Print Shortlink

Newton’s Law of Economics: The Power of Sentimental Investors

Newton’s Third Law of Motion (for every action there is an equal and opposite reaction) may well apply to the correlation between investments and investor sentiment.

 

For example, the nation’s largest bank, JPMorgan Chase, recently announced that instead of posting $200 million in profit, as it had previously estimated, it had actually lost $2 billion. In a conference call to analysts and investors, CEO Jamie Dimon blamed the losses on a complex hedging strategy the firm had engaged in over the past six weeks and warned that the company could lose more.

 

[CLICK HERE to read the article,JPMorgan suffers big loss,” at CNNMoney.com, May 11, 2012.]

 

On the day of the announcement, the company’s stock plunged 9.3%, as you might expect. But the interesting thing is that other investment banks also took a hit – Morgan Stanley fell 3.7 %, Goldman Sachs fell 3.3%, and Citigroup dropped 3.8%. Why? Because investors are concerned that other large banks may have made the same mistake. When pressed as to whether the losses were due to flawed execution or if broader market forces may have played a hand (that could impact other firms), Dimon responded, “Just because we’re stupid doesn’t mean everyone else was.”

 

[CLICK HERE to hear the audio, “Miss Jamie Dimon’s conference call? Hear it here,” at Marketwatch.com, May 11, 2012.]

 

[CLICK HERE to view the video discussion, “JPMorgan discloses $2B in losses in ‘flawed’ hedging strategy,” at msnbc.com, May 11, 2012.]

 

If you apply Newton’s Third Law toward economics, investors ran in the opposite direction. It happens all the time.

 

In fact, new research from the Wharton School reveals that investor influence has a whole lot more impact on stock market pricing – and mispricing – than previously believed. The paper purports that investor sentiment influences stock prices up or down to a degree that cannot be explained by fundamentals like earnings and revenues. Furthermore, stocks are more likely to be overpriced when enthusiasm is high than underpriced when it is low – meaning that “irrational exuberance” has a more powerful impact than pessimism. Or, bulls can move market prices higher than bears can lower them.

 

[CLICK HERE to read the article, “Investor Sentiment and Stock Prices: Explaining the Ups and Downs,” at Knowledge@Wharton, May 9, 2012.]

 

[CLICK HERE to read the research paper, “The Short of It: Investor Sentiment and Anomalies,” from University of Pennsylvania – The Wharton School; National Bureau of Economic Research, March 12, 2012.]

 

Isn’t it interesting how investors as a group can have so much impact on market performance when investors as individuals have so little? If you could use some help devising a plan for the financial matters that you can control, please give us a call.

 

1100362