Thursday, January 03, 2008

Flight to Quality and Other Market Ideas

* Flight to Quality - This past week, we've seen 10-year Treasury yields fall over 7% and the S&P 500 Index (SPY) drop by nearly 3%. With fears of recession, traders and investors appear to be seeking the safe haven of Treasuries. I went back to 2002 (N = 1488 trading days) and found 51 occasions in which ten-year yields dropped more than 5% in a week during a stock market decline. Interestingly, the following week, the S&P 500 Index averaged a whopping gain of 1.73% (40 up, 11 down)--much stronger than the average five-day gain of .05% (766 up, 671 down) for the remainder of the sample. It appears that the flight to quality may also represent panic selling, something we see more at a short-term market bottom than a top.

* More From Dr. Lo - Here's a link to several studies from Dr. Andrew Lo at MIT and his research team, including an article we did together on the role of emotion among daytraders. I see Dr. Lo has a new article posted to his site, which looks at what went wrong for quantitative funds in August of this past year. It's an insightful paper, illustrating systemic risks among hedge funds that are not well appreciated.

* What We Can Learn From Neuroeconomics - I've long been convinced that trading has as much to do with brain hardware as software. This comprehensive review article includes a detailed look at emotion, cognition, and the brain--and what that means for economic decision-making.

* Shopping Centers in the Brain - What if the buying of stocks is not so different from the buying of goods at a mall? Apparently there's a link between shopping decisions and brain structures that are involved in addiction. And what if we think we make rational trading decisions, but actually base these on snap judgments? Research suggests that's how many of us make choices at election time.