Recent volatility in financial markets has been enough to make most people afraid to even glance at their investment accounts, with many filing away their monthly financial statements with the envelopes remaining sealed. "Out of sight, out of mind," we nervously reassure ourselves.
Certainly there are profound fundamental economic factors contributing to the recent financial turbulence, but basic human psychology also plays a pivotal role, especially at this time of year. And the upcoming daylight savings time change in Canada and the U.S. may compound the problem.
With the amount of daylight diminishing in the fall, a substantial fraction of the population suffers annually from seasonal depression. Up to 10 per cent of people in North America suffer severely, and most of the rest of us experience winter blues to a milder degree. Careful research has established that depressed people are more risk averse. Consequently, as an investing public we are collectively less willing to bear financial risk in the fall. Combine this human tendency with a bit of bad economic news, such as we have seen come out of Europe recently, and the result can be plummeting stock markets, much more so than if the same news had emerged in the spring when daylight is becoming more abundant and our moods are more buoyant.
My co-authors Mark Kamstra, Maurice Levi, and I showed the impact this human characteristic has on stock markets around the world. (See "Winter Blues: A SAD Stock Market Cycle" American Economic Review 93(1), 324-343.) In countries located at more extreme latitudes, such as Sweden, where daylight fluctuates more dramatically through the seasons relative to North America, seasonal stock market fluctuations are relatively more dramatic. And in southern hemisphere countries such as Australia, where the seasons are six months out of phase, so are the seasonal effects in markets.
As if this wasn't enough to make your average investor more nervous about investing in the fall, there is also a market-wide effect that arises due to daylight savings time changes. With the disruption in sleep habits that arises from the time change, a phenomenon psychologists call 'sleep desynchronosis,' many of us experience a variety of cognitive changes (which have been shown to lead to increased car accidents) and we also become more anxious. With heightened anxiety can come a greater reluctance to bear financial risk, and the result is often a decline in stock markets on the Monday following the time change. Of course on any given day, markets may go up or down, but my co-authors Kamstra, Levi, and I showed that markets decline on average following the time change. (See "Losing Sleep at the Market: The Daylight Saving Anomaly" American Economic Review, 90(4): 1005-1011.)
Certainly with formerly arcane terms such as 'austerity measure' having become household expressions, we know there are important economic events occurring around the world. Such fundamental conditions are undeniably the primary driver of financial market performance. But human psychology plays a significant role as well.
The instinctive reaction at this time of year may be to want to curl up in a ball and sleep through the fall and winter seasons. Metaphorically, that is not a bad investment strategy. Once an individual has a carefully planned portfolio in place, the best response to unsettled market conditions is to look away. For individual investors, a buy and hold strategy has been shown to outperform an attempt to market time. So remember you are human and try not to lose any sleep over the matter.
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