Positive Thoughts

The January Effect

What the Stock Market Can Teach You About New Year's Resolve.

For the first two weeks of each new year, small stocks outperform the overall market in the U.S. What’s behind this so-called “January Effect”? According to Kelly McGonigal, a health psychologist at Stanford University, the typical explanation goes like this: In December, investors dump losses to get a tax break, which pushes prices down. Low prices entice January buyers, which drives stocks back up. But lately, economists have been floating a new theory. The January Effect is the result of good old-fashioned New Year’s optimism. That’s right, the same hope that has launched a million diets is behind one of the most robust market trends in history. At the very same time resolutions are being set, unrealistic market optimism peaks. We’re all optimists in January. The January Effect is just one example of the human mind’s desire to imagine a positive future. And while optimism helps us tackle challenges, new research from both economics and psychology reveals how much a liability unrealistic optimism can be.

For example, a recent analysis found that 75% of cases investigated for fraud by the SEC are the result of unrealistically high initial profit projections. When reality doesn’t match the predictions, companies “manage earnings,” hoping profits will catch up. And while they’re busy ignoring reality, they’re missing opportunities to fix what’s going wrong. Optimistic New Year’s resolvers show a similar tendency to cook the numbers. Most people make wildly unrealistic predictions about how much they will exercise. But when confronted with the gap between their predictions and their actual exercise time, people don’t become more realistic. Instead, they increase their estimates when asked to predict how much they will exercise in the next month. Like companies trying to catch up to projected earnings, would-be exercisers ignore reality and aim even higher.

In the meantime, they aren't doing any of the analysis needed to figure out why they didn’t exercise, and what they need to do to make sure it happens. In both cases, the goal is to maintain expectations, not to correct course. This is how optimism gets us into trouble. Economists call this “delusional optimism.” We refuse to adjust our expectations. Economists even have a word for those deluded by optimism: “lemmings.” Lemmings are blind to the obstacles in their path, and just keep pushing on to their inevitable demise. In the face of setbacks, they become more optimistic, right up to the point where they fall of the cliff. The money runs out, the investors walk, the SEC steps in—and everyone is forced to confront the fact that things aren't going as hoped. For many, setting a New Year’s resolution is an exercise in going over the cliff.

 

Psychologists have found that the stronger a person’s optimism, the more they underestimate the challenges they will face, and the less likely they are to ask for help.

 

Kemo D. 7

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