Most consumers wait for things to go on sale before buying them, look for promo codes prior to purchasing something online, and suggest that discounts are the greatest influence on their purchase decisions around the holidays (see, for example, Invesp, as of May 10, 2022, and The Street, as of December 17, 2021). Such behavior isn’t entirely surprising to students of economic theory; perhaps the most fundamental concept in economics is that lower prices attract more buyers. However, when it comes to financial assets, such intuitive logic sometimes gets turned on its head – discounts can beget more sellers.
Almost every month this year, the “discounts” on financial assets from their year-end 2021 prices have gotten larger, leaving the S&P 500 with its worst first half-of-the-year return since 1962 (narrowly avoiding its worst first half since the Great Depression). The U.S. Treasury index has never had such a poor first half-of-the-year return since its inception in 1973, and by some measures the 10-Year U.S. Treasury note has, astoundingly, experienced its worst first half since 1788, at least according to Deutsche Bank research as of July 1. Household names like Visa bonds and the ARK fund are “35% off” and “75% off” their 2021 prices, respectively, yet market participants do not seem to be attracted to these assets the way consumers are drawn to discounted t-shirts or televisions (see Figure 1).
Figure 1: Discounts in financial assets tend to incite a different reaction from discounts in retail
Sources: Bloomberg, data as of July 18, 2022 (LHS); NBC/Reuters, as of Nov 21, 2017 (M); Bank of America, data as of July 7, 2022 (RHS)
Economists, however, do have an answer to this apparent paradox of crowd behavior between discounts in retail and financial assets: loss aversion theory. It suggests that the reason for a transaction is the need to either gain pleasure or avoid pain. Buying goods on sale gives pleasure (even if they depreciate), while selling financial assets at a loss avoids the pain of further losses (even if there is appreciation potential). In both cases, it feels better when there is a crowd accompanying you. In May 2021 we wrote about how crowd-following could run counter to basic investment philosophy (see Figure 2), albeit at a very different time for markets:
“Investors generally want to “buy low, sell high:” to buy more bonds at higher yields (lower prices) and fewer bonds at historically low yield levels. However, what investors often need to do is to meet income requirements in order to match liabilities. Hence, they are often forced to buy more bonds at lower yields (to raise sufficient dollars of future annual income), such that they end up being overweight when yields are at their lowest. Over the last decade, the Bloomberg U.S. High Yield Index has traded in a yield range of about 4% to 12%, and both those extremes have come during the pandemic period. At a 4% yield, an investor may want to own no high yield at all, but they may need to own a lot of it.”