Monday, December 12, 2011

Anger in the Markets

If it seems likes investors are little more angry these days, it's not just your imagination. MarketPsychData has the stats to prove it.

MarketPsych's Frank Murtha caught up recently with Dow Jones and offered some commentary on the subject and some suggestions for financial advisors in dealing with it.

HERE is a link to a brief video.

Happy Investing.

And hey... let's be careful out there.

Dr. Frankenstocks

Frank Murtha, Ph.D.
Co-founder of MarketPsych

Friday, December 02, 2011

Anger about the Federal Reserve is Rising

Based on our analysis of news chatter, we're seeing a disturbing (in my opinion) trend - increasing anger expressed in references to the Fed in news media.

The below chart demonstrates Anger mentioned in all references to the Fed since 1985.  You can see both the declining anger as the U.S. came out of the Volcker-induced recession of the early 1980s and the recent rise in anger associated with economic stagnation and political polarization.  

The reason this anger is significant is because high levels of anger can drive drastic and often self-defeating behavior.  This is true for individuals (e.g., suicide bombers) and also for crowds (e.g., the U.S. Congress considering abolishing the political independence of the Fed).

More to come about such social and emotional trends...
Richard L. Peterson, M.D.

Wednesday, November 09, 2011

Dead Turkeys: In the Short Term the Market is Dumb

My friend, Ian, once told me a story about domesticated turkeys. You know, the tasty kind. One night, during a loud rain storm the flock became unnerved. The crashing thunder frightened them. The driving rain disoriented them. The terrified poultry ran for cover. Panicked turkey after panicked turkey piled into a shed. Eventually so many crammed themselves in there, the whole flock suffocated.

When the farmer came out the next day he found an entire shed packed with dead turkeys.

(Note: I like to think there was at least one, tragic, non-conformist turkey who upon entering the shed and getting squooshed, began to question the wisdom and tried in vain to rally his turkey brethren., "Stop! Go back! For the love of God, man! This is madness!" In the movie version, "Turkeytanic!", I would give this part to Leonardo DiCaprio.)

If you've read this blog, you know that one of my favorite pastimes is watching the Yahoo Finance headlines change over the course of the day. (It's fun. Seriously. Try it.)

Yesterday, I watched the news that Italian Premier, Silvio Burlasconi would be resigning hit the Market. It caused a 100 point upturn and the media credited the impending change as a catalyst for positive movement.

Today I woke up and saw the following, "Uncertainty over Italy's Future Slams Markets". Money quote:

'"The positive impact of Berlusconi's promised resignation is being diluted by a lack of clarity on where we go from there," said Adam Cole, an analyst at RBC Capital Markets.'

Let me sum this up; The reaction boiled down to, "Hooray! he's gone!" to "Oh, sh*t! He's gone!" overnight.

Which brings me to my point; when we get stuck in a short-term focus - especially when we are hit with unexpected news - the Market is full of dead turkeys.

Our award-winning book, MarketPsych, is dedicated to helping professionals and laypeople alike overcome such pitfalls. And we frequently give talks and workshops on the subject (for more info contact us at [email protected]).

And my partner, Dr. Richard Peterson's amazing sentiment data over at can give you the tools to not merely avoid mistakes, but help you profit from the folly of others.
We invite you to check out both.

Thanksgiving is coming, people. Don't be a dead turkey.

Happy investing, everyone.
And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, Ph.D.

Co-founder of MarketPsych

Saturday, November 05, 2011

Bubble-ometer at WSJ

Our Bubble-ometer received coverage in Jason's Zweig's column in today's WSJ.  The Bubble-ometer is hosted on, where we have several free tools for investors based on social media sentiment.

The Bubble-ometer is simple in concept but has been predictive since it was developed as seen in these past Bubble-ometer posts:  calling the late 2010 rally and identifying a Bubble top in June 2011.

We're working on a more complex version of the metric as can be seen in the second blog link above, which we're calling the "market risk index."   We're also comparing sectors to identify arbitrage opportunties.  Please sign up for our free monthly newsletter, and we'll keep you posted about these developments.

Happy Investing!

Wednesday, October 19, 2011

Investor Personality Test at WSJ

Hello, investors.

Thanks to a recent mention on the Wall Street Journal site by Jason Zwieg here (thanks much, by the way) we had a record number of people taking the test. So many infact, that it temporarily crashed our servers. We apologize to anyone who did not get their test results. The test should be up and running now. Thanks to all those who took an interest and completed the assessment. We hope you'll find your results interesting and useful. And please don't hesitate to reach out with any questions you may have.

Happy Investing.

And hey... let's be careful out there.

-Dr. Frankenstocks.

Frank Murtha, Ph.D
Co-founder of MarketPsych

Friday, October 14, 2011

The Fear Index

The MarketPsych Fear Index has remained high despite the recent rally in the S&P 500.  This is actually a very bullish sign for the next couple of months.

Investors "anterior insulas" are still "hot" from the unexpected and relatively traumatic selloffs of August, and as a result, most of those with a hair-trigger panic-sell reflex already exercised their right to sell at the bottom.

You can see the cumulative mutual fund outflows inspired by this fear in the following chart:
While uncertainty and volatility is virtually guaranteed for the next 12 months (pending election, further defaults in Europe, Iranian belligerence, etc...), we're likely to see an equity rally through year-end.

Happy Investing!

Friday, September 09, 2011

The Psychology of a Debt Spiral (and Positioning for The Next Stage)

“All economic movements, by their very nature, are motivated by crowd psychology.”  
~ Bernard Baruch
Bernard Baruch opposed the reparations terms of the Treaty of Versailles, knowing them to be impossible for Germany to fulfill following the destruction of WWI.  I wonder how Baruch would handicap recent events, as German taxpayers summon the will to bail out the near-defaulting states of Europe's periphery (or rather let those countries default and then bail out their own banks directly).

We're in psychological terrain - confusion, declining confidence, political gridlock - that sets us up for a real economic danger not only in Europe, but also in the U.S. - a developed-world debt spiral.  A debt spiral is a self-fulfilling prophecy of decreasing confidence leading to risk aversion, economic stagnation, and an ultimate debt default and/or collapse in the banking system.  In the psychological literature there are a few insights to inform us about what may come next and what we can do to prepare.

Please CLICK HERE to join us for our Free Webinar on "The Psychology of a Debt Spiral (and Positioning for the Next Stage)" on Monday, September 19 at 4:15pm EDT.  

In this 20 minute webinar we will touch on the psychological side of issues driving the current crisis:
1.  What are the stages of a debt spiral?
2.  What is likely to happen to European sovereign (PIIGS) debt?
3.  Why financial stress goes on until "capitulation" occurs - even after fundamental uncertainties have been resolved.
4.  Solving a debt spiral:  The role of leadership, and how politicians can use psychological insights to improve confidence and the economy.
5.  The best investment positioning in this climate.

We're facing more than a routine correction in the markets.  Despite excellent corporate earnings and 60-year lows in interest rates, equities have sold off sharply and are poised to decline further.  The reasons for this trap are fundamental to a tipping point, and past that point psychological drivers - such as loss of confidence - take over.  

This loss of confidence is reflected in the angry public mood in the U.S. and Europe.  When angry, people blame  – some blame high frequency traders, while others blame the Fed, politicians, or even successful minorities or professionals (e.g., "bankers").

Chart of online investor anger (derived from social media linguistic analysis at

As investor anger grows, risk-taking and spending decreases.  In fact, simply being exposed to another’s anger reduces spending and financial risk-taking (Winkielman et al., 2005Trujillo et al., 2006).  As a result, anger depresses a consumer economy and that country’s financial markets.

One result of anger is mistrust.  And if investors no longer trust the goverment to turn around the economy, then who can they trust?  This is the nagging doubt that ultimately collapses confidence and fuels a debt death spiral such as the one we are at the cusp of. 

In a debt spiral, increasing investor fear leads to decreased spending and investment, and thus a contraction in economic activity.  Due to the economic contraction, government receives less revenue and is inclined to cut back spending further.  Ultimately debts cannot be paid, credit collapses, and an economic depression ensues.

When confidence collapses politicians are forced to reveal, and voters are forced to confront, the truth about our current economic malaise.  The truth contains unpleasant information:  demographic time-bomb, underfunded pensions, public and private over-indebtedness, entitlement costs rising faster than economic growth, to name a few.

Naturally government officials (especially elected ones) are reluctant to speak honestly about the magnitude of the liabilities being faced nor to call for sacrifices.  This reluctance to speak openly is defended as not wanting to stoke more fear that could accelerate the debt spiral.  What we hear from politicians is characteristically benign – but does not address policies or procedures to deal with a debt default (which further weighs on confidence).

Consider the estimated more than $100 trillion in future U.S. liabilities in the context of the current U.S. debt of over 80% of GDP.  Most developed countries cannot pay back the money they owe without major structural changes (immigration, high inflation, currency devaluation), and eventually many will either stagnate or default.  This has already happened in Greece, and may happen sooner rather than later in other European states.  The default contagion is likely to spread to the U.K. and the U.S. within a couple years.

Austerity will accelerate the “day of reckoning” since we already appear beyond the tipping point.  This is what accounts for the market’s declines following the debt ceiling agreement.  Fiscal stimulus is a "Hail Mary" - it will delay the day of reckoning and will stealth-tax everyone (except gold and some property owners) through inflation.    However, if the stimulus is spent on truly productivity-enhancing projects (broadband internet access, high-speed rail, electric car infrastructure, an energy-independence “Manhattan Project,” breakthrough applied basic science research), then it has a long-shot of succeeding.

To restore investor confidence, trust in leadership must be restored.  Honesty and forthrightness from leadership about our debts, with credible plans to address them, are necessary.  There are lessons from the psychology of addiction that will indicate when the current crisis has finally run its course.  The process of the economy and the markets hitting bottom is parallel to the idea of an addict hitting bottom.  You can recognize “hitting bottom” when you see acceptance of the dire situation from political leaders, hear honest talk about mistakes made, see proposals of fundamental structural and policy changes to address those mistakes, and hear the “we’re all in it together” ethos expressed with sacrifices expected from all economic classes.  In essence, when you see leadership with credible plans. 

A long-term question is, will politicians be able to stand together when economic confidence collapses, or will opportunistic blaming continue?  

If European voters express support for closer political union – federalism – in Europe, then the fundamental Euro crisis may gradually be resolved.  But that is unlikely based on the results of the recent election in the German state of Mecklenburg-Vorpommern.  More likely Europe and the Euro will stumble along with more and bigger band-aids.  As anger and frustration rises, political positions polarize and the choices become, by necessity, more extreme and unity less likely.  Democratic voters are easily swayed by mis-information that resonates with their emotional states.  So without steps made towards federalism in Europe, the Eurozone will continue to suffer, and some members may leave (if that were possible).

If the crisis leads to a real collapse before the U.S. election of 2012, then look for coherent and forceful leadership before stepping into the equity markets.  Although a big panic that creates values before then is also a good short term opportunity.   Note the image to the left  showing the collapse stage of the Nasdaq bubble - there were a series of short-term panics before the actual bottom was put in.

In particular, look for honesty about past mistakes, significant policy changes to prevent those from happening in the future, and the sharing of fiscal pain across classes.  Also positive would be a stimulus that actually focused on productive investments, not just pork or taxpayer "relief".

The debt spiral and collapse of confidence are unfolding now, and equity and bond markets are likely to be suffering until mid-October.  Consider gold and cash as safe havens (gold can still run dramatically before it peaks).  There is no reason to “buy the dip” at these levels.  There may be more dipping to come.

We're happy to say that our big (and publicized) macro calls, based on sentiment analysis, have been correct in the past 12 months:  
1.  We called the market rally from September 2010 through April 2011.  
2.  We identified an equity bubble publicly in June 2011 and cited the risk to investors.
3.  Dr. Murtha was on NBR on August 2nd explaining that a major correction is due (the day before the first crack in the markets).  
4.  We called a bounce "Turnaround Tuesday" off the Downgrade lows, to be followed by continued selling.
5.  We even threw in a few one week buys during the savagery.  BAC turned out very well, but HPQ lagged the market a bit.

We look forward to discussing these issues further at the webinar!

Happy Investing,

Sunday, August 28, 2011

Buy on Hewlett-Packard (HPQ) for Monday

HPQ heads-up:  Our media analysis is showing a recent uptick in bullish forecasts on HPQ stock (following on a series of very negative comments after several unpleasant surprises and a 20% stock drop following recent earnings conference call).  Such patterns generally lead to stock outperformance over the subsequent week.

See HPQ sentiment graphs here at marketpsychdata for more information.

Happy Investing!

Wednesday, August 24, 2011

Buying Bank of America During a Panic

We don't usually (ever?) publicize trading signals AFTER they were made good, but I found this one interesting:
>> 20110824,BAC,B,7940,6.3,50000,1,63846,1327214649.6,3,20110829,smb_t3_v1,S3.hvix.Reboundnr1.hi.Volfd3.hi.Selloffnd3.hi.PR2.lo

What that code represents is one of our quant sentiment-based trading signals telling us to buy BAC (Bank of America) and hold for a week.  The stock is currently up 9.76% today.

Yesterday we noticed our sentiment cluster showing GDX (Gold miners) as overbought and KBE (Banks) as oversold.   Both of these have mean reverted.  The current environment is excellent for mean-reversion based strategies.

In September we're launching a new newsletter in which we will be distributing our trading signals before the market open.

Happy Investing!

Monday, August 22, 2011

Holster that pistol - and load the Howitzer

The harder the conflict, the more glorious the triumph (quote by Thomas Paine)

After the roller coaster rides of the last couple of weeks in the markets, many of us in the financial advisory business walk in to the office with knots beginning to form in our stomachs - and out at the end of the day looking for the closest martini bar. Our routine consulting methods seem ill equipped to address (not to mention resolve) the angst we encounter in the faces and voices of our clients.

For our advisor readers, the MarketPsych Insights team assembled the following list of steps we think are a handy reminder of time tested methods that are usually helpful.

1. Start with EMPATHY by exercising true listening skills and gently probing for emotional (and perhaps thoughtful) reactions to market gyrations, we serve a valuable role as sounding boards to relieve client tension. The most important aspect of this step is to shut up and let the client talk. Think of yourself as a steam valve. Every time you ask a question, or state an opinion, you are preventing high pressure steam from being released. Let the client unload; you may get new and valuable insights into their fears.

2. Be prepared to help them EVALUATE PERSONAL IMPACT of any changes in their wealth levels. Not only is this helpful in moving the discussion into more deliberative (i.e., less emotional) territory, but it also helps to extend the investment time horizon beyond short term whacks into longer term plans. In all of my recent client meetings, we review their financial security analyses to clarify what (if any) implications result from short term losses in value. People are usually better off than they feel.

3. Remind them that huge market volatility always brings OPPORTUNITIES. The key idea is to provide an inventory of solutions (investment or otherwise) that will add value over their investment horizon; if they are prudent enough to make decisive action now. Making decisions in tough times also provides clients with a sense that they have at least some control over their destiny, which is always a good thing.

4. Discuss process and methods to institute DOWNSIDE PROTECTION. You might institute something a simple as an agreed set of automatic triggers for communication or portfolio actions. These may include only communications, or perhaps move to more complex venues such as put options, or other portfolio protection measures. You may also explore identifying shifts in asset mix to more undervalued yield oriented strategies as well as the consequences of doing so for longer term planning. Again these measures provide the client with a broader set of tools to manage their emotional fears and feel a greater degree of control.

It is in times like these that we either strengthen our relationships with clients, or find them eroding. Spending more time in dialogue with clients in tough times is not only good for them, but it is good for you (and your business).

Mark, the Advisor

Wednesday, August 10, 2011

MarketPsych Alert: Investors at Risk for Classic Investing Mistake

(First off- it you haven't read THIS , we invite you to do so. For one thing, it is so scarily accurate that you will not only want to subscribe to Dr. Peterson's Data Service, you will want to rent him out for parties. For another, it contains wisdom and stick-your-neck out prognostications for what to look for next.)


Would you rather have flowers in your garden or a bunch of gnarly weeds?
Obvious answer, right?

Not so when it comes to investing. And at "crisis points" like this one (markets down another today and fear is getting higher than Timothy Leary at a Grateful Dead concert ), it puts investors at risk for one of the biggest investing mistakes.

When the market is as scary as it is right now, there's always a temptation to sell. Perhaps to avoid further losses, or maybe just to have more cash available to go bottom fishing when the dust settles.

(MarketPsych Note: The above sentence has just been voted the single worst mixed metaphor in MarketPsych Blog history.)

Awkward phraseology notwithstanding, at times like this many investors will look to liquidate some stocks to free up cash.

The temptation will be to sell the stocks in which you have the biggest gains. Here's the problem.

The stocks that have performed well have done so, because they are BETTER stocks. There may be exceptions, but stocks that go up are by DEFINITION better stocks than those that don't.

Here's MarketPsych's internationlly famous "Wicked Gardener" Analogy.

Your portfolio is a garden. Good stocks are blooming flowers. Bad stocks are weeds.

Many investors free up cash at times like this by clipping those beautiful flowers and holding - or in some cases watering (i.e. buying more of) -- those weeds.

By doing so investors systematically clear out their quality holdings, ensuring that what remains in the portfolio are lower quality, worse run, worse performing companies.

Be aware of not only of this temptation, but also the underlying motivation. When looking at positions to sell, ask yourself this; are you chosing the stock because it is the one you should going forward? Or are you really selling a stock because it hurts less than realizing a loss on a position? And be 100% honest.

Because if it's the former - good for you. If it's the latter, well, we can relate, but protecting your feelings comes at the cost of protecting your money. It's a recipe for long term investing failure.

So I'll make a deal with you:

You do what's right with your money.

I'll work on my metaphors.

And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, Ph.D.

Sunday, August 07, 2011

Downgrade! - The Psychological Terrain of What Comes Next in the Markets

Investors are in the same conundrum as the human brain.  The brain receives more than 1,000,000 sensory inputs every second.  But the brain's owners (us) can't consciously pay attention to each of those inputs.  During the latest crisis, investors are receiving tremendous amounts of information (mostly negative).  How can they possibly make sense of it all?  

Fortunately they can turn to the field of neurofinance for answers.

The brain's solution to information overload is to craft general feeling impressions and weave those impressions into stories - narratives - that serve as easily memorable summaries.  These narratives provide a concise explanation of what has happened and what to expect going forward.  

Over the past three months we've seen investors turn away from a narrative of recovery and towards the narrative of debt default and stagnation.  In the narrative of recovery, large deficits and debts are expected to be repaid through growth - as happened to the U.K.'s debts after WWII.  

But burdened by evidence of an economic slowdown, the recovery narrative for Europe and the U.S. collapsed over past three months, culminating in the downgrade of the U.S. AAA debt rating by S&P.  

As a result, investors are looking for a new narrative to guide their investing, and what they see is political paralysis (in the U.S.) and political impotence (in Europe) in dealing with the economic issues.

The new narrative being adopted by investors - whose readjusted expectations have contributed to the price shocks we've seen over the past two weeks - is focused on the unpayable debt overhang the developed world faces.  And the more it is recognized as unpayable, the more likely it will become unpayable through higher debt service costs - a self-fulfilling prophecy.  That feedback loop is the real danger of the current narrative.  Over the short term, this panic will play itself out, hopefully by mid-week, leading to a short-term (days) rebound which is likely to be prompted by a surprise announcement of QE3 or other government action after hours.  However, long-term we're still in the throes of a fundamental problem with developed world economies - political impotence and excess debt.


Anger is the by-product of the current narrative.  Anger and Fear are qualitatively different.  Fear is about the future and is often an overreaction.  After a spike in fear and a plunge in the market, there is usually a rebound and a return to business as usual.  Anger indicates a more fundamental reassessment of the investment environment.  And now we're facing investor (and social) anger.

Based on our linguistic analysis of financial social media, you've seen in the past few blog posts images of very high anger and disgust among investors.  Those emotions are feeding into expectations as well - it appears that investors' earnings expectations have been dropping for some time.  In particular, you can see that expectations of earnings for S&P 500 companies have been slowly declining since February 2011 and are at their lowest level of the past 12 months.  See the chart below:

For the short term, there may be a rebound by Tuesday or mid-week.  The way panics tend to play themselves out, we see a follow through sell-off through Monday, then a stabilization, and then "turn-around Tuesday."  So the odds are that we get a little bounce.  

But longer term, this selling will continue to play itself out.  There are really two alternatives to how we solve the huge U.S. debt overhang (increased taxes and lower spending are both required, but they still can't address the entire liability overhang).  We can inflate our way out of it (increased spending and QE3), or we can try to improve our balance sheet by cutting spending (fiscal austerity).  

Inflation is a stealth tax on everyone, while fiscal austerity is more obvious.  At this juncture, the U.S. is likely to fake fiscal austerity while going the path of inflation.  The U.K. is genuinely going with austerity (as is Ireland and Greece currently).  However, it remains to be seen how long citizens can tolerate slow economic growth due to austerity.  Eventually they are likely to succumb to the desire for short-term needs (jobs) - and vote in politicians who promise to increase spending despite the risks of inflation.  In any case, it promises to be an interesting decade.  

If you still doubt that market psychology matters, your doubt is likely to be tested again and again in the coming months.

There are still safe havens for investors - emerging markets such as Brazil, Chile, Peru, and Indonesia, and several African nations are emerging with credible investment environments.

Of course, in the midst of a crisis, we tend to turn away from what is unfamiliar (the familiarity bias) and pull our money closer to home.  In the case of the current crisis, that is likely to be a long-term mistake.

Happy Investing!
Richard L. Peterson, M.D.

Thursday, August 04, 2011


... Just winked.

I commented on this on last night's Nightly Business Report, but the debt crisis has revealed a fascinating an unforseen shortcoming of the Market.

But first some perspective. Do you think for a moment that if we decided to raise the debt ceiling quietly and without any fuss that the markets would have blinked? I mean, it's been raised 74 times since 1962. Ten times since 2001!

What? Is the 75th time the charm?

Of course not.

And it's not like our national debt snuck up on us. A few miles away from me at Union Square there's a gigantic COUNTER revealing the national debt up in real time.

So what's the big fuss? Why did people, who could have shouted "DOWNGRADE!" in a crowded market any time over the last few years, pick this moment?

Here's the dirty little secret: The Market can't focus on EVERYTHING.

It just can't. The Market (i.e., the investing public) doesn't have the mental bandwith to factor in every variable. So it can only focus on a few issues at a time, usually the ones that appear most urgent or emotionally charged.

Avoidance works. And a problem isn't a problem until we decide it is. That's what makes a bubble. A whole bunch of people decide to ignore a problem... until they don't.

So instead of getting a relief rally for defusing the debt-ceiling time bomb with 1 second left on the clock, we got a renewed attention on some significant problems. The rose-colored glasses are off... the shades are on. And they have given people a dimmer view of our plight.

It's actually quite ironic if you think about it.

If we had chosen to raise the limit and ignore the problem - just as we've been ignoring it for years - August 2nd would have come and gone without incident.

When we decide to, you know actually address the problem for once... we are "at risk for a downgrade".

Hardly seems fair, really.

MarketPsych's Co-founder and resident genius, Dr. Rich Peterson, has a fascinating post below on what the implications may be. We invite you to check it out.

In the mean time, happy investing.

And hey... let's be careful out there.


-Dr. Frankenstock

Frank Murtha, Ph.D.

Thursday, July 28, 2011

Bumping Against the Debt Ceiling: The Psychology of Imminent Default

When I compiled our financial sentiment indices in the mid-2000s, I never imagined I'd spend so much time looking at the "Anger" and "Trust" metrics.  Ah, how the world has changed.

FYI, hear an interview of Jason Zweig (WSJ), Tess Vigelund, and myself here on MarketPlace Money (NPR).

As you can see below, investor anger is at an 18 month high due to the debt ceiling paralysis:

Despite so much anger, we've only just begun to see fear creep into the stock market.  There has been an enormous divergence between investor sentiment (which has become exceptionally negative) and market prices (which have stayed relatively flat).

Part of the reason for flat prices is that more than 80% of the companies reporting 2Q earnings this season have beaten their analyst consensus estimates.  That's incredibly bullish.  Furthermore, there is a party going on in Silicon Valley.  Start-up tech companies are being routinely valued over $10 million, even without a working product.  It feels good to be in coastal California right now.

So now let's talk about what is likely to happen.  How this might play out assuming each side is negotiating from a sincere position (in game theory it is sometimes advantageous to "act crazy" in order to increase one's negotiating clout, as the Tea Partiers may be doing).

Psychologically speaking, here is what we are facing:
1.  A widely anticipated event with either a positive or a negative outcome
(long term, psychologically speaking, this situation is all bad, but more on that in a later post).
2.  The negative outcome is unprecedented.
3.  There is little that can be done to prepare for a negative outcome.

Unfortunately the negative outcome is also the most likely, and the debt ceiling will not be raised by August 2nd.  If this negative event occurs, there are likely to be band-aids applied - an executive order raising the debt ceiling, social security check IOUs redeemable at most banks (as California issued each of the past three years), and interest payments to bond holders that will be paid.

Yet there is a sense of foreboding and doom about the negative outcome, precisely because we don't know what it will look like.  (In fact, if you're a contractor for the State of California, you know exactly what it looks like - IOU certificates and long delays in payments).   Since we know some potential outcomes, let's discuss those to dissipate the doom.

What if there us a ratings downgrade of U.S. Treasuries to AA?
- Based on the regulations for pension funds, banks, etc... to hold AAA Tier 1 assets in part of their portfolio, there simply won't be enough liquid assets for all that money to move into.
- This would necessitate a change in the rules governing "secure" assets.  So fundamentally, very little would happen except a lot of confusion and panic in obscure derivatives markets that we haven't yet heard about.

In terms of the negotiations themselves, the psychology has played out such that neither side can back down.  If either backs down, they will lose face with their constituents.  If they both go through with the default, then they can both claim victory (of sorts).  Recall that Tea Partiers were elected to throw perfectly drinkable tea into the ocean - to cause short term pain (refuse a debt ceiling increase) for longer term gain (better fiscal management).  And we're currently seeing Obama's (necessary) second "stand" - healthcare reform was first.  See that graph of Anger above?  Anger causes people to become LESS flexible, not more. 

As a result of this angry (and very public) game of chicken, neither side can back down.  So ... missing the August 2nd deadline is quite possible.  "Default" on interest payments is unlikely, but issuance of "IOUs," an executive order based on the 14th amendment, or some other interesting stopgap measure is likely.  

So expect a downgrade eventually.  Expect a market sell-off.  Then expect a rebound in the short term after the panic.  (The panic in August will be good time to buy for the short term).  Long term we're seeing the symptom of a systemic disease - a disease of the U.S. political system that will not be cured without some type of major surgery.  Let's hope we can find a good surgeon.

Just like the past three years, it is time to park assets in safe havens - not cash or currency, but gold and revenue generating (emerging market bonds and some real estate) and inflation resistant stocks (recall QE3 should be helpful for the mini-bubbles in Silicon Valley: digital media, technology, mobile devices, etc...)

Happy (or at least not Angry) Investing!
Richard L. Peterson, M.D.

Wednesday, July 27, 2011

Welcome Back, Fear. (I'm Yer Huckleberry).

And, oh, by the way... WHAT TOOK YOU SO LONG?

For a moment there I entertained the notion that the collective human nature of the investing community had reached a higher plane of inner peace and tranquility, free from the materialistic worries that bedevil less enlightened souls.

But the investing community has not attained nirvana. They just don't know what to do.

I heard a financial news commentator ask a fair question today, "Why hasn't the market reacted to the debt ceiling crisis? Why hasn't there been a sell off?"

The unsatisfying and tautalogical response that leapt to mind was, "Nobody's sold off because... nobody's sold off."

Let me explain that better. Picture the OK Corrall scene in the movie Tombstone. (On the off chance you missed one of the best films of the last 20 years, I'll set the stage.)

It's a good old fashioned wild west showdown between the good guys and the bad guys. The fight had been coming for more than an hour's worth of movie time. Marshall Wyatt Earp has had enough. Earp and his posse draw their guns and head down to the corral to confront the marauding Clanton gang. The outlaws caught by surprise, look up and immediate reach for their guns too.

And then... nothing. Nothing but palpable tension ready to erupt in gunfire and an unbearably long staredown. Eight furious, frightened gunslingers with their fingers on their triggers looking at one another. The pressure builds and no one moves a muscle.

Then it happens.

Doc Holiday winks at Billy Clanton. Billy's face contorts with rage and....

KABOOM! Guns blazing! Bullets richocheting! Bodies flying! Total mayhem! Total AWESOME mayhem.

So where are the fireworks? Why hasn't the market reacted? It's not for a lack of emotion. It's not for a lack of understanding. It's not for what my science teacher told me is called "potential kinetic energy". (This kinetic energy has the potential of LeBron James.)

No. "The Market" hasn't sold off simply because... it hasn't.

But should the first frightened seller - of enough consequence to influence others -squeeze the trigger... it will cause another seller to do the same. Then another. And another. And then so many that the computers can't keep up.

Gunfight. Rock slide. Stampede. Sell off. Same thing.

So far, everybody's kept a cool head. The guns are in their holsters.

Which is the way we like it 'round these parts.

Peace and quiet. Law and order.

No need to get twitchy now, stranger.

Everbody relax... everybody ree-lax...


Happy Investing.

And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, Ph.D.

Tuesday, July 19, 2011

What Happened to Fear?

"There are a lot of worries out there, but people aren't very worried."

No, Yogi Berra, has not been brought on board as a guest blogger.

This is just the best way to explain the strange paradox of the U.S. Equities markets in July of 2011.

There has seemingly been a daily trickle, if not stream, of negative economic news coming from countries that have great soccer teams and dreadful balance sheets (e.g., Ireland, Greece, Spain,
Portugal, Italy... to be continued).

Yet, MarketPsych's sentiment indicators show that worry/fear were actually much higher earlier in the year.

That's not to say that investors aren't emotional.

Investor sentiment is worse than it has been since 2009, yet market performance is still
going strong. This divergence is noteworthy... and strange (see below).

The red line represents Investor Sentiment since the start of 2010. The gray/green/red line represents the peformance of the S&P 500 Index.

Weird, right?

Maybe this unusual split is because fear does not appear (for a change) to be the dominant emotion.

So if fear isn't driving sentiment... what is?

Our proprietary tools (designed by Dr. Richard Peterson and available at indicate the following:

ANGER: People are ticked off at the forces behind the market, and likely still bitter about the effects of the banking crisis in '08. TARP and the political wrangling over the debt ceiling in the U.S. cetainly isn't helping assuage this feeling.

DISGUST: Disgust is often felt in reaction to things that are unclean. That's a good way of describing investors emotion. Investing just seems to be a dirtier business than it used to be. And they are revolted by it.

LACK OF TRUST: People are more cynical about the equities markets, and less likely to believe the authority figures are willing or even capable to do what they pledge.

So investors are "Mad as hell"... but will they "take it anymore"?

So far, the answer is, "yes".

But doing so appears to have created a great deal of emotional tension.

Happy Investing.

And hey... let's be careful out there.

-Dr. Frankenstocks

Wednesday, June 29, 2011

Expanding our horizons

We should set our sights on horizons we will never live to see. (Asian proverb: source unknown)

Two ideas in my recent experience have given me a new appreciation for longer term thinking (and in particular, my personal responsibility for the actions of others who will be impacted).

One emerged when Bernadette and I recently toured a family owned (and operated) balsamic vinegar farm in Modena, Italy. It had been in the family for generations. We toured the facility and learned how traditional artisanal balsamic vinegar is made; particularly that well aged variety over 25 years old. The taste of just a drop or two of the thick, syrupy older product produces a sensory experience that is exquisitely layered with deep and rich flavors. In truth, it has been infused with the experiences of multiple generations of the family and their lifelong work on the farm. I will never taste balsamic again without thinking about this particular family and their enthusiastic embrace of an artistic food dynasty. A few interesting observations resonated with me as follows:

1. It takes about 100 litres of liquid over the aging process, evaporation, and years to ultimately produce about a litre of final product.
2. Fruit starts in a larger barrel and as it ages, is moved into smaller barrels. The picture nearby indicates the evolution of balsamic through five barrels in a row that reflect a particular vintage year.
3. The fruits planted in one generation are actually cultivated in the next and harvested in generations beyond.

Obviously, in planning a business that, by its nature, is multigenerational in scope, the family is forced to think about who will succeed them to make decisions. As well, the current owners realize that they own the responsibility of shaping the character of their family and ultimately ensuring appropriate training for the job.

The second idea instance emerged through an excerpt from the book, Moral Intelligence 2.0 by Doug Lennick and Fred Kiel. It contained a reference to a State of the World Forum in which a presentation was made by a Polynesian tribal chief from Hawaii. In describing how his people thought about responsibility and accountability, the chief indicated that, in his culture, it was presumed that current leaders were accountable to the three generations that preceded them and responsible for the seven generations that followed them. Let that sink in for a moment. Not only were people expected to be responsible for their own actions, but in fact, had some obligation to include the rules and teachings of three prior generations in their current decision making, and the personal responsibility for identifying and teaching their successors in a way that influenced the next seven generations.

I suspect that most of us would have difficulty (and perhaps some sleepless nights) believing we were responsible for 11 generations. However, I do also believe that there is unusual value in considering how our personal actions and decisions reflect the views and moral teachings of those who preceded us. Additionally, even modest amounts of effort to enhance the capabilities of those who will succeed us will undoubtedly have a major impact on our communities both near and far.

As we think of recent couple of years of market whacks that reflect short term thinking, and perhaps myopic greed, I suggest we ask ourselves (and those close to us) questions arising from a longer term perspective. Most importantly, we should remind ourselves that we are more responsible for others than we might think.

Mark, the Advisor

Thursday, June 23, 2011

Is the Market Bubble Bursting? (see chart).


For a talk earlier this week I reproduced our "Bubble-ometer" first profiled in Fall 2010 for the period from April 1998 through June 22, 2011.  It turns out that based on this simple metric of the number of mentions in financial social media of stock price action versus the number of mentions of company fundamentals (speculation versus thoughtful investing), we're likely in the midst of a speculative bubble.


To figure out a basic profile of market tops, we studied social media language predominant in the two weeks around seven recent market peaks: 
  • Technology (QQQ) in early 2000,
  • Homebuilders (XHB) in mid 2006,
  • Financials (XLF) in mid 2007,
  • S&P 500 (SPY) in late 2007,
  • Energy (XLE) in mid 2008,
  • Solar (TAN) in mid 2008, and
  • Gold Miners (GDX) in April 2011.
  • Sentiment is highly positive.
  • Outlook (future-oriented) is positive and rising.
  • Expressed Fear and discussed Dangers are low and declining.
  • Expressed Joy and Positive Superlatives (“Best!”) are high.
  • High frequency of discussions of positive earnings surprises.
  • Discussions about the stock price are significantly more common than discussions about accounting fundamentals (a sign of “day-trading”).
SIGNIFICANTLY:  Outlook (beliefs about the future) diverge from actual events (reality) at a peak.
In most cases, prices start to fall, but Outlook remains positive until surprising negative news collapses the Outlook vs. Reality disconnect.  Joy gives way to worry and doubt.

Most importantly, did we see a market peak this April?  Suprisingly to me, the data suggest yes.
I'll keep working on the research, but the preliminary results indicate the next year is unlikely to be good for long-only investors.  Sign up here to keep abreast of our research via our free newsletter.

Richard L. Peterson, M.D.

Monday, June 20, 2011

Social Media Predicts the Stock Market

Lunch event tomorrow:  I'm explaining how SOCIAL MEDIA PREDICTS THE STOCK MARKET tomorrow (Tuesday June 21st) in Los Angeles at CFA Society (open to all):

I was just at the Battle of the Quants in London last week, moderating a panel on the use of social media data in predicting stock prices.  A number of funds are doing this, including our own fund (MarketPsy Long-Short Fund LP) which did it successfully for 2 1/4 years.

On the panel were several interesting groups, including the "Blog Fund" - Pluga AI run by Yutaka Matsuo, a machine learning and AI expert at the University of Tokyo.  Also the "Twitter Fund" run by Paul Hawtin at Derwent Capital, Arnauld Vincent from Mines Paris Tech, Kevin Coogan from Amalgamood, and Axel Groß-Klußmann from Humboldt Univeristy in Berlin.  All in all we had a lot of fun.  Our own data is available at

Happy Investing!
Richard L. Peterson, M.D.

Thursday, June 02, 2011

Here We Go Again (Again)

We've blogged about it before.

It's a bonafide MarketPsych pet peeve, the financial equivalent of watching someone chew with his mouth open or say, "irregardless".

What will it take to keep people from being "surprised" at "unexpected" results from noise-laden, short-term indicators (I'm looking at you, Jobs Report) comprised of 33% data, 33% speculation and 33% magic pixie dust?

This article by Randall Forsyth at Barron's says it quite well.

Of course, we have been making this point for a long time, here for example.

Now if you'll excuse me, I have to stop blogging now so that I can find a brick wall and bash my head against it repeatedly.

Happy Investing.

And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, Ph.D.

Monday, May 23, 2011

The Euro-zone Will Split - "It's the incentives, stupid!"

During the financial crisis I found it helpful to ask myself, "what is the worst that could happen?" and "what EXACTLY does that look like?"  By going through the steps of "the worst" it became apparent that the U.S. government could pump money into the system ad infinitum.  Despite the risk of inflation, this was the preferred course of action through stimulus packages and bail-outs.  Politicians knew that if the economy collapsed, in addition to widespread misery and unemployment, they too would lose their jobs come the next election.  As a result, the political imperative was to inflate.

We're seeing a different problem in Europe.  Spending cuts have caused economic malaise and the huge structural inefficiencies in the PIIGS (sorry) will not be addressed in less than 10 years - educational and institutional weakness take a while to progress past. 

Fiscal austerity is leading to economic deflation in vulnerable countries and social unrest.  Most people in Greece and the other PIIGS want employment and dignity.  They will soon be finished with the humiliation of budget cuts, indebtedness to German banks, and 20% unemployment.  Recall that unemployment and losing a sense of dignity inspire anger (and are even the fuel of suicide bombers). These are powerful forces.  The incentive for the populations of these countries is to default, exit the Euro, and start over with a "Junior Euro." 

Democratic citizens will demand a default.  If the current politicians won't do it, eventually they will elect ones who will.  As the political cycle moves forward, and one country successfully defaults (oh, wait, Iceland already did!) all the PIIGS will default (or "restructure" their debts).  No economist can defeat human nature. 

And the consequences?  Well, if you've read the excellent book "This Time Is Different," you'll see tables of data indicating that most countries that default a few years thereafter have better lending conditions.

Personally I'm surprised that this trade opportunity - to short PIIGS European debt and even better, Spanish banks - has remained open for so long.  Maybe another example of delayed learning (it takes us a while to learn and adapt to a new reality like the possibility of "developed" countries defaulting).

And implications of this default for the U.S.?  Near term money will move to U.S. dollars as the safet trade.  Long term?  Less inflation of commodities than you might think - China is going to have its own bubble pop (benignly, hopefully).  Definitely gold will do well.  Yes, gold is in a "bubble", but with real structural momentum behind it, it is likely to go on for a while. 

Happy Investing!
Richard L. Peterson, M.D.
rpeterson- at-

Wednesday, May 11, 2011

Mind Muscles(tm): Shred Your Stories

This series of blogs will look at new behaviors you can create that give you additional investing and trading choices that positively impact our risk and profitability. The foundation for these Mind Muscles(tm) can be reviewed at:

Each additional blog will introduce a market bias, myth or mind trap and demonstrate how to create a new behavioral skill that will give you a new positive response to market conditions. It is always easier and faster to make improvements by working with someone who can provide an outside frame of reference andsupport for change. We at MarketPsych are ready to provide coaching and training for you and your organization.


"The mind has a job. And that's to give us all the stories that prove that what it thinks is true."

Byron Katie

The world comes at us with a seemingly infinite amount of data every day. What we see, hear, touch, taste and smell is more than we can possible take in and analyze in real time. So our brains perform some wonderful services for us.

The amygdala, located in the limbic part of our brain scans our world for threats. It has no self-conscious awareness to slow it down, so it is very very fast (think startle reflex). It has libraries of threatening patterns and when it senses a pattern match in our environment, it reacts very quickly. I was jogging in the woods some time ago and found myself leaping sideways to the other side of the fire road. I was on a collision course with a rattlesnake. Without conscious thought, my body reacted quickly.

The brain also takes complex tasks and automates them so we don't have to consciously direct every detail. By combining patterns of neural activity into larger complexes neural structures, we can drive a car and while having a conversation with a passenger.

The brain also filters out huge amounts of information that isn't judged to relevant.

Additionally, it identifies, defines and codes raw data into a simple concepts. When the wake-up alarm goes off in the morning, our brain doesn't have to create all the logic to identify the raw decibels, pitch and tone as an alarm…it already has a "table" that simply says "alarm." If we didn't have these functions, the amount of data coming to us would be overwhelming. We couldn't even get out of bed.

But all this pre-processing also shapes the information that we receive in our conscious brain giving us a distorted sense of reality. And one of the most powerful distortions our brain creates is "stories." In addition to the pre-conscious information organizing process where our brain filters, deletes, automates and structures our information, the way we remember it and give it meaning is by creating stories around related parts of data.

During the height of the Japanese nuclear reactor scare recently, I was at a training that included a number of new age therapists. They were eating seaweed to help protect them from potential radiation. I called my daughter who works as a project manager at NASA and asked her about the risk. She sent me the assessments which stated that the risk is insignificant. I relayed that to the "seaweed munchers" and the response from one person between mouthfuls was, "Oh, the government just doesn't want us to know."

It is easy to chuckle and see this as a story fabricated by someone who needed to believe that they needed to protect themselves against an unseen, unfelt danger. However, it is much harder to see these fabricated stories in ourselves because they don't feel like stories, but they feel like reality.

As Byron Katie stated in the opening quote, stories are created after the fact, after our beliefs are in place to give us comfort that they are true.

As professional money managers, traders and investors, a costly bias is taking our own stories at face value. But if our stories are necessary, and we can't help but create them to give us meaning and memories, how can we deal with them as investors and traders? The answer is to see our stories as simply stories that we create. This awareness, without judgment or criticism allows us to reframe them and use them positively.

Once we see our stories as self-created, then we can observe them and learn from them. One of our jobs is to continually "Shred our Stories." This of course is a lot easier said than done because the closer our "stories" are part of our our survival mechanisms and beliefs, the more we become attached to them. However, when we frame our stories as models that simply help us navigate the current world, the easier it is to "shred" them when they no longer become useful.

You can create the "Story Shredder" Mind Muscle which will help you shred stories that are no longer useful. The more you use it, the stronger it gets.

The first step is NOT to create useless stories in the first place. One way to do this is to watch or read the news as if it were a series of "fairy tales." Look at these fairy tales as a bucket of emotional content created to support what we want to believe. Pay attention to the emotional content and how it will shape the stories of others and their investing behaviors. Look at all other information sources in your life that feed the creation of stories and reframe them in a way that allows you to beaware of them without allowing them to feed your beliefs.

The second step is to practice "shredding." This original format was created by Byron Katie ( and I have adapted it for you. First, find a story that you depend on and believe to be true. To make this first one easy, find a story that isn't that critical to your life. Now ask yourself the following questions.

  1. Is it true?
  2. Can you absolutely know that it’s true?
  3. How do you react, what happens, when you believe that thought?
  4. Who would you be without the thought?

Next, find a story that contradicts the story you are shredding. Tell yourself THAT story. Embellish it. Create all the details you can. Notice resistance to the new story. But do it anyway!

Let yourself fully experience the new stories. Find three examples in your life where the new story is true. This is not about making you wrong, just about discovering alternatives that give you "story freedom."

The Mind Muscle homework is to "Shred a Story a Day" using the four questions. You can start with non-critical stories and work your way up to the ones that are connected to your survival. As you do this, you will start to notice the "stories" others tell themselves and recognize them as stories. You will see the news, not as fact, but as interesting fairy tales that have an impact on the world. You will look at the market and notice the stories you bring to the interpretation.

Mind Muscles(tm) are like physical muscles, the more you use them, the stronger they get. However, just like muscles, you may notice some "fatigue and soreness" when you first start to exercise them, but keep it up! Soon you will be shredding stories as easily as a piece of paper.

As you build this Mind Muscle(tm) you will see more information with less bias and see new market patterns emerging early and faster.

Richard Friesen
Training & Development

Sunday, May 08, 2011



Hello, Fellow Investors!

MarketPsych took some time out of its busy consulting/speaking/writing schedule to share another Digital Short Film.

This one (once again starring Jim and Fast Eddie) explores the concept that behavioral finance people call, "Herding". A concept which, if you think about it, is really another way of saying "Peer Pressure."

Yes, Peer Pressure. That same powerful social force that perhaps in your younger days caused you to do things like get a "mullet" haircut, procure special oversized "warmers" for your legs (when, in fact, they were in no need of warming), and pretend you actually enjoyed your first cigarette.

Well, we're all older now. Wiser too. But peer pressure still lies at the heart of many investing failures. The key to overcoming this force (in high school or the stock market) is to develop a strong enough identity (i.e., sense of who you are) to make decisions based on what's right for you - not what you see others doing.

The concept is so important, we put it in the title of our book. (MarketPsych: How to Manage Fear and Build Your Investor Identity)

We invite you to click on the film clip above or if you prefer, here, to follow the adventures of Jim and Fast Eddie, and maybe have a laugh while you do so.

Please visit us at for more information on the books, products and services we provide to the financial community.

Happy investing. And hey... let's be careful out there.

-Dr. Frankenstocks

Frank Murtha, PhD

Saturday, April 30, 2011

The Role of Lead Advisor

To lead people, walk behind them. (Lao Tzu)

In the aftermath of the 2008/9 market whacks, we have all felt the erosion of trust. However, in many cases, this lack of trust may be putting investors at risk; specifically when a client decides to subdivide their portfolio among 2 or more advisors in hopes that they will reduce their exposure to poor performance.

In a recent report (for investment professionals only) published by SPDRÒ University and [email protected], a healthy discussion was presented regarding the need to identify an advisor to play a leading role in oversight of the entire portfolio in the pursuit of client objectives. Specifically, the conclusions were drawn from a survey of more than 800 investors and 2,000 advisors. Select points from the survey were as follows:

  • 48% of investors moved money away from an advisor (during the recent market turmoil).

  • At all wealth levels, the primary and secondary reasons given for the move were to diversify risk, and to take advantage of an advisors specific area of expertise, respectively.

  • Surprisingly, even for those investors who have a primary advisor, 55% indicated their primary advisors were unaware of the decisions and performance of the other advisors.

  • For advisors, this represents and interesting dilemma since we cannot address issues that emerge in rooms whose doors are closed to us by the clients we are trying to help.

At least some of the specific potential problems are that:

  • Separate advisors have overlapping strategies, thus not achieving overall diversification.

  • Multiple advisory relationships could be more expensive (lack of aggregate pricing breaks).

  • Excess diversification could result in an investor paying active management fees for index like performance.

  • Lack of specific recognition (and collaborative engagement) of specialty investment expertise in identifying and engaging unique opportunities or special value added ideas.

  • There is added complexity (and difficulty) in assembling performance reporting and data aggregation.

The survey also indicated that the most important attribute for a primary advisor (60% of the respondents agreed) was to "help guide a client's financial life from investment management to spending, tax planning, education planning, estate planning and generational wealth transfer".

So what should we do? It is clear that clients expect advisors (who are important to them) to pursue an in depth and holistic understanding of their lives. Further, this knowledge should drive the process we use in aligning our service with their objectives in developing our recommendations, communicating, teaching/educating, and helping to improve the quality and efficiency of their decision making process. It is also important to periodically evaluate our success (or lack thereof) from the client's point of view and perhaps take active steps to improve the collaboration among the client's advisory team.

Trust may be fragile, but it can definitely be renewed through the actions we take in support of our clients.

{Note: the MarketPsych tools and process initiatives are resources that have been designed to help advisors engage precisely those attributes described by the survey as important for primary advisors.}

Mark, the Advisor

Monday, April 11, 2011

Mind Muscle(tm): Extreme Event

"Our internal process is more important than anything else because it drives everything else."

This series of blogs will look at new behaviors we can create that give us additional investing and trading choices that positively impact our risk and profitability. The foundation for these Mind Muscles(tm) can be reviewed at:

Each additional blog will introduce a market bias or mind trap and demonstrate a new behavioral skill that will give you a new positive response to market conditions.


I recently gave a presentation to the "Insurer Investment Forum XI" in San Diego produced by Strategic Asset Alliance. One of the concerns of the investment arms of insurance companies is the increased potential for sudden market movement.

Risk is moving from a wider distribution and diversification to a more systemic concentration. This produces what statisticians call "leptokurtic kurtosis." This means more of the variance in price distribution is the result of infrequent and more extreme deviations, as opposed to more frequent modestly sized deviations. This means both a higher peak and fatter tails in event distribution.

The anticipation of more extreme events is driven by concentration of economic decision power. Let's look at the list of contributors:

  • Increased use of index funds such at ETF, Index Futures
  • Increased control of major corporations by the federal government
  • Expanding regulatory environment in energy / finance / health care
  • Expanding management of the healthcare industry by federal regulation
  • Greater power and demands on the Federal Reserve
  • Continued control of interest rates to manage conflicting goals of inflation and economic growth
  • Breakdown of contractual law (i.e. GM bond holders)
  • Growing unfunded liabilities from Federal, State, local governments
  • Instant dissemination of information to trigger emotional contagion
  • Instant electronic trading for rapid money transfers
  • Ad hoc firefighting at all levels of government
  • US Dollar value becomes political
  • US Treasury debt ownership concentration
  • Shifting tax and regulatory structure

How do we as money managers, investors and traders manage the potential for more extreme events?

Our neurology isn't made to conceive of and prepare for extreme events when things feel normal. Our minds want to extrapolate the nature of the current environment into the future, especially if we can't conceive of solutions to the problems brought by these extreme events.

They didn't see it coming!
  • Long Term Capital Management calculated the odd of their own failure at "1 in 3 billion."
  • Goldman Sachs stated the chaotic market price actions of early August 2007 were a "25 standard deviation event."
  • In 2007, Citi's chief financial officer claimed that the firm was simply a victim of unforeseen events.

Extreme Event Exercise:

The goal of this exercise is to build a Mind Muscle that gives us a new willingness to acknowledge rare events and to prepare for them as we see increasing evidence of their viability. It is one of my favorites to do with clients at longer workshops. The purpose of this exercise is not to predict the future or to replace risk management systems, but to prepare you mind to act quickly when needed.

Write down 5 events that although unlikely to happen, would significantly change financial opportunities, risks and profits for your industry or company. Make at least two of the event highly unlikely. For example, some of the events could be:
  • Multiple state, city and municipalities declare bankruptcy or insolvency
  • Oil at $300 a barrel in 30 days
  • Collapse of the dollar
  • Collapse of Bonds
  • Housing prices sink another 50% this year
  • Internet failure for 30 days
  • Congress passes a balanced budget
Make up your own!

The next step is to create a time line for each of the 5 unlikely events. What indicators would be likely to occur before this event happened? Even small early indicators. Label in days/weeks/months/ years before event. What other events would cascade from this event? What emotional contagion might occur creating mass hysteria? What feedback loops might get caught in an ongoing spiral?

This visualization will build new Mind Muscles, the ability to see events that few others will be able to notice. As these events unfold, you will have already been down that path. You will be able to see the end! You will not be frozen, but will have the ability to act.

This exercise will not only build visuals for specific events, but give your brain the ability to visualize consequences for additional events that you did not consider.

The next step is to create incremental early action plans as early indicators crop up on your time line.

As your brain visualizes several unlikely alternatives, it will develop the capacity to see these and other unlikely alternatives develop. Our brains create patterns to make sense of the world. If there is no pattern, evidence of a changing landscape is hard to see. So, create more patterns, build that Mind Muscle(tm) and become more creative and decisive as we approach the next extreme event. As always, we at MarketPsych are ready to help you in this process with our in-house training.

Richard Friesen