How Credit Cards Affect Our Brains

It’s been known for decades that credit cards encourage spending. But why that happens still isn’t entirely clear. New research offers some fresh insight into the causes—and how consumers might be manipulated in an increasingly cashless society.

Research on credit-card spending has tended toward the explanation that delaying payment removes a barrier to purchases in shoppers’ minds. A study published in February in Scientific Reports found evidence of another kind of trigger. Differences it found in brain activity between shoppers planning to use a credit card and those planning to buy with cash indicate that buying on credit doesn’t just ease shoppers’ inhibitions, it actively encourages purchases, the researchers say.

The upshot: When people are shopping with credit cards and see a product they like, the neural network in the brain that produces a sensation of reward perks up, which seems to create a craving to spend, says Sachin Banker, assistant professor at the University of Utah, who worked on the study as a Ph.D. student at the MIT Sloan School of Management.

“You’re basically feeling more reward when you shop with credit cards,” he says. “We don’t see that with cash. It was actually a very stark difference.”

Researchers used a form of magnetic resonance imaging to measure the brain activity of the study subjects as they participated in a shopping exercise. Each participant was shown a total of 84 everyday products over the course of three sessions and was asked whether they would buy each product at the stated price. Half the products were offered for purchase by credit card and half for purchase with cash. None of the products cost more than $50.

The differences in the shoppers’ brain activity support the hypothesis that after repeated credit-card purchases over time the brain learns to anticipate the rewards of credit-card shopping, according to the report. And that suggests that consumers could be conditioned to spend through the use of various sensory rewards in new payment systems, Dr. Banker says. For instance, with digital payments the use of particular sounds or vibrations on your smartphone when you make certain purchases but not others could, over time, teach your brain to anticipate rewards for buying specific products while you’re shopping.

Dr. Banker adds that further research could be done to see if the study’s theories hold true at higher prices. It also could study consumers who tend to overuse or misuse credit cards, to understand further why they act as they do. This study focused on people who mostly paid on time and used credit cards appropriately. Understanding brain patterns for other types of consumers could help lead to solutions that attempt to pre-empt harmful spending behaviour, Dr. Banker says.

Wall Street’s hottest trade has gone ice cold.

For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.

The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.

Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.

“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.

Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.

Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.

Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.

“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.

Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.

“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”

Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.

Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”

The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.

The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.

These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.

Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.

The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.

Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.

Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.

And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.

“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”

How Credit Cards Affect Our Brains

Buying with plastic doesn’t just eliminate a barrier to buying. It actively encourages purchases.

Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.