Financial stability as we have always known it is showing cracks. The climate in the financial markets is changing. Despite earlier assumptions, it turns out to be a definitive shift.
To thrive in a new climate, adaptability is needed. Market participants lacking this quality face the same fate as the dinosaurs. Dominant market players fail to realize that a major catastrophe is not necessary. After all, dinosaurs at the top of the food chain do not pay attention to their surroundings.
Bad weather ahead
Several regulators have warned about doomsday scenarios in their reports on financial stability. Financial stability, or rather the lack thereof, has been a concern for quite some time.
Developments such as inflation and successive interest rate hikes by central banks have turned small hairline cracks into fissures in the continent where dinosaurs once ruled. Weaknesses in the financial system have surfaced as a result. The reports predict disasters if inflation does not decrease. Corrections in the financial markets appear to be inevitable.
Optimism bias
According to De Nederlandsche Bank, the Dutch central bank, there are too many uncertainties, making the current expectations a significant risk due to their excessive optimism. With corrections in the financial markets looming, a change in approach or adapting the established methods is not an unnecessary luxury. There is no sign of any movement towards preparing for the scenarios that the reports warn about.
Instead of changing their approach, such as incorporating investor-focused interventions from financial psychology, hopeful scenarios are being outlined in the entrenched dinosaur way. An important argument in this regard is that after rain comes sunshine, and inflation will surely meet the European Central Bank’s 2 percent target by the end of 2024, thereby eliminating the consequences of inflation.
According to De Nederlandsche Bank, there are too many uncertainties, which may make these expectations overly optimistic. However, this viewpoint is largely disregarded by market participants. The increasing likelihood of corrections in the financial markets, which is already happening, and the question of “when” rather than “if,” is considered a footnote.
The fact that many investments do not align with investors’ risk experience and that corrections in the financial markets will cause a lot of trouble for market participants receives no attention whatsoever.
Resistance to change
External risk factors for a sustained high inflation and its consequences should logically lead to a change in approach. Altered external conditions require change, and that is difficult.
Only 20 percent of people are in the action phase of change. Most are in the precontemplation phase, a prehistoric dinosaur mindset where they believe the environment will adapt to them. This resistance is driven by the primitive brain, which still operates in a prehistoric tribal culture. Change represents a danger to its survival. Adaptation requires energy.
Warnings about disappointing economic growth in reports do not outweigh this resistance. Implementation of behavioral insights into investment policies is not given any consideration. Why change something that has always worked? The likelihood of the economy experiencing the effects of the asteroid that ended the dinosaur era is marginalized as a small chance.
The coup de grâce of the inevitable
Recent studies indicate that dinosaur species were already declining in their last years based on population counts. As a species, the dinosaurs were already living in their twilight years. The impact of the asteroid, which until recently was seen as the end of the dinosaur era, was not the end of a glorious era. The impact delivered the final blow of the inevitable.
The major players in the financial markets have seen their positions weaken in recent years. The current financial instability seems to mark the end of the reigning dinosaurs in the financial markets. However, there is a glimmer of hope: there is still an opportunity to change and adapt to the altered climate before the asteroid of corrections in the financial markets hits.
Although the behavior of the key players in the financial markets occasionally resembles that of the extinct Neanderthals, Homo sapiens has proven its ability to survive through adaptability.
Anne Abbenes is a financial psychologist, trainer, coach, advisor, and researcher of financial behavior. She is a lecturer in Behavioral Finance & Financial Psychology at institutions such as UCLL (KU Leuven Association) and a board member at the Financial Psychology Institute Europe. Her column originally appeared in Dutch on InvestmentOfficer.nl.