Bucking conventional wisdom

Social MoodA leading indicator of stock

markets

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Who’s Hungry?

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The Crash of 1929

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The Great Depression

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Bubbles and Busts; rinse and repeat

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Wallstrip Chat

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2007

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2008

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2010

10American society is again disenfranchised.

The Haves vs. Have Not’s

Red States vs. Blue States

Main Street vs. Wall Street

Moreover, the demise of high-profile icons— Tiger Woods, Ben Roethlisberger and Jessie James—suggested that the socionomic tide turned anew.

Right?

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2011

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The New World Order

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The Fork in the Road

Path 1: Deflation; debt destruction, asset class deflation, dollar appreciation and an outside-in globalization once the dust settles

Path 2: Give the drunk another drink with hopes he doesn’t sober up; risk assets rally, dollar declines and the intense friction in our bifurcated world manifests through social mood.

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The Tricky Tri-fectaSocietal Acrimony: Pushback against big business, financial institutions, BP oil spill

Social Unrest: The Tea Party, Occupy Wall Street, riots in Greece, shootings in U.S schools

Geopolitical Strife: Middle East, Cyber-warfare, ???

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The Newtown tragedy hit close to home—the tri-state area is a singular community, sports rivalries notwithstanding—this could have been Anytown, USA. And it’s not just this senseless act that is so very horrifying; it’s the rate and pace at which these events have transpired since 2008:

•Feb. 11, 2008 in Memphis, Tennessee: A 17-year-old student at Mitchell High School shot and wounded a classmate in gym class. •Feb. 12, 2008 in Oxnard, California: A 14-year-old boy shot a student at E.O. Green Junior High School causing the 15-year-old victim to be brain dead. •Feb. 14, 2008 in DeKalb, Illinois: A gunman killed five students and wounded 17 more when he opened fire on a classroom at Northern Illinois University. •Nov. 12, 2008 in Fort Lauderdale, Florida: A 15-year-old female student was shot and killed by a classmate at Dillard High School in Fort Lauderdale. •Feb. 5, 2010 in Madison, Alabama: At Discovery Middle School, a ninth-grader was shot by another student during a class change. •Feb. 12, 2010 in Huntsville, Alabama: During a meeting on campus, a biology professor who was denied tenure a year earlier shot her colleagues, killing three and wounding three others. •March 9, 2010 in Columbus, Ohio: A man opened fire at Ohio State University, killing two employees and wounding one other after receiving an "unsatisfactory" job evaluation. •Jan. 5, 2011 in Omaha, Nebraska: Two people were killed and two more injured in a shooting at Millard South High School. Shortly after being suspended from school, the shooter returned and shot the assistant principal, principal, and the school nurse before taking his own life.

•Jan. 5, 2011 in Houston, Texas: Two people opened fire during a Worthing High School powder-puff football game. One former student died; five other people were injured.

•Jan. 8, 2011 Tucson, Arizona: Rep. Gabrielle Giffords was shot in an assassination attempt. At least 17 others are shot by a gunman, who opened fire during a constituent meeting outside a local grocery store. Six people were fatally wounded, including US District Court Judge and a young girl.

The “other side” of the rally

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Continued (unfortunately) • May 10, 2011 in San Jose, California: Three people were killed in a parking garage at San Jose State University. Two former students were found dead

on the fifth floor of the garage and a third, the suspected shooter, died later at the hospital.

• Dec. 8, 2011 in Blacksburg, Virginia: A Virginia Tech police officer was shot and killed by a 22-year-old student of Radford University. The shooting took place in a parking lot on Virginia Tech's campus.

• Feb. 10, 2012 in Walpole, New Hampshire: A 14-year-old student shot himself in front of 70 fellow students.

• Feb. 27, 2012 in Chardon, Ohio: At Chardon High School, a former classmate opened fire, killing three students and injuring six. Arrested shortly after the incident, the shooter said that he randomly picked students.

• March 6, 2012 in Jacksonville, Florida: A 28-year-old teacher at Episcopal High School returned to the campus after being fired from his job and shot and killed the headmistress with an assault rifle.

• April 2, 2012 in Oakland, California: A 43-year-old former student at Oikos University, a Christian school populated by mostly Korean and Korean-Americans, opened fire on the campus, killing seven people and wounding several others.

• July 20, 2012 in Aurora, Colorado: During a midnight screening of the film The Dark Knight Rises, a gunman opened fire on the crowded theater. At least 12 people are killed and 38 others are wounded.

• August 5, 2012 in Oak Creek, Wisconsin: A gunman opened fire at a Sikh temple, killing six people and wounding three. Police shot and killed the suspect, Wade Michael Page, after the attack. Page, a neo-Nazi, served in the UD Army from 1992 to 1998.

• December 14, 2012 in Newtown, Connecticut: A gunman killed 20 children and six others at the Sandy Hook Elementary School. He killed his mother at her home prior to the massacre at the school, and committed suicide after the rampage.

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Why the Debbie Downer?These were not random acts of violence; they are symptoms of a much larger and pernicious disorder: the devolution in American social mood, a detachment from reality, an erosion of the family construct.

History books will depict this period with the benefit of hindsight and an absence of emotion; for the rest of us, we must figure it out as we go, in real-time, and prepare ourselves for what’s to come.

Much like the Great Depression, we are living through an era, not an event.

As we’ve learned too often in our time together, there is a difference between loss and loss.

So, what does this all mean, and more importantly, how can we shift this seemingly self-perpetuating course?

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There are obvious one-off suggestions—a ban on assault rifles, rigorous testing and treatment for mental illness, more thorough child safety precautions—but through a broader lens we must understand the fundamental difference between socioeconomics—which posits that the economy drives social mood—and socionomics, which argues that social mood drives financial, economic, and political behavior.

As animal spirits manipulate fund manager behavior and lead to healthy corporate balance sheets – created by the same policies that shifted risk from one perception to another—the chasm between the stock market rally and a legitimate economic recovery becomes increasingly apparent.

Policymakers take solace as the Dow Jones Industrial Average trades at all-time highs, the housing market seemingly bottomed, employment—or, the method in which it is measured— moves in the right direction and taxpayers were made whole their AIG (NYSE:AIG) experiment.

But questions remain that I don’t hear being discussed in many circles:

How Can we Stop the Madness?

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Were the social consequences of our policy directive considered when decisions were made in the heat of a crisis, and what—if anything— can we do to remedy that?

If social mood dictates the price of financial assets, when will this dynamic express itself through the world’s largest, if not entirely free, thermometer that is the stock market?

And now that we’ve witnessed “societal acrimony” and “social unrest,” what awaits us as the final phase of our tricky trifecta prepares for the grand finale?

I am not smart enough to provide these answers but I’m aware enough to ask the questions; for every action there is an equal and (in a leverage finance-based interwoven world) possibly larger reaction, and we would be wise to respect the unexpected.

The Hard Truth

20Answers I Really Wanna Know

At what point does an industrialist become a robber baron?

Or a savvy speculator a profiteer?

At what point does success become privilege?

The answers to these questions have profound implications for the future of free-market capitalism in an intertwined finance-based global economy.

If calmer heads don’t prevail, the bottom line might be the least of our concerns.

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2012

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2013

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S&P 500 Index 1995-2013

2412 Cognitive Biases That Endanger Investors

1. Confirmation Bias

This is a fatal flaw of trading; we tend to surround ourselves with information that validates our own point of view and dismiss input that conflicts with our reasoning (also known as cognitive dissonance). This is the primary reason why we always strive to see “both sides of every trade” as the residual grist between variant views is where education—and profitability—resides.

2. In-Group Bias

This is a manifestation of confirmation bias, or the tendency to surround ourselves with those who share similar takes on the tape. This could pertain to our physical environment or a virtual experience, such as Twitter. Not only does this provide a false sense of security in our individual viewpoints, it makes us suspicious—or angry—with outsiders who dare to question how we feel. (See also: The Gold Scold.)

3. Gambler’s Fallacy

One of the most famous disclaimers in finance is that past performance is no guarantee of future results. This bias is often referred to as a “glitch” in our thinking in that it extrapolates what happened in the past to construct an idea of what will happen the future. How many of you have played roulette at a casino under the premise that a string of red increases the likelihood of a black outcome? That’s flawed thinking; the odds of red (or black, for that matter) or 48% on each independent spin.

4. Post-Purchase Rationalization

One of our Ten Trading Commandments is that the definition of an investment should never be a trade gone awry. Nobody initiates market exposure expecting to lose money, but we should never post-rationalize our risk (such as ignoring stop-losses or throwing good money after bad). We would be wise to remember that good traders know how to make money but great traders know how to take a loss.

5. Neglecting Probability

History is littered with stretches where in hindsight we’re reminded not to confuse brains with a bull market. This bias limits our ability to properly assess risk, whether it’s overstating an unlikely event (such as buying a stock for a takeover) or understating an unlikely event (such as Y2K, the fiscal cliff, or a terrorist attack). Tail events do happen, of course, but betting on an outlier is a long shot by its very definition.

6. Observational Selection Bias

This is when we suddenly notice something we haven’t noticed before, and wrongly assume the frequency has increased (when it hasn’t). Let’s say I bought cannabis stocks as a way to play (what I perceive to be) the legalization of marijuana. All of a sudden, everywhere I look, there are more and more signs that support my thesis; the topic is featured on 60 Minutes, it’s a hot-button issue during the election, it gained momentum in the mainstream media. While some of that may prove true, I am on the lookout for news, whether it’s conscious or not.

7. Status-Quo Bias

Most of us are creatures of habit in our own way; we use the same toothpaste or align with a particular smartphone device. That routine often extends to our investments in the marketplace; we’re comfortable with the stocks (or indices) we often trade and often miss opportunities outside of that comfort zone for fear of the unknown. Change isn’t only positive, it’s inevitable.

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8. Negativity Bias

Let’s face it: We live in a sensationalist society where scare tactics and negative headlines garner the most attention. If you doubt this for a minute, turn on your local news tonight. Scientists theorize that we perceive negative news to be more important than positive news. The risk—for the bears and for humans as a whole—is the tendency to dwell on bad news rather than embrace good news, and there’s the added twist that the stock market is widely considered to be a leading indicator.

9. Bandwagon Effect

How prevalent is this when it comes to the financial markets? They teach it in college as a stylistic approach (momentum investing)! Nobody in our business—or in the media—wants to miss a move in the stock market, and history is littered with bubbles and busts that demonstrate this bias in kind. In life, this is driven by our innate desire to “fit in and conform"; in the markets, it’s driven by two factors: fear and greed.

10. Projection Bias

This is predicated on projecting our thoughts and beliefs onto others and assuming that others are wired the same way (they’re not). This can lead to "false consensus bias," which not only assumes that other people think like we do, but that they reach the same conclusions. In short, this creates a false consensus, or sense of confidence when in fact one doesn’t, or shouldn’t, exist.

11. The Current Moment Bias

This is a direct descendent of the immediate gratification mindset that dominated society for many years—and some will argue that the government is currently operating in this mode, mortgaging our children’s standard of living to achieve short-term fixes. In short, we want to live as well as possible and pay for it at a later date (as evidenced by the level of debt and our growing deficit). The housing crisis was rooted in this bias, as is the basic concept of leverage.

12. Anchoring Effect

This tendency, also known as the relativity trap, compares a situation to a limited sub-set of information; it’s when we focus on a number or value and extrapolate it to a current situation. This often manifests in the marketplace through the fundamental metric, when we observe that a stock is “cheap” relative to its peers or a historical precedent (also known as a “value trap”).

Cognitive Biases