In the folktale “Henny Penny” (also known as “Chicken Little”), the eponymous lead character gets hit on the head by
an acorn that drops from a tree and reaches the alarming conclusion that the sky is falling. She then sets out to warn
everybody, ultimately amassing an ardent following of farmyard fowl (such as Ducky Lucky, Turkey Lurkey and Goosey
Loosey) who ignore their better judgment and seek refuge from the collapse of the heavens in the den of a wily and very
hungry fox.
There are two main morals to this story. First, one indicator looked at in isolation and without proper context does not tell
the full story. It is always a good idea to look beyond a narrow subset of data to reach well-founded conclusions about what
is going on. Second, it is essential to understand what a reasonable range of outcomes is, and not place undue weight on
low probability events regardless of what some people may be saying.
In general, people are not so much “risk averse” as they are “loss averse”, meaning that they tend to want to protect against
losses rather than make similar gains. That asymmetric view of risk means, given even odds, the average person is more
willing not to lose $5 than win $6, even though the latter yields the better-than expected outcome — and some research
into decision-making suggests that the psychological impact of losses can be twice as significant as that of gains. As a
result of this irrational cognitive bias, people place additional emphasis on downside risks, focusing on potential adverse
outcomes and preparing for the worst regardless of how low a probability event that may be. This approach can lead
investors to act against their best interests in the name of avoiding potential (though unlikely) losses — and as Henny
Penny & Co. found, this is to their detriment.
The full commentary including Equity and Fixed Income Update can be found HERE. Happy reading!
