Stocks were under pressure last week, as the S&P 500 fell by 1.23 percent to 2,976.61. That left the benchmark index up 18.74 percent 2019-to-date, and just 1.25 percent below the all-time closing high hit on Monday. With major indices still relatively close to record levels and the economic expansion in America recently becoming the longest in modern U.S. history, some investors may be worried that the likelihood of a larger correction has increased. Such concerns are understandable since drawdowns are far from uncommon and there are indeed numerous potential catalysts for stocks to pull back in the near-term. However, the probability of something happening and the severity of what actually does occur are perhaps being overestimated by regular investors, according to research from Yale University’s Robert Shiller and William Goetzmann. Indeed, on October 19th, 1987 the S&P 500 plunged by over 20 percent, the largest single-day drop on record. Ever since then the researchers have been polling investors on the perceived odds of a similar market event happening within the next six months. Over the roughly three-decade sample period respondents have typically assessed the likelihood of a comparable crash as being around 10-20 percent.
Given that there have so far been zero “Black Mondays” since 1987, investors were clearly overestimating the probability of a repeat occurrence. This exaggeration was found to be even greater when an adverse event was being widely covered by the financial media, e.g. surveyed investors would often assign a significantly higher crash likelihood if asked during or soon after a big down day in the market. That is just one of the many examples of how investors will frequently rely on easily-recalled information to estimate the probability of something occurring. Shiller and Goetzmann also found that crash assessments can negatively influence equity flows (exacerbate the flight to and from risk assets), especially when investors give excessive weight to short-term fluctuations in the market. Such irrationality can lead to people having too low a portfolio allocation in stocks simply because equities have been under pressure, and too high an allocation after a favorable period for the market. Altogether, this study is yet another reason why regular investors should consult with a professional financial advisor to help make sure that they stay focused on the long-term, refrain from making emotion-based trading decisions, and maintain a portfolio that is appropriate for their risk tolerance, nearness to retirement, and other unique circumstances.
To recap a few of the things we learned about the economy last week, the positives included that trade-related inflation pressures moderated, single-family housing starts and authorizations rose, homebuilder sentiment improved, consumer confidence firmed, retail sales growth strengthened, gauges of regional manufacturing activity rebounded, and second quarter gross domestic product projections were revised higher. As for the negatives, mortgage applications declined, rental construction contracted, capacity utilization fell, industrial production disappointed forecasts, and initial jobless claims increased. This week the pace of economic data remains elevated, with several important reports on housing, manufacturing, and employment scheduled to be released, along with the first official estimate from the government of Q2 GDP growth due out on Friday.
What To Watch:
- Chicago Fed National Activity Index 8:30 AM ET
- FHFA House Price Index 9:00 AM ET
- Existing Home Sales 10:00 AM ET
- Richmond Fed Manufacturing Index 10:00 AM ET
- 2-Yr Note Auction 1:00 PM ET
- MBA Mortgage Applications 7:00 AM ET
- New Home Sales 10:00 AM ET
- EIA Petroleum Status Report 10:30 AM ET
- 2-Yr FRN Note Auction 11:30 AM ET
- 5-Yr Note Auction 1:00 PM ET
- Durable Goods Orders 8:30 AM ET
- International Trade in Goods 8:30 AM ET
- Jobless Claims 8:30 AM ET
- EIA Natural Gas Report 10:30 AM ET
- Kansas City Fed Manufacturing Index 11:00 AM ET
- 7-Yr Note Auction 1:00 PM ET
Sources: Econoday, SSRN, NBER, ThinkAdvisor, FRBSL
Post author: Charles Couch