Macro Signposts | 13 May 2025

This week, during PIMCO's annual Secular Forum, I asked Anastasia Buyalskaya to guest author Macro Signposts. Dr. Buyalskaya, a behavioral science advisor to PIMCO, integrates behavioral insights and methodologies into our investment process.

How Does the Data Make You Feel?

By Anastasia Buyalskaya, Ph.D. - advisor to PIMCO on behavioral science

Within every investment firm, there are invariably a few individuals who evoke comparisons to the character Spock from Star Trek - highly analytical thinkers who view emotions as potential impediments to rational decision-making. Often trained in disciplines such as physics, engineering, or neoclassical economics, they tend to approach markets as though they operate under fixed, predictable laws akin to those of the natural sciences.

However, behavioral finance has shown that the reality is far messier. Markets are not mechanistic systems; they are driven by sometimes unpredictable human beings who are influenced by emotions, biases, and cognitive limitations.

This note serves as a reminder that investment decisions - especially in 2025 - are shaped not only by data and logic but also by complex psychological forces that traditional economic models often overlook. To navigate these challenges, it is essential to explore how emotional responses shape investor behavior alongside traditional data analysis.

When the macro data makes you feel something

All investors - even those who don't fancy themselves a Spock - spend their days sifting through heaps of data. Some of this data has instrumental value, providing actionable insights. For example, newly released consumer survey results may prompt an economics team to update their inflation expectations, while changes in capitalization rates can lead a property team to revise their financial models. Investors typically seek to isolate relevant instrumental information amid the vast amounts of data.

However, as humans, investors are also consumers and borrowers themselves. This means that macroeconomic data falling outside of a normal or expected range may also have affective, or emotional, value. For instance, if rising prices have led to tighter consumption patterns for an investor or their loved ones, increased inflation expectations may not only prompt professional forecast adjustments but also evoke negative emotions about a difficult economic future. If an investor or their family members are planning to refinance or purchase a home, higher interest rates may trigger not just updates to financial models but also negative feelings about a more constrained borrowing environment.

Are these emotions just distractions that investors ought to minimize, or might they also have instrumental value?

The function of emotion

Before judging whether the affective value of information is beneficial or detrimental, it is important to understand the purpose of emotions - why humans have them in the first place. Emotions are functional states that arise in response to specific stimuli (e.g., encountering a bear) to focus attention and guide decision-making in adaptive ways (e.g., fleeing danger).

This explains why four of the six "core" emotions (the taxonomy commonly used by psychologists) are negative: Their evolutionary purpose is to alert us to threats and increase our chance of survival. Among these core emotions, fear is commonly referred to when markets plunge and recession risks rise. Interestingly, the oft-used counterpoint, "greed," is not an emotion itself, but it often appears in the absence of the negative emotions that signal impending danger.

It is clear that emotions helped humans avoid being eaten by bears back in the day. But an investor taking the elevator up to their air-conditioned office in the year 2025 faces dangers far less immediate or life-threatening than those encountered by our ancestors. So does this mean that emotions are no longer necessary - and may even be a distraction - in modern-day investing? Could Spock's approach of disregarding emotions altogether actually be the correct one?

Investors with emotional impairment will likely perform poorly

To test this question, a seminal study by Bechara et al. (1997) asked whether individuals who lacked emotional experience would make better decisions. The researchers studied "normal participants and patients with prefrontal damage and decision-making defects" and compared their performance on a risky gambling task. While both groups had access to identical instrumental information, the participants in the second group lacked the affective signals that typically influence decision-making.

The results were just the opposite of the accepted view that "overt reasoning on declarative knowledge" was necessary for optimal decision-making in complex situations. In the study, the normal individuals were more likely to identify the correct strategy and avoid big losses. Even more intriguing: This group seemed to be in tune with the riskiness of the bets well before the true risk was consciously apprehended. The researchers measured this by looking at anticipatory skin conductance - physiological reactions that occur in anticipation of emotionally charged outcomes, a scientific "spidey sense" - when they pondered a choice that later proved to be risky.

In this case, emotions clearly helped decision-making by serving their intended function: warning individuals of the dangers of a risky bet. Rather than being a nuisance, emotions appear to act as cautionary signals shaped by an individual's past experiences with risk. This is why the closely tracked CBOE Volatility Index or VIX is known as the "fear gauge": Spikes in market volatility tend to increase an investor's alertness and speed of decision-making. Lacking this response, investors might exit volatile positions too late (if their own fear is justified) or miss opportunities to purchase temporarily distressed assets (if the fears of others are not justified). Emotions may therefore serve a useful instrumental role in signaling where we are within a cycle or anticipating the effects of a policy before that information is even fully processed through rational analysis.

Another core emotion - surprise - functions to alert us when something is different from expectations, prompting us to revise our forecasts accordingly. Given how frequently investors have been surprised in 2025, perhaps tuning in to their emotional reactions, rather than brushing them off, could have been beneficial.

Overly sensitive investors are also prone to poor performance

Given the "finance-as-physics" bias, many investors would benefit from tuning in to their emotions more closely. However, for those prone to panic and euphoria, the opposite advice may be more apt. There are clear limits to how much weight should be placed on affective information, and disproportionate weight can also lead to suboptimal decision-making.

In their 1995 paper, Shlomo Benartzi and Richard Thaler found that individuals are more risk-averse when gambles are presented one at a time, a phenomenon they termed "myopic loss aversion." Follow-up research by Shiv et al. (2005) found that this may occur because individuals' decisions are influenced by unrelated past experiences - events that have little instrumental relevance but significant and long-term affective impact. These incidental emotions - carried over from past experience but not relevant to the current situation - led participants to adopt more conservative strategies, which were ultimately less profitable.

In other words, while it is important to remain attuned to your emotional responses - such as those triggered by shifts in market volatility - allowing these emotions to entirely control decision-making, and potentially spill over into unrelated contexts, is also likely to lead to bad decisions. So, what's an investor to do?

The key is managing emotions: attending to them without letting them overwhelm decision-making

Returning to Spock: Although he appeared largely unemotional, he occasionally had intense outbursts that seemed disproportionate to the situation. Rather than mastering his emotions, he pretended they did not exist and was overtaken by them (usually by surprise). In the end, the answer is neither to ignore emotions entirely nor to permit them to guide decision-making unsupervised. Instead, the key lies in integrating relevant affective and instrumental information when making investment decisions.

In their research, David Tuckett and Richard Taffler (2012) found that the best investment managers acknowledge their emotions and learn to harness them effectively in decision-making. Because emotions are typically fast, automatic responses to information, this requires developing emotion regulation skills: recognizing and naming the experienced emotion, creating psychological distance to view emotions objectively, and deciding how and whether to integrate them into our decision-making. One best practice is allowing time to pass between experiencing a strong emotion and making an investment decision to help ensure that the affective information is weighed appropriately - neither fully dominating nor completely ignored.

While there continues to be a lot of economic and market uncertainty as we approach the midpoint of 2025, investors are almost certain to experience a lot of emotion whether that uncertainty is resolved or persists. If that thought makes you uncomfortable, you may consider getting Spock out of your head and adding emotion regulation to your toolbox.

References

Antoine Bechara, Hanna Damasio, Daniel Tranel, and Antonio R. Damasio. 1997. "Deciding Advantageously Before Knowing the Advantageous Strategy." Science 275, no. 5304: 1293-95.

Shlomo Benartzi and Richard H. Thaler. 1995. "Myopic Loss Aversion and the Equity Premium Puzzle." The Quarterly Journal of Economics 110, no. 1: 73-92.

Baba Shiv, Ziv Carmon, and Dan Ariely. 2005. "Investment Behavior and the Negative Side of Emotion." Psychological Science 16, no. 6: 435-39.

David Tuckett and Richard Taffler. 2012. "Fund Management: An Emotional Finance Perspective." CFA Institute Research Foundation, August. WBS Finance Group Research Paper No. 232.


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