[Originally published on Quartz, March 18, 2018]
In 2008, the psychiatrist Stephen Greenspan published The Annals of Gullibility, a summary of his decades of research into how to avoid being gullible. Two days later, he discovered his financial advisor Bernie Madoff was a fraud, who had caused Greenspan to lose a third of his retirement savings.
This anecdote, from a presentation by University of Michigan social psychologist David Dunning, due to be presented at the 20th Sydney Symposium of Social Psychology in Visegrád, Hungary in July, highlights an unfortunate but inescapable truth: We are always most gullible to ourselves. As Dunning explains it, Greenspan – despite being the expert on gullibility – fell prey to Madoff’s fraudulent behavior not simply because Madoff was some master manipulator, but because Greenspan had, essentially, tricked himself. Continue reading
Stocks rose last week. Continuing to elevate following April 2nd’s double tap of the February 8th lows at which the S&P 500 hit 2,581.
Perhaps last week’s gains were due to positive anticipation of earnings season. Which began Friday. And featured higher Q1 earnings and profits from J.P. Morgan, Wells Fargo and PNC Financial Services. These and other bank stocks have outperformed the broader market since the 2016 election. Although last week’s solid reports failed to send them higher. As all three sold off.
It’s possible that investors were concerned about the impact of rising interest rates on future earnings. Or perhaps the market was held in check as investors fretted over possible airstrikes in Syria (more below). Or was it the possible trade war with China?
In today’s post, I’ll talk about passive indexing. The investor class has long fancied its decision-making skills. Its ability to perceive and manage risk. On decisions bolstered by probability and statistics. Rather than the whim of cognitive psychology.
Of course, the “overconfidence effect” has long plagued investors. This simple bias dictates that a person’s subjective confidence in his own judgements is reliably greater than the objective accuracy of such judgements. Especially when confidence runs high. As overconfidence is a perfect example of the miscalibration of subjective probabilities.
Investors — like all humans — base many of their decisions not upon the subjective analysis of statistics and probability, but on simple “rules of thumb.” Cognitive shortcuts, known as “heuristics” that simplify the decision-making process. And leave us feeling good in the wake of those decisions.
Beware the Ides of March.
The VIX volatility index (AKA the Fear Index) began last week at 16.59. By Friday, it had careened to a lofty 24.02. Jumping nearly 39 percent during the week. The S&P 500 declined 6 percent. The technology sector alone slid 7.9 percent. And Friday’s volatility alone brought the S&P 500 lower by 2.1 percent.
As stated in previous missives, we believed equity indices might revisit their February lows. Even break through them. Registering as customary market behavior now that volatility has returned to the fore. Yet, we don’t believe the market has finished its bullish ways. Evidenced by this week’s Monday bounce after having double tapped the February lows. It is obvious, however, that stocks will no longer be providing such returns gratis. As they did last year. When we were given a risk-free taste of the good life. Enough to get us hooked. Now the market will make us pay for such munificence. By dialing up volatility. And forcing investors to sweat it out.
We are 21 percent of the way through 2018. With the S&P 500 down 2.75 percent year to date. If the market year were a baseball game, we’d be in the bottom of the second inning. With the bears holding a one-run lead over the bulls. Zero outs. Bases loaded. But the advantage still resides with the big bats in the bull’s dugout. Who, since 2009, have managed to rally whenever they’ve been pressed. We believe, at least this time, they will do so again.
Why? Continue reading
Last week saw two Gordian Knots breach the surface of our imaginations. One economic. One geopolitical.
A legend associated with Alexander the Great, the Gordian Knot is often used as a metaphor for an intractable problem resolved by finding a loophole or through some creative thinking. Enabling one to “cut the Gordian Knot,” and quickly solve what had recently been a difficult dilemma.
For investors and geopolitical observers, those Gordian Knots came in the divisive forms of:
1. North Korea’s nuclear weapons program.
2. The U.S. trade deficit, and the Trump administration decision to enact steel tariffs on imports.
Stocks careened higher last week. Given excellent corporate earnings and the bounce off the correction lows, the action was as contrived as tears during an Academy Awards acceptance speech. Although people still watch the stock market.
From a valuation perspective, stocks offer bargains. Though many so-called investors do not currently seek them. Intimidated, as they were, by February’s correction. And as we know, if you lack the Moxy to be greedy when others are fearful? You can hardly call yourself an investor.
Last month, stocks fell 10 percent for the first time in years. All things being equal, that made equities 10 percent cheaper than they were on January 26.
Years ago, I asked my sons if they understood why we celebrate the Fourth of July. The nine-year old had a pretty good idea. The five-year old hadn’t a clue. Which didn’t prevent either from soaking the day for all its worth.
We were 240 years removed from the nation’s founding. This great, big, free, independent, stubborn, tough and energetic land.
There was a time in which we celebrated rugged individualism. Feted those capable of waking early. Striking out to take a calibrated risk. Success. Failure. Either way, of their own accord. Continue reading
Where humans and the act of investing collide, we’re often driven more by cognitive biases than by real knowledge or practical experience. Repeatedly making the same mental miscalculations. Swaying to and fro between fear and greed. With little to no attention paid to timeless, effective principles.
According to Wikipedia, cognitive biases represent systematic patterns of deviation from norm or rationality in judgement. Often studied for their impact on psychology and behavioral economics. The consequence of information-processing rules, or mental shortcuts called heuristics, the brain uses these biases to make rapid decisions or judgments. Many, having evolved over millions of years, can be directly tied to our survival instincts.