Opalesque Q&A and Interactive Quiz: The Seven Keys to Behavioral Investing – January 26, 2021

Are stocks and bonds displaying positive correlation due to limited inflation volatility, despite them having theoretically opposite sensitivities to economic growth? At some points during 2020, such as the middle of March, any duration became a risk asset as people sold anything with a bid. This was also true during the first part of the Global Financial Crisis. With massive government spending and Central Bank balance sheet expansion, there is the potential for inflationary pressures and higher interest rates. These could weigh on stocks as well. Companies have been using low interest rates to issue debt. With higher rates, issuing equity may become a more attractive alternative, and the use of debt funding to fuel stock buybacks will become less attractive. Finally, the competing cash flows of “safe” fixed income at higher yields may draw investors away from more volatile equities.

Are bonds and equities now more correlated than in the past? Is this due to market segmentation / specialisation? It appears that the correlation has been rising lately. Certainly the performance of bonds during the height of the Covid equity selloff in March suggests that there can be periods in which the two assets move together.

If Barclays Agg bonds have been roughly flat cumulatively over daily periods where equities are flat or down (which would presumably include many big drawdowns), does that not mean they are, in fact, providing diversification? Diversification, in its literal sense, sure. I was using the word in the sense of providing positive return during crisis periods – sometimes I use the phrase “protective asset” to denote the difference between an asset that fails to lose as much money as stocks and one that actually makes money during the period.

What is the greatest risk right now to multi-generational portfolios? Fiat debasement, without question. Most portfolios can survive equity bear markets, which typically are 50-75% declines. But a 99.99% decline in real value of, say, cash, is an extinction event.

Roy mentioned he had to stop playing the violin when Lehman went under. We all can get overwhelmed by emotions and yet we also know we shouldn’t … When it comes to investing, how do you manage emotion – foremost stress? I believe having a system of physical fitness and enjoyable physical activities to manage the impact of stress on the body, and a similar system in place to manage emotional stress, can improve decision making, stamina, and performance. I find making or listening to music to have positive benefit to my thinking. Many swear by meditation, and of course many other activities. As I mentioned, having a dog (like many, I got my first dog this year) and walking him often has provided me several periods each day to think without distraction or without having screens to watch. It also forces me to walk a few miles each day, which helps as well.

How would quantitative psychology support an investment based on the strength of a new leadership team (e.g., Larry Culp at GE)? Optimism bias at work, or rational? That’s a very interesting question. I think it would be possible to test this. It may be that the emotional impact of new leadership is enough to make a positive impact. I’m a big believer in testing things quantitatively – I suspect there have been a few theses and dissertations written on this topic. Perhaps if you encounter any you would be willing to share with me.

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