There are only two infinite things I know of - the universe is one and human
stupidity the other. Actually, I am not so sure about the universe. Albert
Einstein.
Let us start with an exercise that could be either interesting or not. There
are a bunch of representative but fictitious headlines provided below; eight in
the first group and one after. Read odd-numbered headlines (1, 3, 5, 7) and
then the even-numbered ones (2, 4, 6, 8). Then mark yourself +1 for every
headline that is credible and -1 for every headline that isn't.
1. "Survey predicts global rebound"
2. "Prime Minister denies corruption"
3. "Equity strategists target S&P Index at 1500"
4. "CEO denies accounting fraud"
5. "Global business heads focus on emerging market growth strategies at Davos"
6. "Another banking crisis unlikely, say regulators"
7. "US home prices to rebound, say experts"
8. "FIFA doesn't show favoritism, says Blatter"
And the last
"Gold falls as stocks reach new high"
What's your score at this stage? Now, repeat the exercise with the following,
slightly amended headlines:
1. "Survey (of Wall Street economists) predicts global rebound"
2. "Prime Minister (of India) denies corruption"
3. "Equity strategists (working for major investment banks) target S&P
Index at 1500"
4. "CEO (being investigated) denies accounting fraud"
5. "Global business heads (who are paid in stock options) focus on emerging
market growth strategies at Davos"
6. "Another banking crisis unlikely, say regulators (who are paid to avoid
banking crises) "
7. "US home prices to rebound, say experts (employed by the construction
industry)"
8. "FIFA doesn't show favoritism, says Blatter (who is, well, Sepp)"
And then my favorite of all time:
"Gold falls as stocks reach new high (says the clueless journalist who neither
invests in gold nor stocks)"
Now, what's your score?
Despite being sure that our readers can already discern where this is all
going, I am still obliged to point out the obvious in the interests of not
being misquoted later on. The common thread of course is that the inclusion of
the material inside the parentheses helps to immediately provide a smirk to the
reader's face, while without the helpful material there is something "factual"
about the headlines.
This is why a number of people may have scored over four points in the first
part of the exercise (or worse, nine points - ie they find all the headlines
credible). The "correct" score, in my opinion is -9, ie that none of the
headlines are credible.
After all, what else would you expect economists working for Wall Street firms
that are currently very long inventory of risky assets, very short of capital
and very focused on creating a new bubble of any kind that could help to
underpin a rise in earnings in what could otherwise be a hopeless year; to
actually say if not that a "global rebound" is likely?
Imagine the plight of the brave economist who works for say Goldman Sachs, to
walk out there and tell the world that there are "significant chances of a
double dip recession". Whatever be the merits of that view, it is unlikely that
Goldman Sachs would then be able to flog off a minority stake in, say Facebook,
for the trifling valuation of US$50 billion.
For anyone to purchase these assets from Goldman Sachs and its ilk, a "mass
hysteria" of sorts has got to be in place that dictates a return to global
economic growth and all good things to everyone around. The very likely result
is that the poor economist would be sent to Siberia (or "asset management" as
it is known in investment banks) .
Never mind the actual economic facts; they aren't quite the point here.
When I did the above exercise with a random group of friends, the median score
was +1 in the first part without the parentheses. Reason - my friends seemed to
believe the odd-numbered headlines including the last bit about gold, but found
the even-numbered ones less credible.
This leads one to an unsettling conclusion - that while the wider populace may
have lost their trust in authority figures, they haven't quite translated that
into generic pessimism on investing. Think about that for a minute.
Cognitive bias therefore is skewed against authority figures and/or major
personalities such as Indian Prime Minister Manmohan Singh and FIFA president
Sepp Blatter; however it is much more forgiving of the motivations behind
nameless experts. In effect, people feel much more confident is saying
something on the lines of "FIFA are lying thieves" rather than something on the
lines of "the experts are wrong, yet again".
All of this is interesting, even if it is only tangentially related to the main
point about investing: it does imply though that the kind of political shifts
that were discussed in my last article (see
And they all fall down, Asia Times Online, January 20, 2011) may well
have wider and more disruptive effects on market sentiment going forward than
is currently being appreciated by the expert classes (if I may even call them
that).
There is the biggest cognitive bias of them all - namely that newspapers need
optimistic headlines to sell more papers and get more advertising budgets
allocated to them. That is also not frequently commented upon, but is very much
the elephant in the room when it comes to readers wanting to better understand
the process of writing headlines in the mainstream media.
Lemmings and ostriches
What I see out there in the world of investing is basically very difficult to
express as a metaphor. As individuals, a number of people seem to be in
outright denial of even the basis facts about the world economy (ostriches);
and yet they also have an urgent desire to be with the crowd (lemmings). This
does present a comical mind image of thousands of ostriches with their heads
stuck in the sand; and yet all moving in concert towards a cliff edge.
It's all very well to accuse people of not focusing on risks, but that doesn't
really help if I don't explain specifically what risks are not priced into the
markets today; so here goes:
1. Inflation the nasty: As the figures for the Bank of England
showed last week, as well as those in countries like China and India, there is
a nasty recurrence of inflation into global economies, ushered in by rising
food prices and commodities. This spells an end either to cheap money policies
of various central banks including the Federal Reserve and the European Central
Bank (that could stall global economic growth), or a complete decimation of
currency values (that could push up inflation further).
2. Disappointing earnings: While much column space has been
devoted to the strong earnings being reported by US companies for 2010, the
reports also ignore "one-off" conditions. For example, banks have seen interest
rates at close to zero and this has kept loan losses relatively low; hike the
rates and you have twin pressures on both margins and losses. Another example
is the lift to technology company earnings from the capital investments of
China et al last year, which is unlikely to continue as these countries
themselves confront inflation on an epic scale.
3. Continuing leverage: There is still too much debt out there.
Whether it is American individuals or European governments, the fact is that
based on any currently known trajectory of income expansion these debts can
never be repaid. This has a number of behavioral implications for the future,
not all of which are fully understood (or even partially expressed) by the
expert classes.
4. Political risk: Whether it is Iran (see
The value of a nuclear Iran, Asia Times Online, December 18, 2010),
Tunisia or Phoenix, the rise of extreme political risks cannot possibly have a
salutary effect on market developments. Just the other day, the political
crisis that has been simmering along in Ivory Coast erupted to kick cocoa and
coffee prices globally up when the recognized government of the country banned
exports in order to starve funds from the rebel militia. As I write this
article, Egypt is in turmoil and not to put too fine a point to it, a regime
change in that country has significant implications for the Middle East, Africa
and Europe.
5. Position risks: A careful review of positions being held by
various players in the financial markets - banks, insurance companies, central
banks, mutual funds, institutions, retail investors and others - all show that
the market is prone to wild corrections in the next few months. This is the
reason for gold prices to move sharply alongside changes to stock and bond
prices, for example (technical stuff that I wouldn't dare to go into here).
6. Peripheral risks: Whether it is smaller European countries or
smaller US states and municipalities, there is now a geometric increase in the
risks being posed for the finances of peripheral authorities. That has
significant implications for house prices in the US and Europe as it does for
the behavior for related risk assets (Mortgage backed securities, bank equity
and so on).
7. Demographic trends: In the middle of all the noise over the
past few months, has anyone even paid attention to the demographic trends in
Europe and the US? Somewhere along the line, we are going to notice that the
"right" kind of immigration has stopped or even reversed course, and that
"average" couples are no longer having babies at the "average" time as they
postpone parental responsibilities in an uncertain economic climate. This isn't
the sort of thing that can be reversed quickly - but by the evidence of what I
see the experts stating out there, the risk is barely acknowledged let alone
quantified.
I could go on, depending on just how depressed you wish to get. The point
though has perhaps been made that the headlines are simply a whole lot more
optimistic than ground realities would allow them to be. Please pay heed to
that.
Health warning: Nothing in
the above should be construed as investment
advice. Readers are encouraged not to pay heed to
the ramblings of a pseudonymous columnist writing
in an Internet newspaper but rather to get advice
from people they know and trust; or in the absence
of such people use their common
sense.
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