The pandemic should make us rethink how consumers and investors behave.
I say this because the post-lockdown bounce in consumer spending seems to have been weaker than many expected. Official figures showing that retail sales fell 6.6 per cent between April and August are only one sign of this. Bank of England data show that consumer borrowing has flatlined since March, with debt 12.5 per cent below its pre-pandemic level. They also show that far from running down the big bank balances they built up during lockdown, households have actually added more to them.
There are several reasons for this. Sales are held back by shortages not just of staff in pubs and restaurants but also of goods, which is one reason why new car registrations were so weak in September. And although formal restrictions have been lifted, the fear of Covid is suppressing demand: pubs and restaurants seem quieter than they’d usually be.
But there might be something else. It’s that the picture of the consumer that’s painted in textbooks is if not wrong then certainly incomplete. It shows that consumers choose a bundle of goods, services and leisure which maximises utility subject to a budget constraint. The lockdown added a further constraint to this maximisation problem, but now it is relaxed we should return to the bundles we chose before the pandemic. Such thinking is why so many expected a big post-lockdown recovery.
This depiction, though, is flawed. We are also creatures of habit. During the pandemic we fell into habits of not eating and drinking out and not going to shopping malls, and these habits have persisted. Our spending is also influenced by our peers, so if they spend less so do we.
We’ve lots of evidence for this, much of it gathered by Cornell University’s Robert Frank in his book Under the Influence: my favourite is a study of the effects of the Dutch postcode lottery which found that the neighbours of those who won a BMW subsequently bought new cars even though they themselves had won nothing.
We are not the exogenous calculating machines of textbooks’ imagination. We are instead the products of our environment. Covid-19 has changed our environment and so changed our behaviour – not necessarily forever, but long enough to weigh on spending for a while yet.
This is true not just of consumers but investors too. Hans Hvide and Per Ostberg have shown that people’s stock picks are influenced by those of their colleagues. And Tilburg University’s Ben Jacobsen and colleagues show that our asset allocation decisions are also shaped by those around us. Our choices are also determined by how our options are framed. Shlomo Benartzi and Richard Thaler have shown that pension savers put more into equities if they are offered lots of equity funds but only one bond fund, and less if they are offered just one equity fund but lots of bond funds. And Yale University’s Robert Shiller has shown that investor sentiment is infectious just as a virus is: we catch it from other people. That’s one reason why bubbles arise and why prices have momentum.
It’s for this reason that investors especially must ditch the illusion that we are independent people. Failing to see that we are influenced by others can lead us into expensive mistakes such as buying over-priced assets. We need a more realistic picture of consumer and investor behaviour.
