Investing in the stock market is an endeavor filled with uncertainty and unpredictability. Investors often seek out winning streaks, hoping to capitalize on past successes and achieve substantial returns. However, this mindset can lead to the well-known “Hot Hand Fallacy.” This cognitive bias revolves around the mistaken belief that past success in investing will guarantee future success. Unfortunately, falling victim to this fallacy can have significant consequences for investors.
The Rise and Fall of Stock Market Strategists
In 2022, certain stock market strategists who had adopted bearish outlooks appeared to be heroes. Their predictions aligned with the market’s performance, and they gained considerable attention and credibility. However, as the year transitioned into 2023, the same strategists faced challenges as their bearish predictions did not pan out as expected resulting in them to issue a mea culpa. Factors such as sticky inflation, higher unemployment, and a drop in earnings were in their forecasts which didn’t pan out as expected.
The Elaine Garzarelli Phenomenon
One notable example of the Hot Hand Fallacy is Elaine Garzarelli, an analyst who famously predicted the 1987 stock market crash. Her accurate call on the “Money Line” cable news program on October 12, 1987, gained her instant fame. Fast-forward a week later, October 19, 1987, the stock market dropped by over 20% in a day launching her to instant stardom.
While Elaine has gone on to have a successful career as an analyst, she made a similar call in July of 1996 when she expected a 15-25% drop in the Dow Jones. This time, as the market tends to do, humbled this prediction as the Dow rallied 27% in the 6 months to follow that one.
The Fallacy’s Relevance Today
As markets become more complex and interconnected, the Hot Hand Fallacy is more relevant than ever. Investors may be tempted to follow those who have had successful predictions in the past, assuming that they possess some sort of infallible insight. However, the financial landscape is ever-changing, and past performance may not accurately predict future outcomes.
By avoiding the Hot Hand Fallacy, investors can position themselves for more sustainable and successful investment outcomes.
Presented by the Financial Planning Committee of Lake Street, an SEC Registered Investment Adviser
The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will be successful. Investing involves risk and you may incur a profit or a loss.