One of the most important biases affecting investors is the mistaken belief that big equals important. Every piece of information we process can be judged in two dimensions – its strength and its weight. Confusing one with the other will lead to us to under or overreact to news.
All three of the bad news stories that have hit the headlines in the first few weeks of 2020 have tried to lure investors into this trap. Impeachment, for example, certainly had strength as a news story (it had only happened twice before), but it lacked weight because the Republicans in the Senate were never going to vote Donald Trump out of the White House.
The sabre-rattling in the Middle East a few weeks ago had the potential to carry more weight because it threatened supplies of the world’s most important commodity. But the market was right to assign little significance to the story. Neither side had any real incentive to escalate the situation and oil analysts quickly judged that the world’s problem is too much – not too little – oil.
The jury is still out on whether the coronavirus story has the weight to match its undoubted strength. So far, the drama is most evident at the human level. It is becoming noticeable at the micro-level of, still relatively isolated, company profits warnings from the most affected sectors (Burberry, Cathay Pacific, Yum! Brands). But it is not yet impinging on the macro-level of Chinese, let alone global, GDP growth.
The strength of the story is undeniable. Deserted city streets, cruise liners turning into quarantine prisons and closed borders all make dramatic headlines. But the weight is, at this point, far from crushing.
According to the World Health Organisation, more than a million people a year die in car crashes, in excess of 3,000 a day. That’s four times the death toll to date from coronavirus – every single day. The alacrity with which markets welcomed China’s halving of import tariffs shows how the authorities retain the ability to offset the likely economic impact.
This is not to trivialise the outbreak, or to be complacent about how it could develop from here, but investment is in large part about weighing probabilities. And the odds remain shorter on a relatively benign outcome than a catastrophic one.
What else can we learn from the market’s reaction to this year’s dramas? First, that investors’ response to events can provide insight into the underlying direction of travel of a market. When the Americans assassinated Qasem Soleimani in Baghdad, the oil price somewhat reluctantly edged above $US70 a barrel. It was as if oil felt duty-bound to stage a rally, but its heart wasn’t in it. At the slightest whiff of a Chinese slowdown, however, crude has tumbled. The underlying momentum in oil is clearly downwards.
When it comes to shares, the opposite seems to be the case. The eagerness of investors to buy the dips and the speed with which the bull market has regained its mojo are signs of the fundamental strength of the market. Taking risk off the table seems, well, risky today.
Even as the stock market hits new highs, bond yields are heading lower again. Investors are seeking the safety of government bonds at the same time as they seem to be embracing risk with their shares. Actually, scrape beneath the surface and there is less contradiction than you might think. If you compare the performance of Nasdaq, the S&P 500 and the Russell 2000 smaller companies index, it is clear that investors have a pronounced preference for big, apparently safe, growth-focused shares. This, in other words, is a very cautious bull market, one that lacks depth or conviction.
Which brings us back to why investors are pushing shares to new highs despite all the gloomy news. They believe that the ultimate driver of markets, corporate profits, is still heading in the right direction. While there remains so much uncertainty in the world, they prefer to shelter in the parts of the market that can deliver that growth whatever the headlines tell us.
Tom Stevenson is an investment director at Fidelity International. The views are his own.