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Iron Capital Insights

  • Iron Capital Insights
  • December 11, 2018
  • Chuck Osborne


Groupthink is a term first used in 1972 by social psychologist Irving L. Janis. He was referring to a psychological phenomenon in which people strive for consensus within a group to the point where they set aside their personal beliefs, preferring to keep the peace rather than disrupt uniformity.

Wall Street has increasingly become a giant lesson in groupthink, and simultaneously more and more disconnected from anything resembling reality. This downturn is the perfect case in point. Wall Street seems to have forgotten already that this downward movement in stock prices began in October with Federal Reserve (Fed) Chairman Powell making comments about the need for interest rate hikes because of the rapid growth of the economy.

The groupthink at that moment was that things are so good that the Fed would keep raising rates and this would cause stocks to fall. Then the focus went to what we believe is the real cause of this nervousness, the trade tensions, especially with China. Corporate earnings – the thing that actually matters to corporate owners (aka stock investors) – were very strong for the third quarter, and on every earnings call, CEO’s were asked about tariffs.

Here is a lesson in groupthink for you. In this most recent earnings season, analysts asked just about every CEO that I am aware of about the impact of tariffs on their business. Then analysts started talking to financial media about how every CEO was talking about tariffs…which was largely due to the fact that they were answering the analysts’ questions. The idea that CEOs are universally worried about tariffs became consensus, and this meant an economic slowdown is coming.

So now, this market downturn – which was caused because the U.S. economy is somehow too good – is being prolonged by the idea that an actual economic downturn is coming. On Friday one analyst on a CNBC panel had the nerve to be somewhat optimistic about stocks, and she then had to defend herself. She said something to the effect of, “We all know that the economy will slow next year.”

According to the website, the top two symptoms of groupthink are illusions of invulnerability and unquestioned beliefs, respectively. We all know that the economy is going to slow next year? What happens in the future is by definition unknowable, so while we can make predictions and weigh probabilities, no one knows what is going to happen next week, let alone next year. The idea that we do is a clear sign that we have shut down our individual brains and surrendered to groupthink.

So, what is the probability that we are headed towards a slowdown? Globally we may already be in one. Japan had negative growth last quarter. China’s economy, while still growing rapidly, has seen the rate of growth slow. There have been negative indicators in Germany and some other European countries. On top of all of that, we now have a delay in the Brexit vote in Great Britain.

In the U.S., however, there is no actual data pointing to a slowdown. Unemployment is less than 4 percent and wages are growing faster than inflation for the first time in a generation. The CEO of Target recently stated that this is the best environment that he has ever seen. Are there threats? Of course there are, there are always threats. The largest right now are the tariffs. Regardless of what anyone may tweet, tariff costs, like any tax on a product, are passed onto consumers. We pay the cost of higher prices. Americans once understood that, and as a result threw a great amount of tea into the Boston Harbor.

Might the economy slow next year? Maybe. If it grew at 2.5 percent, which would approximately match that fastest pace in the last decade, then that would equal slowing. The data, however, does not point to this, and neither do the outlooks of corporate CEOs who keep telling us that real business is good. No, Wall Street is alone on this, and that is worrisome as an investor.

While tariffs represent the largest real threat, the stock market itself may become a greater threat. The stock market has the ability to become a self-fulfilling prophecy even when what its prophesizing seems so removed from reality.

What are we to do? When markets move downward it is important to keep things in perspective. We are prudent investors not traders, so it is the long term that matters (long term being three- to five-year periods). Prudent investment is done from the ground-up: know what you own and why you own it. The companies we own are doing well, and ultimately their stock price will reflect that reality.

Prudent investing is also risk averse. While we perhaps have not spoken about it enough, most of our moves this year have reduced the risk in our clients’ portfolios. Most notably, we increased our asset allocation to bonds reducing our weightings toward stocks. As of this moment we have not hit any client risk threshold, but IF this downturn continues, we will take action.

Breaking out of the groupthink can lead to long-term success; not appreciating the damage groupthink can cause can lead to disaster. Balancing those two things is what makes investing more of an art than a science. Caution is in order.

Warm regards,

Chuck Osborne, CFA
Managing Director