This is One of the Most Dangerous Things an Investor Can Face
Today, I want to talk to you about a very dangerous thing.
Confirmation bias is when we tend to look for and interpret things in a way that supports our personal beliefs.
Whether we want to admit it or not, most people make up their minds before they absorb any new information. They then look for facts and ideas that support their views and tend to ignore or dismiss ideas that don’t.
For many things in life, confirmation bias simply leads to arguments with others. But in investing, confirmation bias can mean LOSING MONEY.
And whereas an argument can be resolved relatively quickly by considering the other person’s points (or by saying “I’m sorry”), lost money from bad investing can take a LONG time to recoup.
With that in mind, it’s important to have some kind of objective measure for determining what the market is telling us.
This is especially true during times like the one in which we find ourselves – in which we are attempting to determine if the crisis is over or if another leg down is coming.
Three Charts That Are Telling Me to Watch & Wait
Personally, I like to use credit markets to keep myself objective.
The credit markets are many multiples larger than the stock market. And credit investors tend to be far more sophisticated than their stock counterparts.
And most importantly of all, credit typically leads stocks. So it provides a sounder basis for getting your head around what’s coming.
I note this morning that high yield credit spreads have rallied strongly but are struggling to close the gap from the limit down open on Monday, March 16 (red box below). Personally, I want to see this gap closed before moving aggressively back into the markets.
The same is true for investment grade credit spreads. Here, spreads have actually entered the gap but have yet to break above it.
Considering the Fed has broadcasted it would be buying investment grade credit with “unlimited QE,” I am surprised credit is struggling here.
If both credit spreads break above their gaps, I’d issue an “all clear” on stocks. But right now, they’re struggling to move higher. And until they do, I’m not going to be putting my money to work, no matter what my natural confirmation bias might be.
This, combined with the fact that breadth is struggling to break above resistance (red line in the chart below), has me concerned we are going to see another significant drop.
If these three charts manage to break above the levels I’m watching, I’d look to move more capital back into the markets. But until they do, I’m in “watch and wait” mode.
Yes, I might miss out on some gains… but more importantly, I’m keeping my confirmation bias in check and letting the markets SHOW me what is real.
Editor, Money & Crisis