19-05-2025
It could have been worse: Our irrational love of less-bad news.
Sam Sivarajan is a keynote speaker, independent wealth management consultant and author of three books on investing and decision-making. His forthcoming book will explore how to thrive in a world of uncertainty.
On May 12, the stock market surged with the S&P 500 jumping more than 1.5 per cent and the Nasdaq rising nearly 2 per cent. The catalyst? News that the United States and China had reached a trade agreement where tariffs on Chinese imports would increase by 'only' 30 per cent. This was a market that, just weeks earlier, had been fretting about the possibility of 60 per cent tariffs, and 145 per cent at the start of the tariff wars. As one market analyst aptly put it to The Globe and Mail, 'what was once a terrifying scenario is now a positive development.'
What we witnessed was a textbook example of how markets – and humans more broadly – can transform objectively bad news into seemingly good news, simply because it wasn't as terrible as feared. The 30-per-cent tariff, devastating in any other context, became a cause for celebration. If this sounds irrational, that's because it is. But it's also deeply human.
Behavioural economists have a term for this psychological quirk: reference dependence. According to Nobel Prize-winning economist Daniel Kahneman and his colleague Amos Tversky, we don't evaluate outcomes in absolute terms, but rather relative to reference points. In their groundbreaking work on prospect theory, they showed that our perceptions of gains and losses depend heavily on the reference point from which we start. When expectations are sufficiently negative, even objectively poor outcomes can feel like wins.
A 2006 study by D.A. Kermer and colleagues found that people consistently overestimate the impact of negative events and underestimate their ability to adapt to them. When the feared negative outcome doesn't fully materialize, the relief creates a positive emotional response that can overshadow rational assessment. We essentially celebrate having dodged a bullet, even if we've still been wounded in the process.
This reference dependence combines with several other behavioural biases to create a perfect storm of irrational market responses. Recency bias causes us to overweight the latest information and underweight longer-term trends. When markets had been preparing for 60-per-cent tariffs, the 'recent' news of 30-per-cent tariffs dominated all other considerations – including the fact that any tariff increase is economically harmful.
Similarly, anchoring bias – our tendency to rely too heavily on the first piece of information we encounter – played a key role. Once investors had anchored to the possibility of 60-per-cent tariffs, 30 per cent seemed reasonable by comparison. This ignores the reality that a 0 per cent increase would be the economically optimal outcome.
We see this same psychological phenomenon at work in everyday contexts. Consider restaurant menus that feature an extremely expensive item – a $200 wagyu steak or $500 bottle of wine. Whether intentional or not, these high-priced options shift our reference point, making the $75 filet mignon suddenly feel like a reasonable choice by comparison. It's not a marketing trick so much as a natural consequence of how our brains process relative value. In markets, the threat of catastrophic tariffs created a similar psychological anchor, making merely damaging tariffs feel like a relief.
Optimism bias further amplifies these psychological effects. Research led by Tali Sharot at University College London has shown that humans have a natural tendency to focus on positive information and play down negative outcomes – a phenomenon rooted in the brain's reward and learning systems. This helps explain why investors might mentally transform 'still-bad-but-less-bad' news into 'good' news, celebrating any outcome that exceeds their worst fears. Their focus on immediate relief, rather than future consequences, may cause them to overlook or underestimate potential long-term risks such as the cumulative damage from increased trade barriers.
For investors, these psychological quirks create significant risks. When markets rally on objectively negative news simply because it wasn't as catastrophic as feared, it creates a disconnect between asset prices and economic fundamentals. This disconnect eventually corrects, often painfully.
The more prudent approach is to evaluate news based on absolute impact rather than relative to expectations. A 30-per-cent overall tariff on Chinese goods, agreed for 90 days, will still disrupt supply chains, increase consumer prices and potentially slow economic growth. These fundamental factors should matter more than the relief of avoiding a 60-per-cent increase.
Investors would be wise to ask themselves: Am I celebrating less-bad news as if it were genuinely positive? Have my reference points shifted to the point where I'm accepting suboptimal outcomes? Is my relief at avoiding disaster clouding my judgment about actual risks?
Not that investors should be perpetually pessimistic. Rather they should maintain perspective and awareness to separate emotional reactions from objective analysis. The 30-per-cent tariff news wasn't good – it was simply less bad than feared. The market's exuberant reaction says more about psychology than economic fundamentals.
As investor Howard Marks wisely noted: 'It's not what you buy or at what price that determines your outcome, but what happens subsequently relative to what the market expected at the time of purchase.' Understanding this principle – and our tendency to irrationally cheer when things are merely less terrible than expected – is essential for both investment success and personal growth.
