Trader’s Credo: Manage Those Emotions

August 20, 2021

Real Estate

Trader’s Credo: Manage Those Emotions
Welcome back. Earlier this week and along with several Plunk colleagues, I was in Dallas with real estate experts from around the country. It was a fascinating few days that inspired this week’s topic: Residential real estate from a trader’s point of view.
 
 
Residential real estate: Where drama dominates
 
Who’d have thought that PBS (yes, that PBS, the Public Broadcasting Service) would be the launchpad of an enormous industry: The home-improvement television show? But there they were more than 40 years ago, taking a leap with Bob Vila and friends on “This Old House.” 
 
Today, real estate shows continue to dominate, but for reasons other than learning how to fix century-old plumbing. With the HGTV’ing of everything residential, producers have tapped into the thing that we (want to) adore most, along with pets and pizza: Our homes. And these shows play on the emotions that dominate when buying or selling.
 
We’re simply not good at looking at our homes as shelter — as just another necessary facet of our lives, along with food and water — or considering sales and purchases to be simply transactional. (Of course, there’s also the fact that for most of us, buying and selling our homes are the largest financial transactions we’ll make in our lives.)
 
That’s, in part, why most of us are essentially lousy buyers and sellers. We can’t separate the things that we’ve done in our homes — hosted friends, raised families, shared holidays — from the actual homes.
 
Researchers have studied this common challenge for years as part of the science of neuroeconomics which, as explained by Investopedia’s James Chen, “…analyzes brain activity using advanced imagery and biochemical tests before, during, and after economic choices.”
 

Image from How Neuroeconomics Can Read Your Mind, NYULocal, 2016
 
The stakes keep getting higher with real estate (and just about all asset classes) as prices skyrocket and we (buyers) are hellbent on getting the win — and with superlow mortgage-interest rates, it’s like casinos (aka, banks) are handing out free money. 
 
And so it goes with the largest financial transactions of our lives. 
 
A trader’s perspective
 
Successful traders are notoriously void of emotion in their work — it’s essential to do the job well. If you look at buying or selling a home from a trader’s perspective, then, it becomes little more than just another transaction, just another trade, for which we simply need to read the tape and act.
 
This Investopedia post, “The Importance of Trading Psychology: Containing Fear and Greed are Key to Making Money,” gets to the heart of it: Fear and greed are two emotions that plague transactions, whether on the trading floor or the kitchen floor. 
 
Except for seasoned investors, most home buyers approach the process from a position of fear — fear of not getting the home, fear of paying too much, fear of buying the wrong home, fear that something better will become available as soon as the contract is signed. Sellers often operate from a desire to get the most money possible (rightly so as a goal, although greed often clouds good judgment).
 
As was pointed out in the article, “Neuroeconomics of Decision-Making,” written by Marilyn Kennedy Melia and published in the Chicago Tribune in regard to the housing boom, “Experts who blend studies of psychology, neuroscience and economics are discovering that when it comes to financial decisions — including housing-related ones — humans are practically incapable of stark objectivity.”
 
Further:
 
“One study that focuses on the perception of housing value by people relocating to a different city finds that those transferees who boast about what they can afford when they move to the hinterlands may soon change their rhetoric.
 
Research by George Loewenstein of Carnegie Mellon University and Uri Simonsohn of the University of Pennsylvania looked at 650 movers in more than 170 U.S. cities.
 
The study, Loewenstein says, was a test of the “contrast effects” theory, which holds that people determine the best price to pay for a good based on previously faced prices.
 
The contrast effects theory also holds that important economic decisions are often based on irrelevant, fleeting cues that are difficult to justify rationally.
 
When the movers went from an expensive city, such as New York, to a place such as Pittsburgh, where housing costs are cheaper, they tended to splurge on more expensive housing than movers with the same financial profile coming from areas where housing costs were comparable or cheaper.
 
But the study found that if relocators stayed a while, they readjusted the amount they spent on housing. The New Yorker who makes Pittsburgh his home would downscale, for example.”
 
The article also quotes Kevin McCabe, director of the Center for the Study of Neuroeconomics at George Mason University:
 
“When prices are rising rapidly, we think the brain is designed to do reward processing. There is then a regret pattern that gets set up when we compare our actual outcome to events. You might think, `Why didn’t I get that second home sooner, it’s worth so much now.’ And what you do is quickly buy a second home but you may get caught short when the bubble bursts.”
 
Fun fact: This article was published in 2006 about the housing boom that led to the Great Recession. As I always say, people don’t change and our behaviors don’t, either.
 
Read the tape: What would traders do now?
 
Successful traders operate from a disassociated position, just about as void as (humanly) possible of emotion. When applied to buying or selling homes, this mentality can help parties make better decisions. The tactics are the same, too:
  • Always do your research
  • Create a plan and stick to it
  • You never know the high or low, so don’t think you do

From Wall Street, 20th Century Fox, 1987
 
The markets: Overall
 
Anything market-related in this blog is subject to all the volatility of the markets themselves, of course. Suffice it to say that as I write this, just about all assets are still pushing new highs. Still, in my opinion, most asset classes are also beginning to show “end-of-the-line” behaviors in price tolerance. 
 
To me, twitchy behaviors indicate that changes may be coming, though no one can say exactly when. One thing that’s clear, though, is that the markets today are hyper-related to the news, adding pressure to the pervasive air of uncertainty.
 

The Wall Street Journal
 
As we know, past performance isn’t indicative of the future and we need to be prepared for some negatives. Given this, along with the ongoing problems of too much capital washing around in the system and Covid, this may be the time to unload some holdings. Reading the tape (and CNN’s Fear & Greed Index), overall there’s just too much emotion in the market:
 

CNN’s Fear & Greed Index, August 19, 2021
 
I’d hold off on buying dips; instead, I’d want more clarity before deciding which assets to buy. The real question is which asset is going to hit the price ceiling first and to me, there are indications that it’s housing.
 
This doesn’t mean you should sell a home you’re in, unless you really need the money. If, however, you leveraged assets to purchase more real estate, you may want to research whether now’s a good time to sell some and free up some cash (just a thought from me, never advice).
 
And although these last few years have been anything but typical, from a historical perspective, the longer the run-up, the longer the downturn lasts, so if I had a lot invested in riskier stocks, now may be a good time to explore some gold-standard companies or government bonds (inflation-indexed bonds are often a popular bet in uncertain times and, again, these are just my thoughts, not advice).
 
What about inflation? If you’ve been reading this blog for a while or follow economic news, then you know that the Fed has relatively few options, other than to raise interest rates slightly if it wants to quell worries or realities about inflation. 
 
As has been the case for centuries, money is a proxy for security and position. Capital is security, so the common thinking is to unwind positions when you need security. 
 
And as you forge ahead, look for creative ideas that will always be in demand — often, the best returns could be in the creative capital.
 
Thanks for checking in, read the tape, stay safe and well.

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