VTI - QQQ: It's Time For The Nasdaq To Punish Recency Bias

2023-07-17 17:38:15 ET

Summary

• In all my years in this career and in studying markets, I have never seen recency bias as strong as it is today.
• Recency bias is a psychological phenomenon where individuals give more significance to recent events or information than those from the past.
• We are at peek greed now, and peek greed often punishes uneducated speculators when they least expect it.

Time destroys the speculation of men, but it confirms nature. - Marcus Tullius Cicero.

The stock market is a complex ecosystem fueled by numerous factors, the most important of which is investor psychology. In all my years in this career and in studying markets, I have never seen recency bias as strong as it is today in the way "investors" perceive the future. And it may be time to remind people that past performance is not indicative of future results.

Understanding Recency Bias

Recency bias is a psychological phenomenon where individuals give more significance to recent events or information than those from the past. This cognitive bias tends to influence our decision-making process, particularly in areas such as investment strategies.

Investors affected by recency bias often make investment decisions based on the most recent performance of a stock or a market trend, overlooking long-term performance data or historical market trends. This bias can lead to irrational investment decisions, such as buying into asset bubbles or panic selling during bear markets.

The Role of Recency Bias in the Stock Market

During a bull market, investors may become overly optimistic, believing that the upward trend will continue indefinitely. This belief often leads to overinvestment in high-performing stocks, resulting in an inflated market bubble and significant intermarket divergences. Conversely, during a bear market, investors may become overly pessimistic, selling off stocks due to a fear that the downward trend will persist. This behavior can exacerbate market declines and lead to panic selling (capitulation). The one commonality between stock market tops and stock market bottoms is overconfidence, and that gets fueled by recency bias.

Recency Bias, QQQ, and Nvidia

I've used the line before on Twitter that "you know you're right when the counter-argument is an insult." I have been in the pre-election year melt-up camp since the first week of January after arguing that "the end of the world is the bull case" in October. The sentiment today by the bulls is no different than the sentiment by the bears back then, particularly buy Nvidia Corporation ( NVDA ) acolytes unable to see beyond a vertical price chart that may go the way of Cisco Systems (CSCO) post late-1990s.

AI mania has run wild, but the narratives are simply following price. If I've been wrong on anything this year, it's in the melt-up argument given small-cap ( IWM ) relative underperformance against large-caps ( SPY ). To argue that "breadth is widening" is irrelevant if small-caps, which ARE breadth, aren't actually outperforming.

I noted in The Lead-Lag Report Investing Group here on Seeking Alpha that the risk triggers I'm known for that historically warn of conditions favoring a stock market accident are beginning to send some early warning signs. This isn't about me being a perma-bear by any means, but the stock market is simply not following the melt-up script given the way mania has overtaken a select group of mega-cap stocks which are acting like meme-coins from 2021.

Conclusion: The Stock Market Humbles Us All, Just Not All at Once

Overcoming recency bias requires a disciplined and systematic investment approach. Investors need to focus on long-term trends and historical performance data, rather than being swayed by recent market events. I'm a big fan of systematic rules-based investing for this very reason.

This has been a challenging year from a rotation standpoint, given just how one-sided the momentum has been in the Invesco QQQ Trust ETF ( QQQ ). At the end of the day, price is driven by emotions in the short term, and fundamentals in the long term. We are at peek greed now, and peek greed often punishes uneducated speculators when they least expect it.

For further details see: