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What could go wrong?

Monday, February 27, 2017 15:49
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If you’ve never heard of recency bias, time to learn.

It’s simple. Makes people behave like dogs. It’s the expectation what just happened will continue to occur because, well, it just happened. This goes to memory. Since we recall recent events far better than past ones, they have more weight. Recency bias leads zillions of investors over the edge, since they expect stock markets that have gone up recently to go up forever, or falling assets to hit zero.

Ditto for houses. Even more so, actually, since real estate’s the very reason most Canadians exist. When property values rise, we anticipate more increases. When they erupt, we expect an endless boom. Recency bias is a dangerous thing as it crowds out logic, analysis or risk management – a daily event in hyperventilating places like the godless GTA.

We have stats to prove it.

Each week my pal Nik Nanos does a poll for Bloomberg on how Canadians feel about things. They’re shrugging off mounting risks and warnings about real estate and, in the wake of January’s epic 23% year/year Toronto price gain, doubling down on inflated houses. No matter that BMO now calls it a bubble, that Trump could easily blow things up (see below), that the odds of higher rates are rising, that affordabililty is plunging or governments  seriously considering more market-dousing actions, we’re horny, baby!

The Bloomberg Nanos Canadian Confidence Index has wobbled higher with just 10% now believing house prices could fall (the lowest level in three years) and the proportion of RE bulls climbing to almost 42%. This is even more interesting since a majority think their personal finances suck. A year ago 15% said they were worse off than twelve months earlier, now that’s almost doubled to 28%.

Why the discrepancy?

Yup, recency bias. The belief that what you see is what you’ll get. Logic tells us no asset class can rise at ten times the rate of inflation, be completely detached from economic fundamentals or so dramatically leveraged to a rising mountain of debt, but this is not about rationality. It’s all emotion. Expectation is running rampant. The last time the scent was this strong was 2000, and it smelled like Nortel.

What about stock markets and other financial assets? Aren’t they rising as dangerously, based on the sheer investor euphoria? Maybe. Or not. It’s important to remember people don’t buy mutual funds or ETFs with 95% financing, which would make any large downturn a lot less consequential. Equity values are also based on corporate earnings, not just hormones, providing some measureable metrics (unlike a $1.5 million semi in Toronto).

Having said that, look at this…

Tomorrow (Tuesday) the Trumpster gives a speech to Congress which has all the import of a year-end State of the Union address, and the potential impact of a federal budget. Since his election last November, markets have viewed this wacky guy as a pro-business pumper with a cabinet stuffed with billionaire buddies who’ll do whatever it takes to goose profits and make capitalism great again. The expectation of a corporate tax cut plus relaxed regulations and fatter bottom lines is rampant. He’d better deliver.

Since the November 8th vote stocks have shot up 10% with 17 record closes, making investors about $2.8 trillion wealthier. Yes, the economy’s been a good performer (great job creation numbers, for example, and rebounding corporate profits), but a big part of this surge has been Trumpism – the gamble that he’ll actually come through with the pro-business agenda. That has also boosted the US dollar while depressing bond prices and inflating yields. This has also boosted the odds of a Fed rate hike in March to 40%, and to over 70% by later in the year.

If Trump unveils a plan, there’ll be a large reaction. Volatility could spike from current low levels and equities pop. If he doesn’t have one and spends an hour talking about fake news, spend the day with your dog instead of watching BNN (which is always a bad idea, anyway). If the plan’s tepid, same result. Be very thankful your portfolio is balanced.

The message today is simple. You have no idea what’s coming. Unpredictability is rampant. Donald Trump is its face. If you put all your eggs in one basket – whether a mess of stocks or a McMansion worth millions – be prepared to learn what just happened probably means nothing. Your dog knows.


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