I saw examples of two cognitive biases that impact investment decisions live and in person on Friday – the availability bias and the recency bias. The availability bias is the human tendency to recall examples of things that come readily to mind, and mistakenly infer that these examples are more representative than is actually the case. The recency bias, as the name implies, is the phenomenon of a person more easily recalling things that happened recently. These psychological phenomenon are just a few examples of the cognitive biases that hamper the critical thinking process so important to investment decision-making.
There were scary headlines last week. Bloomberg breathlessly reported that it was the worst two-day start to an October since 2008, conjuring images of those heady times that fall in capital markets. A young colleague suggested to me that „fourth quarters are always rough.“ That colleague was probably recalling the large fourth quarter sell-off last year (recency bias) or may have been reacting to the famous fourth quarter sell-offs in 2008 or 1987 or 1929 (availability bias).
Those four fourth quarters (2018: -13.5%; 2008 -21.9%; 1987: -22.5%; 1929; -28.9%) all were memorably weak periods for stock markets, but should not provide a perception that all fourth quarters are seasonably weak. To refute this mis-perception, I looked at historical total returns for the S&P 500 (VOO) and its predecessor indices dating back to 1927. As it turns out, the fourth quarter has actually produced the best quarterly returns, on average, over time. While the aforementioned sell-offs were outliers, the distribution of returns for the fourth quarter is also meaningfully narrower than the second and third quarters.
What are the takeaways for Seeking Alpha readers? Don’t let cognitive biases shape your view towards markets in the fourth quarter based on flawed views of historical performance. Note that each quarter has produced meaningfully positive returns, on average, over time, which augurs for capturing the equity risk premia over long-time intervals. Markets are currently re-pricing views of forward economic growth, and we could be in for a period of episodic volatility. Over long-time intervals, owning U.S. equities is a winning trade quarter in and quarter out.
Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.
Disclosure: I am/we are long SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.