How the 1% at Davos Make the Same Mistakes as We Do About the Economy

The World Economic Forum in Davos, Switzerland later this month is a textbook illustration of how the 1% are no smarter than the rest of us when it comes to resisting crowd psychology. Which is to say they border on clueless.

Consider the Forum’s latest Global Risks Report, which reflects the results of a survey of “the World Economic Forum’s multi-stakeholder communities, members of the Institute of Risk Management and the professional networks of our Advisory Board Members.”

Among the top 10 global risks to business right now, “asset bubble” ranks 10th on the elite’s list of concerns. That may or may not be an accurate assessment of where an asset bubble belongs in such a ranking. But what is noteworthy is a comparable ranking in the WEF’s Global Risks Report for 2009, published within weeks of the bottom of the 2007-09 bear market and global financial crisis. Back then, the No. 1 global risk was an “asset price collapse” — in terms of both likelihood and impact.

It goes without saying that whatever probability you assign to the threat of an asset bubble today, it’s much higher now than it was at the bottom of the financial crisis. Then, the S&P 500 SPX+0.67% had already declined by more than 50%. Nowadays this U.S. market benchmark index is almost 400% higher.

To be sure, the 1% are not alone in extrapolating the recent past into the future, a cognitive error known as recency bias. It’s human nature to turn bearish after the stock market has performed terribly. By the same token, it’s entirely normal for us to turn bullish after the market has performed spectacularly.

We see the same tendency in the oscillating fortunes of investors’ market-timing and buying-and-holding. It’s at the bottom of bear markets that market-timing becomes most popular, for example, even though investors would be better off at that point committing to a buy-and-hold strategy. And it’s at the top of bull markets that investors adopt a buy-and-hold mindset, just as they would probably be better off if they then became more open to market timing.

Moreover, this has nothing to do with an objective analysis of the historical data, The statistical case for buying and holding remains the same at all stages of the market cycle. What changes is investor mood and confidence.

This is why Warren Buffett famously advises us to be greedy when others are fearful and fearful when others are greedy. Where are we now on this greed-to-fear spectrum? One indication that we’re a lot closer to the greed end of the spectrum comes from the widespread popularity today of buying and holding index funds. Judging by the 200 newsletters I monitor, market timers are struggling. It’s a good bet that just the opposite will be true at the bottom of the next bear market.