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Slugs and snails And puppy-dogs' tails, - Nineteenth century English nursery rhyme. _____________________________________________________
"Honey, what happened to our retirement savings?"
If you're a man, your partner may have asked you this at some point in the past few years.
"Hmmm, I'm not sure what you mean?" you may evasively answer. (The truth is, you're very aware that you invested too much in that awesome small cap tech stock. Sure it's down 50% since you bought in, but it is such a GREAT story, it HAS to work out.)
She persists, "I mean, how come the account has less money than last year? The market was up this year."
Now if you're like most men, you want to please your wife (and yourself). And you probably believe what you say next: "Um, well, I invested in CyberNanoTech and they had a bit of a setback this year because of the FDA, but their long term prospects are amazing, everyone says so, so I'm holding tight."
"What is CyberMamoSpec?"
"Well, Joey at the Club was saying they have this world changing...."
"Honey, what does Joey know about investing, isn't he an orthodontist?"
This is why men need wives, to pop their unreality bubbles. It's at this point in the conversation that his wife may pick up the phone to call a financial advisor. And if all goes according to her plan, which is likely, their financial relationship dynamics will become the domain of a financial advisor, which is another story (and one I often speak to advisors about). |
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"If taking female hormones actually helped you do your job, they would simply hire women here...But they don't. They don't think women are aggressive enough." ~ New York Post, citing an SAC employee and reprinted here.
A couple years ago I began coaching a trader with a hormonal problem.
He told me, "When I trade at my best I'm aggressive and decisive. Ready for whatever the market throws at me."
"And how have you been trading lately?" I asked.
"I'm none of those. I'm indecisive and cautious. I'm just sort of limp when I need to be strong and fast. And I just keep losing money. You know, it's as if I've lost my mojo." |
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While forecasters predicted Hurricane Sandy would be the worst storm in New York history, many people did not prepare adequately.
OK, to be perfectly honest, I did not prepare adequately. In response to a question posed by my New England-born wife before the storm, "Shouldn't we buy a generator?" My response, "Generator? Who needs a generator?" will probably rank as one of the more egregious on my Clueless-Man-Responses List, just ahead of #6 "No, I know where I'm going, I don't need a map," and just behind #4 "Anniversary? You mean today?"
In my (and my wife's) quest to understand the Clueless-Man-Responses List and why it continues to be populated, I did a bit of research. Turns out that due to a mental mechanism called the "projection bias," people's intellectual assessments of a danger ("worst storm ever") conflict with their emotional experience ("I'm fine right now, those forecasters must be exaggerating.") In these scenarios, most people go with their gut - "It'll be fine, it always is." As a result, there is inertia in their preparations.
In fact, as I write this letter I am warm and cozy (and a tad humiliated) at my wife's parents' house in Maine. A couple days without heat and power was enough to turn us into storm refugees. Thank goodness for the kindness we've encountered since the storm. One thing I was impressed by after the storm was the tremendous goodwill and comraderie of neighbors in affected communities. |
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When George Soros "broke the Bank of England," famously earning him $1.1 billion on a single trade, it was not only the Bank of England who was rocked by losses. Some ambitious and formerly successful traders had bet against Soros - traders such as Bob.
Some background: In 1990 the Britain's Thatcher government decided to join the European Exchange Rate Mechanism (ERM). The ERM was a system to reduce exchange-rate variability. With U.K. inflation at three times the rate of Germany's and interest rates at 15 percent, the conditions for remaining the ERM were not favorable.
Due to its inherent impossibility, as well as short-selling by an international group of currency speculators led by George Soros, the UK was forced to withdraw from the ERM on September 16, 1992 ("Black Wednesday"). Soros' trade was virtually guaranteed to be successful due to the large interest rate differentials between the U.K. and Germany. Not all central bankers learned the lesson - Soros and others profited from similar trades put on before the Asian Currency Crisis of 1997. |
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Street craps - played with two dice on a sidewalk - is little like its casino brother. The odds are different, the pace is much faster, and your dealer is typically a hustler or worse, a psychopath. As for me, I learned how to deal street craps in prison.
As a psychiatrist I've evaluated competency and treated mental illness among prisoners, some of whom were hustlers or psychopaths. Street hustlers in my experience are usually quite engaging and reflective, able to gain insights and do productive psychological work. Psychopaths are cold and heartless - mimicking the emotions and social styles they have seen expressed by others. Typically psychopaths don't see a psychiatrist voluntarily, and when they do, they spend a good deal of time looking for angles - how to game the system and get what they want from the doctor.
When a psychopath offered to teach me street craps in a prison, I knew from my clinical training that he was being friendly only because he wanted something from me - information, medications (some medications are used as currency in prisons), or to learn some therapeutic tricks he could use on others. Nonetheless I was riveted as he explicitly taught me how to spin the dice to get the numbers I wanted and how to tap and blow on them to distract unsuspecting clients. At the same time, I told myself, I was gaining valuable insight into the mind of a psychopath. After the tutorial -- and alas too late to do anything about it -- I realized to my horror that my pen was missing.
He wasn't interested in passing time with some friendly banter or in gaining some psychological insights while he was teaching me how to roll the dice - the dice lesson was for distracting me while he swiped my pen. |
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"The intelligent investor is a realist who sells to optimists and buys from pessimists." ~ Benjamin Graham, Jason Zweig in The Intelligent Investor, Rev. Ed. As a psychiatrist I've born witness to many extremes of mood. I've tried to steer manic venture capitalists away from spending their life savings on cocaine and sports cars. And on the other extreme I've born witness to the deep pessimism and despair of suicidal clients, trying to help them choose life over oblivion. My efforts are not always successful, and I've learned a lot about the limits of rationality when faced with extremes of mania and despair. At both extremes many of the people I've worked with are highly intelligent and believe they are acting with perfect rationality. Yet despite their innate intelligence, deeper emotions occasionally sweep away their anchor to reality.
In Ben Graham's quote above, one could be mistaken for thinking of the "intelligent investor" as a robot or algorithm. Human investors feel the extreme optimism and pessimism of the markets. And the effect of this optimism and pessimism is, almost universally, to bias their interpretations of real events. While the best investors feel the moods of the market (that is, they are empathic), they also have the almost super-human ability to act contrary to their emotional biases. Graham's vision of intelligence in the 1950s is what we today call emotional intelligence.
Warren Buffett called Graham's book, The Intelligent Investor, "By far the best book on investing ever written." I think it's worth looking for lessons in Graham's thoughts on optimism.
Today's letter will examine the nature of optimism in the financial markets: How we experience it, how it distorts our investing, how it plays out in markets, and how we can succeed while being both optimistic AND realistic. As we go through these themes, we will look at French and Dutch optimism in the Euro-zone, the delusional optimism at the launch of the Facebook IPO (see Dr. Murtha's hilarious Part 2 video), how portfolio managers can use optimism to their advantage, and visit some tools and techniques for making ourselves better investors.
But first, some housekeeping... |