Jones

The Role of Influence in the Markets

I’m willing to bet the majority of you reading this week’s post have seen the 1940s Christmas classic It’s a Wonderful Life which starred Jimmy Stewart as George Bailey. You know the story; George Bailey contemplates suicide on Christmas Eve because his building and loan business looks like it’s going to go under and he thinks the world would have been better off had he not been born. In the scene that leads to his despair there’s a run on his Building and Loan company and it nearly goes under. What’s clear in the movie was panic set in and more and more people wanted their money fearing they might not get it if they waited much longer. We saw something similar in recent weeks in the stock and bond markets in the United States so I thought it would be good to look at some of the psychology behind what happened. First there was the debt crisis. Americans and the world started getting very antsy as they watched the game of chicken played by President Obama and the democrats with House Speaker Boehner and the republicans. There was talk that an agreement might not be reached because the two sides have very different viewpoints on the role of government, the use of debt and how the economy best operates. The uncertainty lead to fear and as the old saying goes, “Perception is reality.” The fear is rooted in scarcity, the principle of influence that tells us people want something more when they believe it will be less available. When investors think the government will make moves that could hurt their investments they will take actions to minimize their potential loss and quite often that means they sell while they can. The result of the uncertainty; the market lost several hundred points that week even though a deal was ultimately reached. Unfortunately it went from bad to worse the following week! The market reacting to fears of a worldwide recession and not being too pleased the government compromise on the debt started another sell off. On Thursday, August 4, I recall looking at some news outlets during lunch and seeing the Dow Jones was down 350 points! By the end of the day it was down over 500 points which meant it had lost about 1000 points, or nearly 9% of its value, in just over a week. Not good for those of us saving for retirement and/or kid’s college! While the run might have been sparked by fear it was compounded as investors looked around, took note of what others were doing and followed suit. In other words, consensus, the principle of influence that tells us people look to others for their cues on how to act, was at work. This particular principle is magnified in times of uncertainty and we saw something similar to what George Bailey was facing with the run on his little Building and Loan business. By the end of the week, for the first time ever – including during the Great Depression – the United States bond credit rating was lowered from AAA to AA+ by Standard & Poor’s. This creates more uncertainty as investors are waiting to see how the other major credit rating bureaus will react. If they follow suit things could continue to snowball. However, if the other agencies express confidence in the U.S. government’s ability to meet its debt obligations and keep their AAA ratings things might even out some. The White House vigorously contends S&P’s measurement that led to the lower rating was an inaccurate representation of the debt and government spending. Unfortunately, given all that’s gone on government officials may not have much credibility (authority) in this “he said, she said” back and forth that’s taking place. Confidence is not something that can be measure like speed, strength or IQ. Confidence is a matter of perception and, as noted above, perception is quite often reality until something happens to change that reality. Consider this; no one thought a man could run a mile in less than four minutes. Many tried but all failed over the course of human existence. Even physicians began weighing in saying it was not humanly possible. However, all of that changed on May 6, 1954, when Roger Bannister finally broke the four minute barrier. Once he did it dozens of other runners did so in the ensuing months and years. In fact, just 46 days later, his new record was already history as John Landy set a new world record for the mile. Why all these sub four minute milers setting new records? Because all of a sudden people were confident it could be done. Their perception changed and so did reality. It may not be the government’s doing something that will restore confidence, it might be key investment houses, individual investors or some other outside organization but until it happens we’ll all be like the myriads of runners prior to May 1954, a group of people who don’t believe it can be done.P.S. The DJI fell more than 630 points as this post hit the internet! Brian, CMCT


Helping You Learn to Hear “Yes”.