Greg Davies, head of behavioral finance at Oxford Risk, a consultancy firm to banks and investors, details the attitudes that can lead to stock market crashes. The latter being, according to him, often the result of non-rational investments.
What type of behavior does the emergence of bubbles promote?
There is not a single factor. Often times, market volatility is very stressful for those who have invested money. As individuals, we deviate from decisions that are good in the long run in order to satisfy our present need for emotional comfort. One way to do this is to follow the crowd. A large part of the herd behavior can be explained by the reassuring side of seeing other people who believe the same as us and behave like us.
Another factor is familiarity: usually we buy what we know, and if we all want to buy the same things, the price soars. A third phenomenon, which has played a lot, for example in the GameStop affair, is what we call “The fear of missing out “ (“The fear of missing something “). That awful thought that my friends might take unusual advantage of an item I don’t have. Afraid to miss something, I buy it too.
Is the pandemic amplifying these behaviors?
Yes, they have been exacerbated by the Covid-19 and by social networks. As we have more free time, we tend to be more stressed and anxious, the time horizon of emotions has narrowed and we are more focused on the short term than the long term. In addition, in many parts of the world, people have more money than before because it is no longer possible to eat or travel, while governments subsidize people to stay at home. .
Is this the perfect scenario for a bubble burst?
This is the perfect scenario for investments with a higher emotional component than normal. But it doesn’t say that this necessarily leads to bubble situations. Because many people, when they are stressed and anxious, respond on the contrary by fleeing risk and amassing stocks of money.
So what is the main risk?
In general, most people who have cash available in the short to medium term do not invest enough, rather than too much. We can consider that a certain amount of exuberance is necessary in the markets so that they are not irrationally low and therefore to meet the needs of a long-term investor. Exuberance only becomes irrational when valuations become unsustainable relative to underlying fundamentals.
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