Daniel Kahneman – the only psychologist to win a Nobel Prize in economics – first coined the term "anchoring bias." And even today, some five decades later, this behavioral bias is causing folks to make mistakes in the stock market...
You see, when you provide people with an initial price or number, it skews their thinking. They "anchor" to the old info.
Here's a classic example of the bias from a 1974 experiment run by Kahneman and Amos Tversky...
Participants of the study had to spin a "wheel of fortune" to get a random number. Half of the folks ended up with the number 10. The other half got 65.
The participants were then asked whether the percentage of African countries in the United Nations was greater or less than their number from the wheel of fortune. Folks who got the number 10 estimated the percentage to be 25%. Folks who got 65 estimated 45%.
The low anchor numbers biased the guesses lower relative to the effects of the high anchor.
There are countless examples like this from all different kinds of studies. We also see the anchoring bias in effect every day in marketing and negotiation. The first number or price you hear is the one you anchor to – even when that information is irrelevant on its face.
This phenomenon is at work in the stock market every single day. Specifically, investors want to anchor to a stock's high share price.
It's easy to find whether a stock is at its 52-week or all-time high. So that's what investors anchor to.
If a stock is down 20% from its high, that tells some folks it's a good value. And if the stock is trading at its high, they expect it to head lower.
You have to set aside your emotional reaction to a stock trading near its highs. There are better ways to determine its real value...
We always start thinking about a stock by remembering it's a real business. If you buy great businesses at good prices, you'll win over the long term. And, of course, a company's share price by itself tells you nothing about its actual valuation.
For instance, if a company's revenues and profits have grown to all-time highs, why wouldn't its stock price follow suit?
Many stocks hit new highs because the companies are doing something right. If they keep doing those things, prices can keep rising.
So don't get hung up on a 52-week high. A stock's previous price doesn't tell us where it's going next.
Today, many investors are looking at the price of gold... and are getting nervous. The metal is trading just below its all-time high.
Take a look...
Even though the price of gold is up quite a bit, that shouldn't scare you. Again, an asset's previous price doesn't tell us where it's going next.
When my team and I look at gold as an investment, we like to look at the metal's supply and demand. We wrote about this last week. Investors have been dumping gold for a long time. It's only recently that they've started buying again...
Gold has been hated for a long time. I've been writing about how global physically backed gold exchange-traded funds ("ETFs") have seen net outflows for most of last year and this year.
For example, outflows in December were $1.8 billion, $1.6 billion in January, and $1.7 billion in February. In total, we saw net outflows for 10 consecutive months as of the end of February.
But things changed in March, thanks to the panic in the banking sector. Since the failure of Silicon Valley Bank, folks have been worried about their money and whether it is safe in banks. As a result, demand for gold has been increasing.
In March, we finally saw the first net inflow to gold ETFs, totaling $1.9 billion.
Investors are just starting to warm up to gold as a portfolio holding. So the fact that gold is closing in on its all-time high shouldn't scare you away from it. It looks like there will be more gains to come.
If you do want to invest in the metal outside of physical gold and broad gold ETFs, then I recommend gold-investing legend John Doody. John's work is read by gold-mining executives and over 40 professional money managers – at hedge funds, mutual funds, private asset managers, and brokers all around the world.
And today, John thinks we're at the start of a new bull market in the precious metal. He's calling it the "perfect storm" for prices to surge. Many gold stocks could eventually post monster triple-digit returns.
If you missed John's 2023 Gold Rush event, click here to catch up now.
What We're Reading...
- Something different: U.S. debt ceiling deal to face its first test in Congress.
Here's to our health, wealth, and a great retirement,
Dr. David Eifrig and the Health & Wealth Bulletin Research Team
May 31, 2023