In my research on cognitive bias, heuristic and brain fallacies I have been constructing a manual that I hope to eventually publish. Here is a brief except of recent material…
Thank the Critic
And now that you don’t have to be perfect, you can be good. John Steinbeck
The trouble with most of us is that we’d rather be ruined by praise than saved by criticism. Norman Vincent Peale
When someone offers constructive criticism, questions your premise or flat out suggests that you are outside of proper balance in your thinking, (i.e. wrong, bone headed or full of shit) say thank you. Take it in. Mull it over. Some of the best perspectives can come from comments that may initially sound insulting.
Think of yourself as a restaurant. If a patron comes in, has a bad meal, says nothing and never comes back you would never know what had happened. If they complain to management, they are doing the place a favor. Offering feedback that may allow for correction and improvement.
Our instinct is to defend and puff out our feelings of ego and intellectual prowess. Bias, heuristic and all the foibles create a much lower reality of self than what we would like to believe. In the pursuit of understanding brain fallacies this awareness gives us an edge of humility. The advantage of a humble detached approach to who we are and what we aim to achieve.
Criticism is thus much more valuable than praise. Receive it with gratitude and use it for positive development…today.
The above is work that I am doing to share lessons that I have learned and now I can share. Please let me know what you think…and now Q1 2018 comments…
The S&P fell 1.2% for the quarter. See https://www.bloomberg.com/markets
for details.
The dark fallacy of declinism
Definition: People recall the past as better than it was, and often anticipate the future to be worse than it will plausibly be.
By many measures we are living in the most peaceful and prosperous time in history. Some studies have indicated that as little as six percent of Americans see the world as “getting better”.
https://www.acsh.org/news/2016/07/03/only-6-of-americans-think-world-is-getting-better
Max Roser is an economist at University of Oxford. He has produced interesting data on this subject.
It brings to light how our mind has a skewed view of trials of the past and how the simple concept of memory bias stunts our ability to form an informed vision of the past. I have found wonderful material on this (excerpt below) from Matt Ridley’s wonderful book, “The Rational Optimist: How Prosperity Evolves”
This should not need saying, but it does. There are people today who think life was better in the past. They argue that there was not only a simplicity, tranquillity, sociability and spirituality about life in the distant past that has been lost, but a virtue too. This rose-tinted nostalgia, please note, is generally confined to the wealthy. It is easier to wax elegiac for the life of a peasant when you do not have to use a long-drop toilet. Imagine that it is 1800, somewhere in Western Europe or eastern North America. The family is gathering around the hearth in the simple timber-framed house. Father reads aloud from the Bible while mother prepares to dish out a stew of beef and onions. The baby boy is being comforted by one of his sisters and the eldest lad is pouring water from a pitcher into the earthenware mugs on the table. His elder sister is feeding the horse in the stable. Outside there is no noise of traffic, there are no drug dealers and neither dioxins nor radioactive fall-out have been found in the cow’s milk. All is tranquil; a bird sings outside the window.
Oh please! Though this is one of the better-off families in the village, father’s Scripture reading is interrupted by a bronchitic cough that presages the pneumonia that will kill him at 53 – not helped by the wood smoke of the fire. (He is lucky: life expectancy even in England was less than 40 in 1800.) The baby will die of the smallpox that is now causing him to cry; his sister will soon be the chattel of a drunken husband. The water the son is pouring tastes of the cows that drink from the brook. Toothache tortures the mother. The neighbour’s lodger is getting the other girl pregnant in the hayshed even now and her child will be sent to an orphanage. The stew is grey and gristly yet meat is a rare change from gruel; there is no fruit or salad at this season. It is eaten with a wooden spoon from a wooden bowl. Candles cost too much, so firelight is all there is to see by. Nobody in the family has ever seen a play, painted a picture or heard a piano. School is a few years of dull Latin taught by a bigoted martinet at the vicarage. Father visited the city once, but the travel cost him a week’s wages and the others have never travelled more than fifteen miles from home. Each daughter owns two wool dresses, two linen shirts and one pair of shoes. Father’s jacket cost him a month’s wages but is now infested with lice. The children sleep two to a bed on straw mattresses on the floor. As for the bird outside the window, tomorrow it will be trapped and eaten by the boy.
Ridley, Matt (2010-06-10). The Rational Optimist: How Prosperity Evolves (P.S.) (Kindle Location 230). HarperCollins. Kindle Edition.
Declinism has entered the political consciousness with the notion that we can somehow reclaim the glory of past United States manufacturing dominance. The populist slogan that is now actually being floated is that of tariffs and threats of “trade wars”. Markets have been quick to react negatively to these announcements from the White House.
The negativity is based on the long held American belief that free markets critical to the dynamic nature of the US economy. Tariff actions are sought continuously by a range of industries that seek relief from global competition. Many of these industries have not innovated. There are also structural disadvantages of high environmental, labor and safety standards that have rendered large areas of US manufacturing uncompetitive with China which does not have those levels of regulation. This issue is daunting as once the global trade markets are disrupted, the scenarios are impossible to predict, but likely adverse for inflation, growth and global co-operation.
Ironically, a great era of deregulation is occurring with regard to domestic regulatory policy and yet all modes of “control” for global trade are under serious consideration. Hopefully it will be explained to populists that the history of protectionism is littered with adverse outcomes, shortages, inflation and other stark economic consequences.
The cognitive deck is stacked with bias that leads us to these pessimistic conclusions. Recency bias, survivorship errors and the structural flaws of the way human memory works leads us to these misunderstandings of the past. Hopefully cooler heads with knowledge of economic history will prevail.
Awareness of a bias towards declinism is a critical trait of successful investors. The success happens when calm and indifference is applied during down markets. When things are good, it’s easy. When the downswing arrives, that is where the courageous, long-term minded investors with knowledge of these brain fallacies have an edge.
The scenario of a dark future is that of the threat of technology, robotics and artificial intelligence to destroy jobs, occupations and entire professions. This is not exactly a new argument. It may actually have begun around 1779 with the story of Ned Ludd, the apprentice who was said to have destroyed two machines in protest of the threat of automation stealing his job and started the original “techno protest”. This is the genesis of the term “Luddites” that is often used to describe those who fight the threat of new technology and what it can do to workers.
The industrial age has shown that innovation leads to more new opportunities as it destroys the old. Barrons Magazine cover from 3-9-18 carried the title, “The Great Labor Crunch”. https://www.barrons.com/articles/the-great-labor-crunch-1520655014
Here we can ponder the projection of a shortage of over eight million workers over the next ten years. This may be driven by demographic shifts in the ageing of our population, declining birth rate and recent efforts to curtail immigration. The challenge is likely to be too few workers, not a dearth of jobs!
The market is facing significant headwinds. It was not that long ago that I was writing about ultra-low interest rates and the historic monetary expansion known as QE I, II, III. The reverse of these two megatrends are likely to challenge the markets.
The markets have emerged from an extended state of persistent gains to a mode of rising volatility. There are three big trends driving this edgy behavior.
- Rising Interest Rates
The shift from ultra-low borrowing costs to a rising rate environment will ultimately slow the economy and potential growth of earnings for investors. The Financial Crisis drove central banks into uncharted waters in the efforts to nurse wounded economies around the world. The US emerged first with Europe and Japan lagging and still under certain crisis measures that are proving difficult to unwind.
This trend of rising rates will have growing potential to place a drag on economic activity as it also diverts capital from equities to fixed income as lending for more normalized rates becomes more attractive. Borrowing costs are on the rise which is ultimately a deterrent to further economic expansion.
- Escalating US government debt
The tax cut of 2017 was legislated under fierce political pressure to “get something done”. The notion of less government is a debate that seems to stop at the part where pro tax cut politicians explain that cutting programs is a critical part of the reduction of federal tax revenue.
Cutting taxes is the easy part. Taking away programs seems much more difficult and never seems to arrive. The result is rapidly growing federal debt. Fundamentally, this means that the US Treasury is issuing growing quantities of bonds on an ongoing basis. This is compounding the rise in interest rates and creating rising anxiety in the global bond markets. The tax cut runs a great risk of actually hurting the economy.
- Unpredictable leadership in the White House
Numerous policies are changing at one time. A partial listing would include:
Tax reductions that include broad changes in the way money flows based on new incentives
Messages of trade protectionism devolving into threat announcements that are then walked back as negotiating tactics
Wide ranging regulatory changes being implemented rapidly, ie net neutrality, offshore drilling, emissions standards, reversal of efficiency standards and subsidies for clean energy
Immigration policy that is also impossible to predict and seems to be bogged down by numerous legal challenges
Foreign policy challenges that include Ukraine, Brexit, North Korea, Syria, Russia and Iranian nuclear agreement not to mention significant shift in relations with Saudi Arabia and Qatar
The monetary and interest rate challenges are not unique in that the typical economic cycle stages reach rapid expansion where the risk of inflation drives central banks to raise interest rates. This does not always lead to recession. The ultra-low rates of the last ten years have led to an incredible recovery. The unwind process of these ultra-low rates and it’s consequences are impossible to predict. The political risk is a pure wild card as this type of presidency has little modern precedent.
As time passes, the “Financial Crisis” of 2007-09 has many lessons to teach. Equity investors recovered in a much different and generally more rapid pace than the residential real estate markets in the US. One reason for this difference is likely due to the fact that real estate is platformed on leverage / mortgages. During the downturn, residential real estate was bloated with individuals that had little knowledge of what damage the borrowing could do in a significant downturn.
“Wall Street” is generally perceived as the primary villain of ten years ago for many good reasons. Let us also remember that many individuals were mortgaging drastically beyond their ability to pay. Individuals were the buyers of the evil Wall Street loan products. The markets then ebbed and those who were over-levered were “upside-down”. Many of these casualties of the crisis were manipulated into bad financial arrangements. Some may have even been coerced. Many people simply made flawed decisions. Stories of everyday people borrowing against their home above what was prudent never resonated. That line just doesn’t have the pizazz that the “big banks” and “Lehman Brothers” as evil doers that created a compelling media narrative.
A significant opportunity in economic education was missed as there is very little material broadcast to masses in this regard. Maybe low money down loans should come with a warning label (with a skull and crossbones?) instead of reams of fine print.
The point that has rarely been made, is that many “victims” of the financial crisis did it to themselves. When I hear the utterance “I lost a lot of money in the market during the crisis” I wonder why. Was the investor forced to sell or was it panic? Here we see little recognition of the glaring deficit between rational behavior and poor economic thinking of the masses. Was there any way to stay patient as markets moved lower week after week? It was really tough, but after a V shaped bottom equity values had greatly improved after about 30 months. That should have been doable for many long-term investors. Rational behavior is the most difficult to obtain when it is needed most.
Two big structural impediments for improvement in these types of difficult low-frequency decisions are defined as:
Fundamental attribution error: When we are trying to understand and explain what happens in social settings, we tend to view behavior of others as a paramount factor. We then often explain behavior in terms of internal disposition, such as personality traits, abilities, motives, etc. as opposed to external situational factors. This can be due to our focus on the person more than their situation, about which we may know very little. We also know little about how they are interpreting the situation. When we are playing the role of observer, which is largely when we look at others, we make this fundamental attribution error. When we are thinking about ourselves, however, we will tend to make situational attributions. In short, I got unlucky, but you made mistakes.
Self-serving bias: is any cognitive or perceptual process that is distorted by the need to preserve and enhance self-esteem, or the tendency to perceive oneself in an overly favorable manner.
“Court had learned long ago that in any gunfight, one does not rise to the occasion. Instead, one defaults to the level of ability he has mastered.” Mark Greaney, Black Blast pg 14 This is a quote from the Grey Man series of novels that has so much to teach us. Rising to the occasion is a myth. Therefore we must train and practice with all of our ability in daily life and as investors. When the tough times arrive, that will be the time to summon our fundamental abilities as that is likely all there is, not some heroic level of calm.
As long-term investors that hold broadly diversified portfolios without leverage, we should be able to stay patient in the next downturn. It will be gut wrenching to watch values decline, but keeping a rational and patient outlook may create the best future.
Bloomberg recently pointed out that “since 2009 the average correction in US stocks has lasted 200 days and lopped 14 percent from the S&P 500.” https://www.bloomberg.com/news/articles/2018-03-27/200-days-of-pain-is-the-lesson-from-ugly-stock-corrections-past
Recency bias is one factor that limits understanding the fact that downswings are common and a normal part of the equity investing process as prices swing based on infinite factors that are pointless to try to predict. 200 day periods of negativity are difficult but we must remain confident with the knowledge that this is normal and to be expected.