This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

When Recency Bias Goes Wrong -- the Perils of Chasing Past Returns

NEW YORK (TheStreet) -- At the end of 2013, investors were unwittingly taking part in an interesting behavioral experiment with respect to recency bias. Most are familiar with the concept: It is the innate tendency for humans to project the recent past into the future.

In the investment world, this means expecting the most recent performance of a security will continue indefinitely going forward. In simple terms, it is the belief that whatever was performing the best will continue to outperform and whatever was performing the worst will continue to underperform.

As we know now, 2013 was a highly abnormal year in the markets where U.S. equities outpaced every other asset class by a wide margin (with the exception of bitcoin). U.S. equities also did so with unusually low volatility and a nearly straight-up advance seen only a few times in history.

The behavioral experiment, then, was whether investors would throw caution to the wind and assume that the unusual nature of markets in 2013 was likely to be repeated. Would they once again suffer the perils of chasing past returns?

The answer, of course, was a resounding yes. At the end of 2013 we saw inflows into U.S. equity funds at the fastest pace since 2000 and outflows from bond funds at the fastest pace in years. We also saw extreme bullish sentiment on U.S. equities and bearish sentiment on virtually everything else. Investors were indeed betting that 2014 would be an exact replica of 2013.

Must Read: Natural Resources, Meet Your Future Managers

In the first month and a half, we have seen the results of this bet. Nearly every asset class that underperformed U.S. equities in 2013 is outperforming in 2014 (see table below).

Overall, there is a negative correlation of -.78 between the return of an asset class in 2013 and its return in 2014. Bitcoin is the most dramatic example of this reversal of fortune with a -47% decline this year, following a 5866% parabolic advance last year. In the opposite direction the junior gold miners, as seen by the Market Vectors Junior Gold Miners ETF (GDXJ) have shown the most notable turnaround, up 41% this year after suffering a -61% decline last year. 

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $93.64 -0.11%
FB $118.57 0.84%
GOOG $698.21 0.75%
TSLA $241.80 0.43%
YHOO $36.53 -0.19%


Chart of I:DJI
DOW 17,891.16 +117.52 0.66%
S&P 500 2,081.43 +16.13 0.78%
NASDAQ 4,817.5940 +42.2360 0.88%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs