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Blog #8
(September 12th, 2008)
HORMONES TRUMP SUPPLY-AND-DEMAND
By Tom McAllister, CFP™
A basic rule in financial planning is the Law of Supply and Demand. We've all be taught the theory:
When demand for something is greater than the supply of it, the price goes up. When there's a greater supply of something than demand for it, the price goes down. But for all of my forty six years as an investment professional and financial planner, I've been puzzled and fascinated by seeing that the "law" doesn't always work!
Take the last few weeks, for example. Oil prices moved all the way up to $147 per barrel, even though demand wasn't increasing anywhere near fast enough to justify such a swing. Then, not more than a couple of weeks later - whoosh! Oil's back down below $120 a barrel. Then, look at the news about the value of the U.S. dollar. First, the dollar drops way down to numbers that can't be explained by supply and demand. More recently, the dollar rallied from 63 cents to 68 cents (versus the Euro) and from 50 cents to 53 1/2 cents (versus the Pound).
Just before all these swings started happening, the news was filled with reasons the price of oil MUST rise (because of China's and India's increasing demand). So, I'm asking myself, why has the price of oil fallen? The dollar, pundits stressed, MUST weaken (because of our mounting deficits and negative trade balance). So, why, I'm asking, is the dollar strengthening?
During all of my career, extreme swings in the market have puzzled and fascinated me. The conclusion I'd come to was that prices simply tend to go to extremes until reality sets in. (There's an old saying in the commodities markets that the cure for higher prices is higher prices!)
A recent study done by two professors at Cambridge University in the U.K. has just about converted me to a whole new way of thinking about wild market swings. (It's kind of a wild idea, but it does offer a logical explanation, as you'll see, so here goes…) The Cambridge study recorded levels of testosterone among stock and commodities traders as they began their work day (remember, nearly all traders are male). They noted a correlation between testosterone levels and profits! When a trading day turned out to be especially volatile, cortisol levels (a hormone that reduces stress) rose, and there was less risk-taking, and hence less profit. The researchers concluded that testosterone-driven over-confidence among traders caused the kind of investor behavior associated with market "bubbles". Recent behaviors in the stocks of major financial institutions, by contrast, point to cortisol-driven behavior.
After almost a half century observing people lurching first in one direction, then in the other, I may be abandoning my belief in the power of the law (the Law of Supply and Demand, that is), and admitting
THERE MAY BE TRUTH IN TESTOSTERONE!
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