Negativity Bias: Rattlesnakes and Bunnies

I just wrote about recency bias and how it can affect how we process information. You’ll come to find that I’m a fan of behavioral finance and it often influences my analysis of the markets. I think understanding how humans tend to think and act can help us manage wealth. So, it shouldn’t come as a surprise that the thing I was thinking about on my way home from a week in New York was another psychological phenomenon: Negativity bias.

I think most people read negativity bias as meaning people tend to be negative or pessimistic, but that’s not what it actually means. Negativity bias means that our brains give more weight and attention to negative experiences, emotions, and information than to positive or neutral ones. This tends to hold true even when there might be the same or even more frequent positive experiences. Just like with recency bias, negativity bias is all about survival. Our ancestors had to stay alert to threats to survive. Hence, we learned to pay attention to negative stimulus more than positive stimulus. Those of us that have a high negativity bias tend to notice danger faster, remember threats longer, and react more strongly to unpleasant emotions or feedback. In other words, they are the people that start running when they smell smoke, not when the fire is already at their door!

How does this play out in the investment world? It shows up in two ways. First, investors tend to feel the pain of losses more than they feel the joy of gains. One of the first things Paul told me about his investment philosophy was that “clients hate volatility.” I agreed, but noted they really just hate downside volatility! Everyone likes it when portfolios are up 20%, but they really, really, really hate it when they are down 20%. If you think about it, it’s probably true for you too. This part of negativity bias tends to show up in how we structure portfolios. It’s part of the reason we value diversification and non-correlating assets. We know that our goal is to keep clients invested over the long term and avoiding painful drawdowns helps us achieve that goal.

The second way negativity bias shows up in investing is more interesting to us right now and has more to do with tactical allocations. Imagine a scenario where you are hiking with friends on a 4 hour-long loop trail. For the first hour of the hike, everything goes great. You’re enjoying the views and having a great time. Suddenly, a rattlesnake slithers across the path right in front of you. How do you think you will spend the next 3 hours of the hike? Chances are that you’re going to spend a lot less time looking at the scenery and lot more time looking at the ground. Now, what if I told you that there was a 0.00001% chance of seeing two rattlesnakes on the same hike? I’d guess that many people would still keep their eyes down in anticipation of the second rattlesnake. More importantly, when you get back and a friend asks about the hike, you’re more likely to tell them about the rattlesnake than the beautiful views. You spent 239 minutes hiking peacefully yet the 1 minute of danger is what defines the hike. That’s how deeply negativity bias is engrained into our brains.

How does it relate to investing today? It helps explain why so many clients are concerned right now about another tech bubble. If you lived through the Dot-Com bubble, you saw the NASDAQ go down 78% from peak to trough. If you had $1,000,000 invested in it, that means it got all the way down to $220,000 at the bottom! More importantly, it took the NASDAQ 15 years to recover! Worse, many people that had wealth invested in concentrated positions in tech companies saw their wealth vanish completely. That is the type of pain that will stay with you.

It’s important in investing to keep our own emotions and biases in check. To do that though, we need to be aware of them first. Right now, negativity bias is driving a lot of people to see only the parallels between the Dot-Com boom and the AI boom. I won’t go into a comparison here because Paul did a great job of reviewing the two in the previous newsletter "Are We Headed for Another Dot-Com Bust?". The summary version is that while there are a lot of similarities, there are several key differences with the biggest one being that the companies driving the innovation in AI are mature, healthy companies with strong earnings and cash flow. To use our hiking metaphor, imagine we’re in the third hour of our hike and we see the brush on the side of the trail move. Our brains will jump to alarm, and we might even expect a rattlesnake to slither out again. However, it could be anything. It could be a bunny rabbit or a small bird.

I was thinking about negativity bias on the way home because one of the clear messages from my trip is that many investors are solely focusing on the bad economic data. They didn’t try to refute the bad data and were clear-eyed about the uncertainty related to a chaotic tariff rollout, the negative economic effects of immigration policy, the government shutdown, and the deterioration in the labor market. However, they were equally clear that they felt investors, to quote Piper Sandler’s Chief Global Economist, Nancy Lazar, “are getting stuck in the mud and missing the rest of story.”

What is the rest of the story? It’s a lot of what we’ve been telling clients to pay attention to all year long:

Rate Cuts: The Fed has already cut interest rates 100 bps already and there are more to come. Goldman Sachs predicted another 4 cuts in 2026 which is frankly the low end of my expectations. One interesting point Nancy Lazar made was a reminder that the economic benefits of rate cuts lag for a full year. In other words, we should just start to see and feel the benefits of the rate cuts now. (It’s also worth reminding people that the Fed was raising interest rates heading into the Dot-Com bust, another key difference between 2000’s and now.)

Tax Refunds: The Trump administration made several adjustments to 2025 taxes but did not have the IRS adjust withholding rates. So, there should be a big wave of tax refunds in the first part of 2026. We’ve known and talked about this piece of stimulus for a while now, but the size of it was much larger than I expected. Piper Sandler expects the refunds to “boost disposable personal income in 1Q by 10%.” That’s a sizeable bonus for the average American.
Public and Private Capex Boom: The US Government is continuing to invest in public infrastructure at a rapid pace using funds from bills passed by Biden and now Trump’s OBBBA. At the same time, private companies are pouring money into AI Infrastructure. Companies are racing to build data centers and the power generation needed to run them. In dollar terms, the spending should outpace any previous investment in history. In inflation-adjusted terms, it trails only the railroad expansion right now and some predict it will surpass even that grand endeavor.

I also picked up two new pieces of stimulus as well from my meetings. I’d heard of both before my trip, but didn’t fully appreciate the magnitude of the benefits:

Capex Expenses Rule Changes: One of the lesser-known items in the OBBBA was that it made the 100% bonus depreciation rules permanent. The rule was initially added in the TCJA but started to sunset in 2023. This change effectively reduces the tax burden on companies dramatically. Piper Sandler estimates it takes the effective corporate tax rate down to 10%.

Deregulation: The Trump administration is deregulating industries from energy to tech to finance. Many argue this may prove foolhardy in the long run, but in the short run deregulation will improve the financial situation for many companies.

But what about jobs? What about inflation? The people I talked to were remarkedly calm about both. Piper Sandler noted that the US has had many jobless economic recoveries. JP Morgan noted the deflationary impact of reduced energy prices and increased automation from advanced technology. Piper Sandler also noted that stimulus takes a while to flow through to the economy, specifically that it takes a full year for the benefit of interest rate cuts to show up in the economic data.

While their comments convinced me we are making the right decision by keeping clients fully invested, we remain more worried about the economy beyond the first of 2026 than our friends on Wall Street. As we’ve said before, it’s not clear to us that the job market will be fixed easily by interest rate cuts. Perhaps the rate cuts stimulate the economy and small businesses ride to the rescue . . . or perhaps we have a multi-year period where new hiring activity is slow because AI-enabled programs allow companies to do more with less people. Perhaps the tariffs and rate cuts combine to drive prices up to the levels we saw in 2022… or perhaps inflation stays relatively under control in the low 3% range.

This trip was a good reminder that these are all just potential scenarios. We should not assume some negative data is proof of another rattlesnake in the brush. It might be a rattlesnake, but it also might be a cute bunny. Unfortunately, that is where negativity bias compels us to fear the rattlesnake more than hope for the bunny. It wants us to act now to avoid the pain we expect later. We encourage our clients to take a breath and keep your gaze on the horizon. Remember that the S&P 500 has produced positive returns 74 times out of the last 100 years. In other words, there are typically more bunnies than rattlesnakes!

Chris Roth
CIO
5T Wealth, LLC
Main (707) 224-1340
Cell (707) 637-7222
Chris@5twealth.com

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