Sunday, September 20, 2020

Animals on Wall Street

ASK THE CFP® PRACTITIONER


“The markets are moved by animal spirits, and not by reason.” ~ John Maynard Keynes

Question: I’ve heard the phrase “animal spirits” on several financial news networks. I’m curious as to what it means. Can you explain this?

Answer: Animal spirits is a term first used by the economist, John Maynard Keynes in his book “The General Theory of Employment, Interest and Money,” written in 1936. In the simplest of terms, animal spirits refers to instincts and emotions. What you may have heard on the news lately is Jamie Dimon, Chairman, President and CEO of JP Morgan Chase remarking that President Trump “has awoken the animal spirits of investors.” Keynes wrote his book right after the Roaring Twenties, the Crash of ‘29 and the Great Depression. The book explains that business owners and investors are encouraged to take risks because of animal spirits or instinct. Over time we’ve learned optimism, rational and even irrational exuberance are all based on confidence and intuition. Keynes himself defined animal spirits as “a spontaneous urge to action rather than inaction and not as the outcome of a weighted average of qualitative benefits multiplied by quantitative probabilities.” Translation: Human behavior and

psychological motivation is difficult to quantify. The positive activity attributed to more vague characteristics such as instinct, intuition or gut feelings falls under the heading of animal spirits. While animal spirits may lift spirits and fuel market activity, actual production and productivity is required for tangible and sustainable growth. Confidence is certainly a factor in future growth and investment, but it’s only one of several ingredients. And as Keynes stated, animal spirits are not particularly tied to qualitative and quantitative benefits and probabilities. Therefore, it’s reasonably safe to say that more facts are necessary to feel truly confident that the Trump bump is sustainable. Whether growth continues, slows, or accelerates from here will depend upon measures other than animal spirits, including tax policy and health care coverage costs. Other markers to keep an eye on are inventories, trade reports, orders for durable goods, consumer consumption and industrial production. Business’ investment in construction, equipment, infrastructure and military spending also influence growth rates. Animal spirits may move markets, but revenue and earnings matter in the long run.

The Animals of Wall Street Animals are no strangers to Wall Street lingo. Bulls and bears are the most familiar terms. A bull market is known as an upward market while a bear market is describes a downward market. The most common explanation for these two terms is that bulls attack their prey with an upward strike of their horns while bears claw their opponents in a downward fashion; bulls for up markets and bears for down markets. By standard definition, a bear

market is when financial markets experience declines of 15-20 % for more than two months. Bull markets occur when there are positive trends of 15-20% for more than two months. Animal spirits and confidence are low during bear markets and high during bull markets. Ostrich investors keep their head in the sand, ignoring anything unpleasant or obvious. Pigs are greedy and yield hogs reach for high income often ignoring risk factors. Sheep lack direction and follow the herd making them vulnerable to the excess of both bulls and bears. As you can see, Wall Street jargon isn’t terribly sophisticated. The slang term for an underperforming asset is dog. There’s even a strategy called “Dogs of the Dow.” Those who ascribe to this technique focus on stocks with the highest yield that are presumably underperformers or out of favor. In the 1987 movie “Wall Street,” Gordon Gekko (Michael Douglas) receives a stock tip from an aspiring and overeager stockbroker named Bud Fox (Charlie Sheen). Gekko puts Fox in his place by telling him that the tip was not just a dog, but emphatically states that “it’s a dog with fleas, kid.” Even the characters’ last names aren’t exempt from animal references; Gekko as a reptile and Fox as the crafty and sly dog. Cats aren’t left out of the terminology. A gruesome phrase is the Dead Cat Bounce, which refers to the supposition that even a dead cat will bounce if dropped from a high enough perch. (I know, that one is bad!) This is similar to the Wall Street advice of “never catch a falling knife,” meaning that if the market or a particular company is in a downtrend and things look bad, they really could be bad; wait for the fall to stop before grabbing the knife.

Animal spirits is shorthand for saying that emotion and human behavior can drive markets. It’s likely that many of us have made major decisions based on gut instincts at one time in our lives. It’s difficult to determine the degree to which confidence enhances economic activity or just how much the lack of confidence may paralyze growth. Not everything related to numbers is always rational. That’s why we manage both money and emotions. Stay focused and invest accordingly.

The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. You cannot invest directly in an index. Past performance does not guarantee future results. There is no guarantee any particular investment strategy will be successful. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time.

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.”

This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC, 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389- 1041, email darcie.guerin@raymondjames.com. Website: www.raymondjames.com/Darcie.

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