To better understand the psychology of our current economic times, especially in regard to the perspective of John Templeton, we posed the following question to three leading psychologists:

One of Sir John Templeton’s most famous quotes is “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy and sell.” We all know we should buy low and sell high and yet few of us have the psychological fortitude to follow this sage advice. What kind of psychological factors contribute to an ability to follow John Templeton’s maximum pessimism rule?

Make sure to click “Continue Reading” at the bottom of this post to read each essay in its entirety.

Here is an excerpt of the response from David Myers, Hope College social psychologist and author of Intuition: Its Powers and Perils:

One can easily see psychological factors at work in what Alan Greenspan called the “irrational exuberance” of the late 1990s stock market bubble, and what some saw as the “irrational pessimism” after the bubble burst. Traders, like wolves, run in packs. “Momentum investing” creates self-fulfilling prophecies—times during which investors buy not because of undervalued opportunities, but because prices are rising. “Everyone’s Getting Rich in Tech: Here’s How to Get Your Share,” declared the May 1999 Money magazine cover. Before long, the same herd will frantically sell when prices are falling.

Here is some of what Paul J. Zak of Claremont Graduate University and editor of Moral Markets: The Critical Role of Values in Society had to say:

Stocks are cheap. So is real estate. Mortgage interest rates have dropped like a rock. So where are all the buyers and borrowers?  Mostly on the sidelines it seems, even with abundant “bailout” money greasing the skids. Sir John Templeton realized that times like these are when the greatest bargains appear.

Why so much pessimism?  The answer I hear most often is “this recession is different than the others.” But I heard the same creed in 2000–2001 when the tech bubble burst, and in 1990–1991 when the S&L crisis hit. Please excuse me if I see history repeating itself and Sir John’s wisdom being on the money. This where some science can resolve the mystery of persistent pessimism.

And finally, social psychologist Douglas Kenrick weighs in:

To capitalize on Templeton’s advice to “buy and sell at the time of maximum pessimism” requires people to overcome an aversion to risk that probably evolved over millennia. When times were tough for our ancestors, they faced a real danger of starvation. If there wasn’t much to eat, as in the depths of winter or during a prolonged drought, high levels of activity would have burned up their few remaining calories. What many animals do under such circumstances is move into hibernation mode, conserving their calories until the springtime rains make it a good strategy to get up and start searching for goodies. Some biological theorists have pointed out that there are physiological parallels between animal hibernation and human depression.

David Myers: The Psychology of Investing

One can easily see psychological factors at work in what Alan Greenspan called the “irrational exuberance” of the late 1990s stock market bubble, and what some saw as the “irrational pessimism” after the bubble burst. Traders, like wolves, run in packs. “Momentum investing” creates self-fulfilling prophecies—times during which investors buy not because of undervalued opportunities, but because prices are rising. “Everyone’s Getting Rich in Tech: Here’s How to Get Your Share,” declared the May 1999 Money magazine cover. Before long, the same herd will frantically sell when prices are falling.

Noting how small bits of good news turns the chatter bullish and sends stocks soaring, and then minor bad news does the opposite, reminds me of my own studies of “group polarization.” Groups amplify their shared tendencies. In one study, we observed that when prejudiced high school students discussed racial issues, their attitudes became more prejudiced. When low-prejudice students discussed the same issues, they became more tolerant.

Group polarization can amplify a sought-after spiritual awareness and strengthen the mutual resolve of those in a self-help group. But it can also have dire consequences. In experiments, group decision making amplifies retaliatory responses to provocation. In the real world, terrorism arises among people who are drawn together out of a shared grievance, and who then become more and more extreme as they interact in isolation from moderating influences. In the marketplace, people who are lusting for gain or fearing loss feed off one another–amplifying their optimism, at one moment, and their pessimism, at another. The natural result is overreaction–irrational exuberance and irrational panic. With the recent market collapse indicating more of the latter, I am reminded of John Templeton’s admonition to resist the crowd impulse.

But how does one resist the crowd impulse when experiments show—and experience confirms—that nonconformity, especially persistent nonconformity, is often painful. My piece of advice is prepare yourself for the crowd’s negative response—especially when you argue an issue that’s personally relevant to the majority and when the group wants to settle an issue by reaching consensus. When researcher Charlan Nemeth (1979) planted a minority of two within a simulated jury and had them oppose the majority’s opinions, the duo was inevitably disliked. Nevertheless, the majority acknowledged that the persistence of the two made them rethink their positions. The lesson is that while you may be initially disliked for going against the crowd, your persistence may eventually win them over. Moreover, for those who can resist the crowd psychology and discern the point of “maximum pessimism” —when pundits are echo-chambers of catastrophizing—therein lies opportunity.

Hope College social psychologist David G. Myers discusses “investment intuition” in his Intuition:  Its Powers and Perils.

Paul J. Zak: My Brain Made Me Do It

Stocks are cheap. So is real estate. Mortgage interest rates have dropped like a rock. So where are all the buyers and borrowers?  Mostly on the sidelines it seems, even with abundant “bailout” money greasing the skids. Sir John Templeton realized that times like these are when the greatest bargains appear. 

Why so much pessimism?  The answer I hear most often is “this recession is different than the others.” But I heard the same creed in 2000–2001 when the tech bubble burst, and in 1990–1991 when the S&L crisis hit. Please excuse me if I see history repeating itself and Sir John’s wisdom being on the money. This where some science can resolve the mystery of persistent pessimism.

People don’t see the bargains because of three peculiarities in the way our brains work that have recently been discovered by neuroeconomists. Before discussing these, I must digress on the economic brain. Yes, all biological systems, including your brain, are economic: there are limited resources available to achieve important goals, like finding one’s next meal or a suitable mate. This means your brain is stingy. One implication of stinginess is that brain regions that originally served one purpose are reused for another purpose. For more on the stingy and “rationally rational” brain, see my Psychology Today Blog.

So, why aren’t people buying bargains? The first reason is that risk aversion is encoded in the human brain in the same regions that process the disgust you feel when you smell spoiled milk or someone’s vomit. Our brains give us a visceral signal to stay clear of potentially illness-causing substances. Volatile markets literally give our stomachs that nauseous feeling. Asset prices in recessions are always volatile as millions of investors sift through news to identify when markets will hit bottom and start to climb out. The stomach churning volatility in markets screams “stay away,” even though the more recently evolved cognitive parts of the brain tell us that now is the time to jump in.

Second, the uncertainty associated with sideways markets activates brain regions associated with fear. Seeing a snake wriggling toward you in the grass or one’s 401(k) whipsawing around both make us uncomfortable. Our fear responses are protective: being unable to forecast what will happen next means that our full attention should be on what is in front of us. The fear response narrows our focus to the here and now. Yet these responses are primitive and blunt, rather than deliberative and nuanced. They activate whether you see a harmless garter snake and when your retirement portfolio won’t be touched for twenty years.

Third, humans are a herd species. We learn from others and watch them intently. This social learning produces fads and fashions, from the latest design by Yves Saint Laurent to the emotion transmitted from the blaring eyeball-catching ad-selling bad news endlessly repeated on CNN. We unconsciously monitor what the other humans think and do and adjust our attitudes and behavior accordingly.

What can you do about this?  Being aware of your brain’s rapid and automatic responses to volatility, uncertainty, and social mirroring allow the deliberative parts of the brain to enter into the analysis. Use rules when making investment decisions, not emotion. Take your time to size up the situation. Turn off the TV news. And, use a certified investment advisor if you are overwhelmed. Sir John’s wisdom has stood the test of time, and I’m confident that it will continue to do so. This wisdom is an opportunity for action. Of course, do not make investment decisions based on my advice and do as much of your own research as you can. If you are so uneasy that you can’t sleep at night, that’s a sign you may have taken on too much risk, and always remember to diversify your portfolio.

Let the pessimists have their day, but scoop up their castoff bargains and you’ll be the wiser investor.

Paul J. Zak is director at the Center for Neuroeconomic Studies at Claremont Graduate University and editor of Moral Markets: The Critical Role of Values in Society (Princeton University Press, 2008).

 Douglas Kenrick: Humans’ Innate Aversion to Risk

To capitalize on Templeton’s advice to “buy and sell at the time of maximum pessimism” requires people to overcome an aversion to risk that probably evolved over millennia. When times were tough for our ancestors, they faced a real danger of starvation. If there wasn’t much to eat, as in the depths of winter or during a prolonged drought, high levels of activity would have burned up their few remaining calories. What many animals do under such circumstances is move into hibernation mode, conserving their calories until the springtime rains make it a good strategy to get up and start searching for goodies. Some biological theorists have pointed out that there are physiological parallels between animal hibernation and human depression.

Anthropologists find that foragers and hunter-gatherers tend to invest their energies in ways that avoid worst-case scenarios, even when those options deny them opportunities for very high average pay-offs. Before refrigeration, extra food just went bad, so that the difference between having just enough to eat and being wealthy was less relevant than the difference between having just enough to eat and starving to death.

In this light, it pays to realize that we are not living on the edge of starvation and, like Templeton, to treat economic downturns as opportunities. Of course, that wisdom may only hold for those who have been like good squirrels and gathered enough acorns to make it through an indeterminate season of scarcity. For some, like those with credit card debt mortgages worth more than their houses, it might not make sense not to unleash their riskiness, but to go into economic hibernation and plan a more careful strategy for the next season.

Douglas Kenrick is a social psychologist who studies human cognitive biases in evolutionary perspective. Some of his recent research examines how economic decisions—even those that seem irrational—may reflect “deep rationality” in the form of biases that served our ancestors well.