A solar-powered market

In this first week of spring, it may be timely to remember Alan Greenspan’s famous line about irrational exuberance.

Exuberance can arise from unexpected sources. The heavens, even. It is well established that sunshine makes people feel more positive. In 2001, two delightfully named American researchers examined whether solar power was strong enough to move a sharemarket.

David Hirshleifer and Tyler Shumway analysed the single-day returns on 26 world stock exchanges between 1982 and 1997. They compared the returns with the prevailing morning weather conditions in the exchange’s host city. Each day’s weather was classified into a continuum ranging from full sunshine to completely overcast.

The results were startling. Full sunshine correlated positively with stockmarket returns. If the weather was sunny, stocks were more likely to rise. If the weather was cloudy, stocks were less likely to rise. The effect was not huge, but it was real. The authors even concluded that an investor could trade profitably according to the weather.

This raises all sorts of possibilities. For one thing, Alan Kohler has been reading the wrong part of the ABC news bulletin all these years. And it shouldn’t be long before Eureka Report includes a weather section – long range, of course. Finally, presumably there is a boutique fund manager already contemplating the Sunny Daze Equities Fund.

The sun has a powerful effect on emotions. Psychologists have long described mood disorders that are climate-based. “Seasonal affective disorder”, or “SAD”, has been observed in all countries with what might be called serious winters. And yes, Australia is one of them. Excuse the bad pun, but SAD is no laughing matter. Rates of depression and even suicide increase during winter and fall during summer.

Last Friday, the Eureka Report published Michael Pascoe’s interview with David Wyss of S&P. (See Fear itself, the markets’ biggest danger). Wyss reminded us that recent volatility in world markets is largely the result of nervousness. It is no surprise that markets are susceptible to moods and passions. So, it should also come as no surprise that returns can be influenced by sunshine. And while Wyss is talking about market-wide sentiment, my experience is that personal emotions are more important to individual investors.

Optimism

Sunny days make people more optimistic. Notwithstanding the drought, when was the last time you heard a bride praying for rain? The problem is that the optimism becomes generalised. In share markets, it colours our analysis of a company’s prospects. The same goes for property markets, hence the all-important spring selling season.

Psychologists call this a “misattribution”. People attribute their mood to the wrong cause. It is the weather that cheers us up or makes us gloomy. But we give credit to, or lay blame on, the object of our investment.

It is not just the sun that causes misattribution. Anything that influences our mood can have a similar effect. Even people. Remember the Virgin Blue float in December 2003? Shares that floated at $2.25 finished the day at $2.40. By February they were at $2.60. Qantas shares barely moved during this period.

Who puts people in a better mood: Richard Branson or Geoff Dixon? For anyone who can’t read a set of accounts, which is a nice way of saying “most people”, the answer should be obvious.

Of course, it is possible to benefit from misattributions – other people’s that is. To do this successfully, we need to learn to master our own moods. As Rudyard Kipling wrote in If: “If you can keep your head when all around are losing theirs and blaming it on you'¦”

The simplest way to “keep our head” is to identify the actual cause of a good or bad mood. Research into sunshine again points the way. Studies have shown that people become optimistic about everything when the sun is shining. However, when people are asked to describe the weather, this generalised optimism falls. When people think about the sunshine, they realise why they feel good. They correct the misattribution and can then start to think clearly about everything else.

Sunny days are just one potential influence on our personal mood. Others that are often overlooked, especially in discussions on investment, include hunger and boredom. Hunger, for example, makes us anxious – not a good state to be in as we open our CommSec screen.

So, when next you sit down to trade, make sure you have eaten and check the weather. Learn to remind yourself that if the sun is shining, this has absolutely nothing to do with anything. Then manage your portfolio accordingly.

More generally, now might be a good time to “cash up” your portfolio. The drought must end eventually. Rainy, cloudy days can cause misery in the markets – just perfect for some rational exuberance on your part.

Adrian McMaster is a registered psychologist and financial planner at www.dover.com.au