Before heading to the office in the morning, I like to take in the headlines with Bloomberg Surveillance whose anchors are kind of hilarious. A little macro and a laugh make for a great to start the day. Partially offsetting this, is the guests’ tendency to be cynical, which is especially noticeable lately as markets set new all-time highs. It’s great to have an array of perspectives, but at that hour, the negativity is like bitter coffee. Unfortunately, as Tom Gardner explains, this isn’t likely to change anytime soon:
Given the context, it makes sense that the pundits are eager to voice a contrarian opinion in front of a global audience. Why does this appeal to us so much? The negativity plays on our natural loss aversion, which is amplified in an uncertain environment. Bad news means run for the exits, while FOMO means ape in. Being early matters in both scenarios. These reactions are hard-wired into our brains and affect us in many ways. For example, here’s an article about how to use loss aversion in marketing to sell more.
Are we helpless to these emotions? Richard Thaler (a father of behavioral economics) thinks so, but also believes that we can design systems to help keep us in check. Humans have a penchant for being lazy, so, if you want good conduct, then make the optimal choice easiest to select. For retail investors, this means trying to take a hands-off approach and to minimize the impact of bias, Thaler recommends using target-date funds. Interestingly, his own asset management firm doesn’t offer any…
The Endowment Effect is another well-studied cognitive bias that makes people “more likely to retain an object they own than acquire that same object when they do not own it.” A favorite independent writer is Klement on Investing. He wrote about this recently and referenced a paper from the University of Alicante, which included results from an experiment where participants estimated returns of a random group of stocks after observing ten periods of their performance. Later, the contributors were either given three stocks or were asked to select their favorite few and once again predict the future returns. Below you can see the bias in action:
Once they had taken “ownership”, the participants suddenly believed the shares would go up with 10 percentage points of additional confidence. I’m not sure how you can control for this, but it’s an important bias to be aware of. There are some interesting considerations here in the context of zero-commission trading & other marketing tactics too…
All market participants have to contend with the endowment effect, fear & greed. Josh Brown wrote an interesting note about these primal emotions recently, but it had a twist. Beyond the simple concerns of losing money or not making enough, he emphasizes a nuance: “Why am I falling behind? Why is that [person] not?” @Downtown made specific reference to the divisive discourse on social media where, after logging in to Twitter for the first time in a while, he saw hashtags like #HFSP (Have Fun Staying Poor). On Reddit he notes that the “emphasis is on those people losing as opposed to our side winning.” Is this an example of the endowment effect gone wild? Are we living in an echo chamber of envy & FOMO?
The note above ends with a reference to Dante’s “The Divine Comedy” when the protagonist and his guide arrive at Fourth Circle of Hell, which is associated with greed. This past September marked the 700th year since the renaissance figure passed away. There are Halloween-related themes in his most famous work, so many tributes were held recently. If you’re looking for something random to dig into over the weekend, then consider pondering over these ideas.
Almost ironically, Dante’s Inferno (Hell) is often cited as people’s favorite section in the masterpiece. It’s almost as if people prefer to be among the heathens than in Paradiso, where there is no conflict. Many have written about the polarizing/amplifying nature of social media. I recommend this conversation between Jim O’Shaughnessy and Tim Urban. Here, the former provides a positive perspective:
Tim Urban discusses a more dystopian potential:
If modern media is an echo chamber, then being mindful of who’s in yours is a good strategy. There are so many writers and intellectuals venturing out on their own via Substack & other mediums – somehow all for free! One of my favorites is Ash Thaker’s Weekend Reads, which he calls a “collection of cross-disciplinary thoughts, perspectives, and opinions.” He recently highlighted this article from The Guardian about how municipalities in Germany are building playgrounds with equipment that is intentionally risky
This seems contrarian in a culture of helicopter parenting & participation ribbons. “Children may feel insecure when they first climb in our nets, but this is actually what makes the structures even safer. Because when you are feeling insecure, you are also extra careful.” If some intrepid child gets carried away & hurts themselves then that experience will stay with them and shape their future behavior.
This line of discussion is often used when discussing Robin Hood & the gamification of investing. It’s ok if young investors are taking excessive risks with YOLO bets because this will form the basis of their investing education. Richard Thaler argues that retail investors would be well-served not to look at their accounts, but HOOD’s user experience is designed to keep your eyes glued to it. Has protecting children from the pain of loss bred a generation of risk incompetence?
This week, we welcomed back Phase I of the return to work and it’s been awesome. The multitude of conversations around the desk is a great mechanism for getting a market pulse. I’ve noticed that the meme stocks continue to amaze and confuse. However, the folks in the office aren’t wishing for the demise of those profiting off these unconventional strategies. Instead, they seem impressed with the skill & resolve these young traders demonstrate. It’s a bit like they’re watching kids climb a dangerous structure at the park. The higher the young’uns move brings out an almost parental instinct to caution them. This comes from remembering their own experiences.
As Stan Druckenmiller noted during his famous speech at the Lost Tree Club, what we’re observing is typical of market cycles. At the age of 23, he was promoted to Head of Research and paraphrases his boss at the time:
Is there a difference between Druckenmiller’s boss’ scars and “risk competence”? Someone who has lost will inevitably avoid doing so in the future. Therefore, it seems natural for seasoned traders to shy away from what a newcomer identifies to be a big opportunity. Imagine you were freshly minted in the markets and came across the following advice from one of history’s best investors:
Fear & greed are at play here for sure. We notice divisiveness & envy in the media, but that’s not the whole story. Retail’s seemingly crazy antics actually make a lot of sense in the Druckenmiller context. Focusing on that and admitting our cognitive biases seems to be a constructive way of looking at the situation. Depending on who’s in your echo chamber, you might see a different mix along the spectrum of perspectives above. However, you’re in control & have the ability to curate. It’s like Nas said in I Can: “Watch the company you keep and the crowd you bring”
Have a great weekend!