SMUG MONEY: Volatility an opportunity? A habit we need to break

Written by Rebecca O'Connor on 4th January 2016

It was mere minutes after newswire reports of the suspension of trading in China this morning that the first release on “opportunities in volatility” landed in my inbox.

Knowing how repetitive financial commentary can become when it is your job to produce it, I wouldn’t be at all surprised if there is a “volatility template” with a default quote, where only the market setback and percentage falls need to be changed each time, such is the frequency of alarming drops lately.

Anyone else got volatility fatigue? Read on.

Snakes and ladders

The “buy low, sell high wisdom” is the silver-lining of any tumble in value, because the forward-thinking will always see an opportunity to profit from someone else’s loss. Nothing wrong with that.

Except that now everyone does it, the craving of opportunity in a world where there is little headroom for genuine added value seems to have resulted in volatility for opportunity’s sake.

If all investors pile into China on the back of lower share prices there, or into oil because “it can’t get much lower”, this behaviour compounds the problem, producing even more volatility: the piling in will push up value again, but if those share price rises are not backed up by real asset value, the market price will not stay there. It’s like an endless game of snakes and ladders where the gap between each gets shorter and the snakes and ladders, ever longer.

Place your bets…

This complexity is necessary for traders and investment bankers to justify (to themselves at least) their whopping rewards. The more complicated and volatile the investment universe is, the more specialised and skillful the navigators can claim to be.

Reality check: it’s just gambling, pure and simple. Except the entire world is playing, knowingly or otherwise.

The commentary on China, US interest rate hikes, a UK referendum on the EU and low oil prices, in question this morning said: “Despite this potent combination there are reasons for investors to be cheerful. For example, a lower oil price will not only boost household budgets, which is likely to increase disposable income, but the travel sector, amongst others, will reap the rewards. Another example would be that Japanese and European shares are likely to do well on the back of interest rate hikes in the U.S.”

Oil is low, so invest in travel…. what about when oil rises again? Or a carbon tax is imposed, sending the cost of flying higher?  Or there is another terrorist scare on an aircraft?

Or the US rate hikes: they make Japan and Europe look good, but what about when Europe follows suit with its own rate rises?

Timing market bets like this might make eye-watering profits for some, but you are just as likely to lose – and get a one-way ticket to stress and anxiety land into the bargain.

Yet still, the quest continues.

Toddler brain

Why haven’t we learned? It’s our brains, stupid. Or something that psychologists refer to as “toddler brain”. Mistakes we repeat with regularity arise from the toddler brain. In the adult brain, we learn from past mistakes, grow from them, and soar above them. Not so if our toddler brain is dominating our thinking. According to Dr Steven Stosny, author of Anger in the Age of Entitlement*: “We’re all capable of making the same mistakes over and over, because, under stress, we tend to retreat to habits of emotion regulation formed in toddlerhood. Habits rule under stress and when the regulatory processes of the prefrontal cortex (the Adult brain) are overtaxed from physical or mental exhaustion.”

According to Dr Stosny, there is increasing evidence of Toddler brain habits in adults – impulsiveness, poor judgment, self-obsession, and volatile feelings. Information overload and overstimulation cause more frequent retreats to the toddler brain, where we have no foresight or ability to think through the consequences of behaviour. You only need to visit a trading floor for evidence of this.

The rise of the patient capitalists

Isn’t investing a more serious business than simply seeing what’s down and how you can benefit from it rising again in the short term?

Yep. Some might think it boring to yearn for middle of the road, steady returns. Not me. If you are like me and suffering volatility fatigue, the prospect of a steady 5 per cent every year looks like a blessed relief.

This is apparently what we can reasonably expect from any of our investments from now on. 5 per cent, the new norm.

Long term, patient capital has been a growing investment trend for a while now – an increasing band of people for whom 5 per cent a year will do just nicely and who prefer to know their money is somewhere sustainable for them, other people, and the planet.

Patient capitalists want funds designed to put money in and leave it there for the next 20 years, so that it will have steadily built up into something meaningful, without you having to chop and change with every market gyration.

Now, it looks like the market will force even more investors into becoming patient capitalists, whether they want to be or not.

Some signs that providers are taking an active lead in this shift are that L&G has ditched quarterly profit reporting and that Morningstar is launching ESG scores for funds imminently.

If there’s an investment habit you might want to consider breaking in 2016, it’s the looking for opportunity in volatility one. Instead of compounding this volatility, maybe just say no to it instead.

*https://www.psychologytoday.com/blog/anger-in-the-age-entitlement/201410/how-we-make-the-same-mistakes-over-and-over