If A Tree Falls in the Forest…

British and Danish
researchers recently published a study in the Journal of Current Biology that
is of interest to investors.

They asked 28 people to
submit a list of songs they’d like to buy online. Then, they had to select
which of the songs they liked most. Then, their selections were rated by two
music experts.

The test group was hooked up
to an MRI to measure their brain’s response to the music
experts opinion of their selections.

The MRI showed that when the test subjects learned they had chosen the same
song as the experts, an area of the brain called the ventral striatum lit up
like a Christmas tree.

Turns out, the ventral
striatum is a reward center wired with dopamine neurons that respond to
pleasures like sugar and sex.

Researcher Chris Frith of
University College London concludes: “If someone agrees with your choice, it’s
intrinsically rewarding in the same way food or money is rewarding… We are very social creatures…and we are desperately
keen to be part of the group." "

So, why should investors be
concerned with this study?

Because this study suggests
that individual investors will be influenced by what “expert” investors think
about their investments on a very basic biological level. I mean, if having
your stock selection validated by an expert is as rewarding as sex…

What’s more, it also helps
explain why popular stock might continue to move higher regardless of
valuation, while other stocks with attractive fundamentals might get ignored.

We can see
this dynamic at play in the stock market. Just look at Chinese stocks.
Fundamentally, Chinese stocks look good. But since they are often frowned upon by
the “experts”, there is no emotional reward to owning them.

Of course, there is another
way to look at this study. If investors don’t buy a stock, it’s not going to
move higher in price. So even if Chinese stocks look good, if nobody buys them,
then the price doesn’t move.

If a tree falls in the
forest…

Fortunately
for investors, the popular opinion on what’s a good investment changes often.
Chinese stocks were very popular last year, now they are not. The pendulum will
swing back.

So, it can be financially
rewarding to anticipate where investors will focus their attention in the near
future. That’s one reason I’ve been recommending land-based oil stocks
recently. It seems to me that, in the wake of the BP mess, land-based oil
stocks will become more popular and trade with a premium.

Plus, the timing seems right
because oil prices tend to be seasonal and put in a high in late spring. We’ve
seen oil stocks sell off from their high at $87. And if the seasonal pattern
holds, we should see a secondary high for oil prices in late summer. That move
has already started, in my opinion.

Another
takeaway from this study has to do with how quickly stocks can sell-off. It
would seem that investors are very quick to change their opinion of a stock to
match that of the experts.

And I suspect even the sense
that one’s investments are out of favor can lead to quick selling. We can see
that clearly in the speed with which stock market declines occur.

It’s been
said that the stock market will reveal an individuals’ psychological flaws. And
so it follows that one of the best lessons for any investor has nothing to do
with fundamental or technical analysis. Rather, the advice to “know thyself”
should ring true.

Thanks for
all your comments and keep ‘em coming to [email protected]