What are the most common behavioural traits impacting investment performance? Surveys have pointed to biases such as overconfidence and loss aversion as the biggest challenges.
Cognitive dissonance rarely features high on the list. Yet in a clash of emotion versus calculation, logic is often the loser. Shifting deep-rooted beliefs is tough, no matter how much thought and analysis we apply. Could this underlie investor complacency about emerging markets?
Most believe the long term growth story of emerging economies. Globalisation seems the natural order, harmonising living standards and prosperity around the world. Who would bet against long term outperformance of those stockmarkets?
Certainly, there have been blips in growth, but for most investors there is a deep-rooted belief in the steady ascendency of emerging economies. Yet, now new factors are at play, growing nationalism, doubts on globalisation, weak agricultural prices, and most of all a strong US dollar.
Investors like to think that deep down they are rational; in a clash between heart and head, analysis should win. The current stand-off between the US and many other nations is laden with emotion. President Trump is characterised as irrational, discouraging objective examination of his policies and tactics.
It is personality and rhetoric that grab our attention. To many, he just seems wrong, or bad for markets; little credence is given to the possibility that he might prevail.
This dissonance means questioning focuses on his motives – not on the possible outcomes. The possibility of dramatically resetting the terms of trade of many emerging economies is not given credence.
Emotionally, most investors believe that long term growth prospects are better outside the US. Instinctively half the US and much of the rest of the world feels uncomfortable with the thought that Trump might do anything right. That discomfort also means that much of what we see and read is tilted to the same perspective.
The president has picked so many different targets that he has become the story. Although stories have powerful emotional appeal, they also seem to make sense to us, apparently rational.
Yet the trade war cannot be seen in isolation; the US is more than ever joining up trade with defence and energy policy. Multilateral institutions may be the losers in this, as nationalist policies gain hold around the world in response to US power. This looks more like a new world order than the sort of environment that has spurred global growth in previous decades.
Investors have already begun to wonder if this might mean more global inflation, but money has not yet drained from emerging markets. Even in developed markets, liquidity is already strained. Managing liquidity in some alternative asset funds, such as hedge funds and real estate, has become more challenging.
One sign that investors are seeing things a little more clearly is the increasing correlation in currency moves versus the US dollar. Investors are beginning to view Turkey as part of a pattern. In time, there may be even more questioning of the globalisation story.
Political leaders in many emerging economies see interference in market pricing, media control and internet censorship as policies that should not interfere with foreign direct investment.
Yet, the ability to attract foreign capital and borrow in depreciating US dollars has underpinned economic policy in many developing nations. Now, more currency risk needs to be factored into expected returns, adding to the pressures of US interest rate rises.
It may take a shock to shake investors into hard-headed analysis. Anxiety can be the trigger to peel the emotion away and make an objective analysis. But, emerging market moves can be swift. Investors need to set aside the media portrayal of US policy and consider what might actually be the result.