What is the Behavior Gap?

Michael Carrico, CFP®, CRPC®, WEALTH MANAGER​

Any time the market moves several percentage points in a week, let alone a day, it can make an investor wonder if they need to be doing something, anything, in response. I regularly get questions from clients around the time of big moves in the markets in either direction. Should the strategy change? Am I missing out? Could I be better positioned? One example of such a move was Tuesday of this week when CPI data was released and came in slightly better than expectations. The S&P 500 index was up 1.91% at the close while the Russell 2000 index, a widely followed small-cap U.S. stock index, ended the day up 5.49% and U.S. Treasury yields dropped sharply. Today we’ll examine what might explain that big day in the markets, why investors might feel a need to act, and whether taking some action makes sense.

Behavior Gap

“…if you don’t ever find yourself recalibrating your decisions, you’re likely ignoring some issues that might become problems down the line.”

― Carl Richards, The One-Page Financial Plan: A Simple Way to Be Smart About Your Money

What Happened on Tuesday?

As a refresher, the U.S. Consumer Price Index (CPI) is one of the two primary measures of inflation that the Federal Reserve uses to determine the pace of inflation in the U.S. economy.  Following the change in CPI data allows the Federal Reserve to measure the effectiveness of monetary policy, such as the level of interest rates, in bringing inflation back to their target of 2% inflation.  While the “headline” CPI is the top line of the report which includes all items, this metric can be volatile because changes in food and energy prices can be both large and fast.  So, the Bureau of Labor Statistics (BLS) strips out food and energy prices to get a figure called Core CPI.  This Core CPI figure is followed closely by the Federal Open Market Committee (FOMC), the committee at the Federal Reserve which sets the policy rate, and Core CPI has been coming down more slowly than the headline number.  In the report published on Tuesday, the Core CPI year-over-year reading came in at 4.0% compared to the 4.1% expectation.  

U.S. Consumer Price Index (headline and core), YoY

Now, a difference between expectations and reality of 0.1% is not a big one, but market participants liked the story it tells.  A few major aspects of the 2023 rally in stocks have been that inflation is coming down towards the 2% target, that the Federal Reserve is done (or almost done) raising interest rates, and that we may even see rate cuts in the near-term future.  At the beginning of the month, we got the FOMC decision to hold rates steady, a lot of commentary followed about that being the end of rate hikes, and Treasury yields fell rapidly as the market priced in those expectations.  Then we got a week of Federal Reserve officials pushing back on that narrative and trying to talk the market down from expectations of the end of rate hikes.  This week we got a CPI report that confirms inflation continued to fall in October and the prediction from the beginning of the month seemed to be verified.  The market picked up again and rapidly priced in not only the end of rate hikes, but interest rate cuts arriving sooner than previously anticipated.  The tables below show the probabilities the market is pricing in of a given policy interest rate at future FOMC meetings.  The current level is 5.25% – 5.50% and as of November 15, the market has arrived at a 100% probability that the Fed will hold interest rates the same in December and January.  That’s a bit misleading because these probabilities change constantly and could be different by the time you are reading this, but it goes to show the change in sentiment in the markets.

Market Expectations for Future Federal Reserve Interest Rate Decisions Aug 22 vs. Nov 15

August 22
November 15

The CPI report was not a blowout beat of expectations, rather it was a confirmation of the already expected path of inflation.  The market may very well be right that the Fed has finished hiking rates, but time will tell.  Claiming to know the future is a fool’s errand, particularly when it’s written down for later reference.  In the absence of additional information contradicting the current narrative, 5.25% – 5.50% may mark the peak rate of the hiking cycle that began in March of last year.  However, new information is available every day which could change the math for the explicitly data dependent FOMC.  Regardless of the path of rate hikes, it does not logically follow that the end of rate hikes means rate cuts are imminent.  Federal Reserve officials have been saying in no uncertain terms that they intend to hold interest rates “higher for longer”.  This is evident both in the press conferences by Fed officials and in the “dot plot” from the September Summary of Economic Projections.  The market is essentially betting the Fed won’t do what they are claiming, and this isn’t the first time we’ve seen this disconnect in 2023.  Something to remember is that the Federal Reserve has a dual mandate of 2% inflation and maximum employment.  With inflation still 2x above target, if the current level of interest rates is effective at gradually bringing inflation back to target and employment remains strong, then what is the catalyst to cut rates?  The Federal Reserve will likely want to ease off the throttle to not overshoot the 2% target, but near-term rapid rate cuts would seem to suggest that there is a reason for the Fed to need to change course and fast which might not be a good thing.

Does the CPI Report Change Things?

Coming back to the original question of this article, do investors need to do anything with this information?  That, of course, depends on the individual, but the October 2023 CPI report is unlikely to have had a material impact on any given individual’s life plans, risk tolerance, or even their Thanksgiving shopping list.  Day traders might care about what will happen in the market over the course of a trading day and therefore care quite a lot about a single CPI report.  However, investors invest for longer term goals and over longer time periods.  As the quote from Carl Richards above suggests, failing to ever examine one’s circumstances or change one’s strategy is likely to leave important issues unaddressed.  That is why financial planning and monitoring is important.  But we often have an impulse to do too much as I wrote about roughly a year ago.  There are certain cognitive biases to which we are all vulnerable and which can often work against our best interests.  One example is the action bias, which describes the instinct that doing something is better than doing nothing, even if there’s no evidence to support that conclusion.  An example given in the linked article is that most soccer goalkeepers defending a penalty kick will jump to one side or the other even though they would statistically be better off remaining in the center of the goal.  Often acting allows us to feel more in control of a situation and, when it comes to finances, we certainly want to feel in control.  Unfortunately, data shows that investors who trade more frequently tend to underperform the market so carefully considering any such action is important.  Carl Richards refers to this difference between investment returns and investor returns as the behavior gap.  

An investor may want to examine their long-term strategy for an update if a major factor used in establishing that strategy has changed.  For instance, risk tolerance naturally changes over time and tends to decline as we age.  Experiencing a life change such as the loss of a spouse or the birth of a child will change someone’s life trajectory.  An individual’s investment time horizon can change if they decide to retire early or delay retirement, perhaps to start a second career.  If you think you’ve experienced such a change or aren’t sure, then a conversation with your advisor might help.

Sometimes Doing Nothing is Doing Something.

As I thought about this topic, I was reminded of something I learned in a Philosophy of Eastern Religions course in college.  In Taoism there is the concept of wu wei which is the idea of the action of nonaction.  Now, upon cracking open my old books on Taoism, I was not surprised to see I misremembered the principle.  Wu wei is about the way one lives in and interacts with the world, being in harmony with the world in such a way that actions are effortless.  However, I do think investors can take a bit of wisdom from the concept of action through nonaction, so I hope any Taoist readers will forgive a tangent inspired by the concept.  Sometimes choosing not to take direct action is a type of action.  Trusting the work already done and the decisions already made is a form of action.  Although, it is much more subtle than jumping to one side of the goal or the other and it may not quite satisfy that nagging feeling our brains inflict upon us at times.  However, reflecting on the work already done to set your course may help calm your mind amid market volatility and make it easier to endure the ebb and flow that investors inevitably experience.  Happy Thanksgiving to all our readers and may you enjoy the holiday next week.


This newsletter may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor. Investment strategies, philosophies, and allocation are subject to change without prior notice. This newsletter is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice. While H&R believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.

Michael Carrico

Michael Carrico is a Wealth Manager at Howe & Rusling.


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