Know your biases
Recency bias, where the events of right now cloud our memory of the more distant past and thoughts of the future, is a dangerous factor in decision-making, whether you are buying a house or a share
As humans we are a mess of contradictory cognitive biases that often cause us to make poor decisions, even as we think we’re evaluating the available data with a clear head.
Recency bias is perhaps the worst of the many cognitive biases. Simply put, it means we give recent events far more importance than they actually deserve, while ignoring or downplaying older, as well as future, data points.
One recent example was in 2021, when the local prime rate was at multidecade lows. This resulted in many people buying houses, because the low rates meant they could afford to do so. The problem is that a quick glance at the longer trend of local interest rates would have shown that the extremely low rates were not likely to last.
Fast-forward two years and the rate increase has been severe, with global inflation at 40-year highs in developed markets. Interest rates have been hiked, hurting those who bought during the cheap rates bonanza of 2021.
Another more current example is Transaction Capital, whose share price collapsed by more than 50% in the past few weeks after a horror trading update.
Many are now swearing off the stock, calling it a disaster and accusing management of not knowing what they’re doing.
However, the (somewhat more mundane) reality is that a number of events came together at the same time, resulting in SA Taxi pretty much hitting a brick wall while WeBuyCars struggles in a market where consumers are under pressure.
Yet the price collapse will probably cloud many investors’ minds and prevent them from having a detailed, unbiased look at the business as a potential investment for the future.
As a result, a share price recovery is probably going to take longer than the process of actually getting the businesses back on a firm footing.
As investors, we need to manage for this recency bias as it can blind us to potential opportunities, or cause us to head into investments best left alone. The first step to manage recency bias is to pause and look at the longer trend. Don’t just take the immediate data, rather ask where the trend has come from and where it may be in the years ahead.
In the case of Transaction Capital, a recovery to its old self, when the share traded around R50, is unlikely in the medium term.
CEO David Hurwitz said taxi owners had been hit by the high petrol price and the fact that under-pressure consumers were taking fewer trips.
The trends, then, that we need to monitor here (aside from old-school earnings and the like) are the petrol price and interest rates. If they start coming down, taxi bosses will be in better shape and able to pay their debts to SA Taxi.
In this case, don’t focus only on the immediate data, always consider where it comes from, where it’ll go and how those changes will affect the decision you’re considering making.