The emergence of meme stock mania in 2021 has reinforced the idea that emotion and self-confidence drive investor behavior more than a desire to research or follow fundamentals. Peter Atwater is a former Wall Street economist who redefined himself mid-career to study social psychology and confidence-driven decision making. The current market environment gives him plenty of material to work with.
Atwater’s style has become one that has gone from quantitative to qualitative and he admits that he is one of the few who does not pay much attention to data. He says that people do not remember numbers, they remember how something makes them feel. He uses the example of how someone remembers how beautiful a summer day felt and looked, but they never remember the temperature.
Atwater also offered his thoughts on the K-shaped recovery and where the post-COVID economy is headed. He sums it up well, saying that if you sat for a living, you probably ended up doing just fine. If you stood for a living, you were probably having some trouble. The government’s response didn’t necessarily help because it was driven by the idea of “trickle down”. The ones at the top were going to benefit first and the entire system was catered to those who could afford it. For those at the top, the recovery was swift. The lag for those closer to the bottom has been long and sustained.
One of the main themes that Atwater consistently reaffirms is the idea that emotions and feelings drive decision making more than numbers. We take risks based on how we feel. For example, if you are playing blackjack at a casino and you’re riding a hot hand, you may be willing to become more aggressive even though the odds of winning or losing are the same with every hand. A more economically relevant example is inflation. The official number may be 2-3%, but if people feel like it is 20% because food, gas and healthcare prices are rising quickly, they’re more likely to change their spending and saving habits.
Along those same lines, Atwater thinks of inflation in terms of a change in affordability and a change in availability. Scarcity is perhaps the most important factor in defining true inflation risk. If there is a number that matters, it might be the price of gas because it has a homogenous demand, it affects everybody and the price is in big numbers at every gas station, so it’s easily quantifiable.
The repetition of higher prices will give people the feeling of where prices are headed. In the 1970s, nobody remembers the price of gas, but they do remember waiting in line. In more recent times, the toilet paper shortage led people to build pantries and hoards. It is the perceived shortages of goods that can lead to inflation due to scarcity.
Among Atwater’s other thoughts:
- Is current inflation “transitory”? The more accurate term is “non-extrapolatable”. Transitory inflation requires people to believe it is temporary. Therefore, we cannot believe it’ll keep going. In reality, it’s not the Fed’s decision, the crowd will decide.
- Could we see a U.S. government debt downgrade? The current market looks reminiscent to 2011. Unless ratings agencies have explicitly stated that government debt does not matter, they have a fiduciary responsibility to address credit quality. An emotional reaction based on social mood will happen far before our ability to issue debt is impacted.
- What are your feelings on cryptocurrency and Bitcoin? It is a great indicator of sentiment, but it’s definitely become more combative. It is not enough that I’ve made money. Now I need to have my opponent’s head on a stick.
- How does the active vs. passive argument look? We are starting to understand some of the shortcomings of passive investing. Its success has fed upon itself, but we are at the point where something else will need to arrive. The extreme shift to passive is a result of cognitive laziness. There is an enormous level of complacency in passive investing that doesn’t get talked about.
- How is the 60/40 asset allocation not broken? Both asset classes are at record highs, so it’s hard to think it’s not a problem here. The real risk is people leaving altogether, not just switching to cash. It is not about risk-off, but risk-out.
Atwater wraps things up noting that we are a nation divided both financially and politically. Those things will start to matter. It won’t be left vs. right. It’ll be top vs. bottom.
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