Confirmation bias and market volatility
My wife came down the stairs and caught me terribly embarrassed as I watched the TV in shame. The "other" cable news channel was on the screen. "Why are you watching this?" she asked, "all they do is lie."
"Sometimes their lies are informative," I answered. "There's just so much going on right now, I wanted to get a different viewpoint." Uninterested, she went on with her chores.
Confirmation bias is the tendency to seek out information and patterns of information that validate our pre-existing world view and biases.
We all engage in confirmation bias, and I would posit that confirmation bias is so important to us as individuals it is often impossible to even perceive. We simply view our opinions and biases as a source of fundamental knowledge and truth, without being aware of divergent frames of reference much of the time. I would go so far as to say confirmation bias is fundamental to being human.
In today's world dominated in the United States by cable news and social media, confirmation bias has gone beyond being simply "a" factor in the way humans perceive their world, to being "the" factor dominating not only perceptions but delivery of information. Cable news channels spew selective coverage and propaganda supporting the preferred world view of their target audiences 24 hours a day, and social media apps use sophisticated algorithms to validate the biases of their users, providing a toxic mix of both affirmative and antagonistic content in a brilliant effort to keep our eyes captured on the screen for as long as possible. Resistance to these complex manipulations is almost futile at this point.
Assuming our species survives the intense tribal polarization resulting from the technological echo chambers we have put ourselves in, I can't imagine future social scientists and policy makers won't look back at the current mess we have enabled and embraced and decide fundamental intervention was warranted, but by that time it'll likely be too late.
So, go ahead, wrap yourself in the warm blanket of propaganda and enjoy your confirmation bias, it's what we Americans do, so why not enjoy it.
There is one area of American life however, where confirmation bias can end up being a proverbial terminal illness. The realm of investing, and now may be a time to check it at the door.
When I think about confirmation bias, it's so easy to believe the prism through which we view the world is as fundamental to reality as the information we absorb through it. Confirmation bias feels like logic, it feels like reason, in reality it is neither. Instead, confirmation bias is a dynamic construct of life experience, concluded logic, our own opinions, the opinions of others, settled facts and raw information all wrapped in a thick layer of emotion. And few things in life elicit as much emotion as money.
Which in my opinion is why confirmation bias presents such a material risk to investors. Recent market movements, especially when involving a higher level of volatility, tend to elicit strong emotional responses as both greed and fear are extremely intoxicating elixirs. When portfolio values rise, decisions are validated even when the decisions themselves may not have contributed to the gains. When portfolio values fall, decision making is questioned, as the pain of losses validates latent fears present in many confirmation biases.
The last few weeks have reminded us that extreme volatility can be an inherent characteristic of investing in stocks. After multiple years of strong gains, confirmation bias may have convinced investors that conventional measures of value and risk no longer applied to the "modern economy" and current market cycle.
In my 33-year career, this has never proven to be true. Financial markets are dominated by expectations of corporate profits and interest rates, and in most of the ways I use to evaluate these metrics, the price of many stocks had become disconnected from what I would consider reasonable measures of value.
Does this mean the stock market is on a one-way trip off a cliff? Well, my confirmation bias tells me this is not the case (although it does feel this way). Instead, I think the correction in stocks being currently endured offers a window of opportunity for investors to examine the confirmation biases induced by recent market performance, which was specifically dominated by a small group of technology stocks, and perhaps re-broaden their investment perspective to a more conventional search for value and opportunity. Not all stocks are overvalued, but the ones I fell in love with over the past few years certainly are. Time for me to take a deep dive on my own confirmation bias.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.
