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Facebook to have IPO: Worlds Colliding 
“Yeah, I know.”
These words came from my brother, Loring, and their significance was unmistakeable – worlds have collided.
My brother is an actor and filmmaker (quite talented too, www.mcquaidbrothers.com, http://twitter.com/loringmurtha). He is about as far removed from the world of investing as one can get. In fact, I suspect he couldn't name more than one holding in his managed portfolio.
But when I mentioned to him the other day that “Facebook is having its IPO. IPO stands for Initial Pub-“ he saved me the trouble, cutting me off with the statement above.
My brother is not an official MarketPsych Sentiment Indicator. We have REAL ones for that. But he might as well be.
It indicates that Facebook's upcoming stock offering is much more than a financial investment. It's a pop-cultural phenomenon - with all that that entails.
In a story that is perhaps apocryphal, Bernard Baruch said that he knew it was time to get out of the market (pre-crash) in 1929 when his shoe shine boy gave him a stock tip.
In a story that is definitely apocryphal, Baruch also said,"By the time your Mom learns the name of the band, they’re no longer cool."
Why? Because it means EVERYBODY knows. Stocks are like "Indie Bands"; part of their appeal is that not EVERYONE is rushing to see them.
Facebook's IPO will attract an entirely new class - indeed, perhaps an entirely new generation - to equities investing.
By the way, the last time my brother mentioned a stock to me it was Sirius Satellite Radio (SIRI) in 2007. Two years later you could pick up a share of SIRI for a dime. A piece of Bazooka Gum or ownership in the most revolutionary company in radio history? Your choice.
Will that be the fate of Facebook? I hardly think so. But as MarketPsych has long (and correctly) maintained, all stocks prices are the product of the aggregate psychology of the investing community.
What happens to that community when Worlds Collide? When the peaceful, orderly state of Financia is suddenly flooded with wild refugees from the nation of Facebookistan?
(Occupy Wall Street Types created chaos when they invaded the Financial District, imagine what will happen when they actually invade the Financial Markets?)
Strange, often tragic things happen when worlds collide. Just ask Independent George.
I didn’t say unpredictable. Just strange. My MarketPsych colleague and resident genius, Dr. Richard Peterson has created www.MarketPsychData.com to provide uncanny predictions utilizing social media analytics for just this sort of thing.
Ironic, don't you think? Using social media to forecast social media stocks?
Worlds colliding, my friends. Worlds colliding.
Happy Investing.
And hey... let's be careful out there.
-Dr. Frankenstocks.
Frank Murtha, Ph.D. Facebook, Social Unrest, and the Predictive Power of Big Data
Facebook, Social Unrest, and the Predictive Power of Big Data Feb 2012, v2, n1
The Value of Social Media (seriously!) |
I tried to close my Facebook account once. Somehow I continued to receive “Friend” notifications in my email. So I tried to close my account again. The notifications still came. After the fourth attempted account closing, and more Facebook emails, I set up Facebook-to-trash email filter. But I’m the exception, Facebook is generally well-liked.
Facebook has a user population of 845 million - ranking it as the world’s third largest country (if it were a country). Apparently it got that population with some socially manipulative tactics such as emails titled “You have friends waiting” – subtext: “What kind of person are you to keep friends waiting?”). And that’s not to mention their North Korea-style user retention policies.
With a Facebook IPO imminent, this month’s letter focuses on crowd enthusiasm, IPO pricing, the emergence of Big Data and social prediction, and the power of social commentary to predict (drive?) the future. We next show our top ten list of countries with the most social unrest. In our Researcher’s Corner we report on the latest (and greatest) genetic study of traders published last week, and we discuss the science of slippery ethics and why no one has been held accountable for the financial crisis. And this week we offer a nod to Isaac Asimov for his prescient take on the emergence of “psychohistory.”
In addition to our usual haunts of New York and Los Angeles, we will be speaking in Chicago and the San Francisco Bay Area in February – we’re look forward to catching up with our friends in those cities! Next week we have 2 coaching schedule openings on February 9th at 1pm ET and at 4pm ET - if you’re interested in one of those coaching appointments, please reply “coaching” to this email to reserve. |
Facebook and the IPO Conundrum |
Have you ever felt like you had to have something – like really must get some of it for yourself?
In honor of investors excited about the Facebook IPO (and their beleaguered financial advisors), Dr. Murtha created this terrific short video spoof of an investor discussing the "The Facebook" IPO with his financial advisor.
This fear of missing out is the feeling that promoters of IPOs work hard to instill. IPO excitement, seasoned with a dash of fear of not being involved, leads to increased demand for shares, higher investor risk-taking, and of course, a higher opening IPO price.
On the positive side, academic studies show that IPOs were underpriced an average of 22% from 1965 to 2005, which is good for those on the inside – those who get the initial share allocation. But the feeling of excitement engendered by IPO promoters (and often the media) drives many investors to jump into shares in the public market, typically on the first day of trading, where emotional reactions to volatility damage their returns. This data and graphics showing trader performance in Groupon (GRPN), LinkedIn (LNKD), and Pandora (P) shares on their first day illustrates the problem. Since these three IPOs in 2011, first day buy-and-hold investors have lost about 20% on average through the end of 2011. IPO excitement inspires rationalizations: “this time it’s different” (overconfidence) and “if I don’t buy now, I may never get it at this price again” (scarcity).
This is not to disparage Facebook as a company. Facebook is riding the crest of a revolution in communication, community-building, and social prediction. And with their enormous trove of data, they are sitting on very valuable insights.
Fortunately for the financial industry, the excitement surrounding Facebook is likely to rekindle individual investor interest in the stock market, and it may be one factor that drives a nice rally in the stock market this year (in tandem with a year-long real estate bounce and certainty about low interest rates).
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Recent Press:
November 28, 2011. Ted Schwartz. ABCNews.com.
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Big Data and Social Prediction |
At MarketPsych we are at the vanguard of social prediction in the financial industry. We developed predictive models that not only are monitoring the buzz about Facebook, but that use the characteristics of that buzz to predict (and trade) Facebook’s shares. We have spent decades modeling social data and trading on it - our MarketPsy Long-Short Fund LP was successful in using this data to outperform the S&P 500 by 27% from launch on September 2, 2008 to the end of 2010 (when we closed it). It’s not only our firm that does this - there is an entire industry of social prediction based on mining behavioral and psychological data.
But we and many of our customers have problems with Big Data – it’s unwieldy and noisy. Consider that our Macro data feed distributes 30 sentiment and topic data points every minute for major economic sectors and industries (40), Commodities (60), Countries (100), and Currencies (50) in two feeds (one feed derived from social media and one derived from news media). In case you didn’t do the math yourself (and I hope you didn’t!), we’re releasing 15,000 data points minutely. This data deluge is actually a summary of our core data. It is derived from 2 million daily articles, analyzed for the presence of 40,000 entities, and scored into 1600 sentiment and topic combinations – all condensed into the 30 Macro indices to render it “usable” by humans. Here’s the general idea:
Predictive analytics is occurring in every industry. One company - from whom I recently received a “we will hire anyone with a pulse who has statistical skills”-type email - Accretive Health (NYSE: AH) reports mining 1 billion health insurance claims in order to identify trends that can be arbitraged to reduce health care costs while increasing health care delivery. But this newsletter isn’t about Big Data companies per se, it’s about social prediction and how we can do better in our own decision making using the insights we are gleaning from social data. More about Big Data generally can be read in this McKinsey study and here is a great summary of companies in this space on Quora.
While it appears cutting edge, it turns out that social prediction using big data is old news.
Isaac Asimov and Psychohistory |
The other day, after the fifth person in a week told me, “sounds like your data is recreating Isaac Asimov’s Psychohistory,” I decided it was time to investigate.
Now I’m not exactly a science fiction fan, but I do enjoy a good story regardless of whether it occurs in our solar system or Qo'noS. In high school I occasionally wrote book reports on science fiction novels (lenient teachers!). But it was largely a matter of finding Jane Austen a bit too stuffy , not a personal fascination with the other-wordly (Prime Radiant? Psionic Suppressions?), that drove such reading.
So today in Wikipedia I read, “Psychohistory is a fictional science in Isaac Asimov's Foundation universe which combines history, sociology, and mathematical statistics to make general predictions about the future behavior of very large groups of people, such as the Galactic Empire.” Cut off the Galactic Empire bit, and that is EXACTLY what we’re doing at MarketPsych. Go figure. I guess we’ll have to withdraw our “Universal People Prediction Device” patent application – Asimov beat us to it.
(I actually started reading the third book of the Foundation Trilogy in eighth grade. But as it’s best not to start a trilogy on the third book, and the concepts were obtuse to me, I put it aside. But I wonder if it didn’t plant a seed…)
Macro Indices: Country-level Social Unrest |
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In addition to economic sectors, stocks, and commodities, few people know that we also monitor social and psychological phenomena by location - cities and countries. For example we have indices of “Social Unrest” related to negative chatter about national governments, authorities, and business leaders in social media. It’s likely this data will prove to be predictive of social events, although we may not have enough unrest incidents (thankfully) to test it thoroughly.
Per an informed source, China experienced 160,000 significant social protest actions last year (from tens to hundreds of thousands of citizens participating). Many of these actions could be (briefly) detected in social media, but they were not revealed in news media due to Chinese government concern about social stability. As a result we are not only tracking news media unrest mentions (since these are censored), but perhaps more importantly, we pick up on psychological predictors of unrest in social media. Such predictors include expressions of anger and frustration towards authorities and mentions of personal hopelessness (a positive predictor of impulsive violence).
Here is our top ten list of Countries with the most buzz about Social Unrest in the English-language media recently:
1 Egypt
2 Somalia
3 Libya
4 Syria
5 Yemen
6 Sudan
7 Nigeria
8 Pakistan
9 Israel
10 China
While social unrest is related to social forces often out of our immediate control, we can gain control how we prepare for and manage ourselves when experiencing setbacks if we understand our propensities to reaction. Genetic and hardwired cognitive biases play a role in our responses to loss, as you can see in today’s Researcher’s Corner, but such factors are by no means deterministic. We can intelligently use our minds to make better decisions.
Researcher’s Corner: Trader Genetics |
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The authors took genetic samples from 60 Wall Street traders in 2008 before the market meltdown. They found that traders with genes conferring moderate dopamine tone were more likely to have longer careers as traders. The longetivity of traders (the study’s dependent variable) was correlated with fewer D4 receptors and also less catabolic (enzymatic breakdown) of dopamine, theoretically leading to higher tonic levels of dopamine and less variability per receptor over time. This dopamine environment might lead to more stability during the ups and downs of trading and should be correlated with behaviors such as less trading in volatile markets (which the authors found) and perhaps more emotional and analytical equilibrium.
The authors conclude: “Combining the personality analyses and genetic findings from the present study, reveals that our sample of traders are analytical, integrative, and can delay gratification. They have a genetic profile associated with balanced levels of dopamine.” As we gather more data we may see additional interesting results.
Researcher’s Corner: Blind Spots in Financial Ethics |
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Last Friday I attended a talk by one of my academic heroes – Harvard GSB professor Max Bazerman – on the subtle cognitive biases that underlie unethical behavior. He has a new book out called Blind Spots which is a fascinating account of his research. Bazerman introduced the topic by explaining that MBA students are taught ethics through case studies that profile high-impact criminal behavior, yet the vast majority of unethical behavior is not obvious or dramatic at first. It is subtle, gradual (slippery slope), and permitted to some degree by observing others. As he points out, the standard MBA ethics education – which focuses on high-profile criminal cases, but not common unethical behavior - is inadequate. In some ways Bazerman’s research gets at the underlying causes of the financial crisis and contributes to our understanding of why no one has been criminally convicted. Bazerman provided behavioral evidence of such socially important biases as 1) The unethical practices of auditors - by which independent auditors are blinded by their desire for ongoing income into gradually “cooking the books” of their clients, 2) The slippery slope by which most unethical behavior progresses, as our minds gradually rationalize misbehavior, 3) The process by which observers will permit minor unethical behavior with no compensation or kickbacks at first, ultimately putting themselves in a bind as serious violations mount and they feel unable to speak up after a history of silence, 4) How people judge ethical violations as less “bad” than ethically proper behavior that ends with worse result, 5) People judge anything that personally benefits them as less unethical, 6) Losses accelerate unethical behavior – similar to the disposition effect – in which people are also more likely to break the rules to get back to even, 7) And amazingly to me, people judge others hiring a proxy to do their ”dirty work” as significantly less unethical than doing the dirty work oneself.
Some of these biases explain, in part, why rogue traders begin and can escalate their misdeeds – collaborators looking away with good results (at first) lubricating further off-the-books trades, a slippery slope of small accumulating losses accrues, and losses accelerate unethical rule-breaking (disposition effect), and finally the climactic blow-up occurs. The same process explains the social, financial, and government biases that gradually allowed the housing bubble and bank risk-taking to grow to huge proportions.
As Bazerman points out, simple self-awareness only slightly ameliorates most cognitive biases. Per Bazerman the best (and only proven) solution to such biases is to reform institutions to help us be less harmed by our biases – the “Nudge” example of Richard Thaler. I would add that 1) learning about the nature of biases and 2) gaining specific self-awareness of biased decisions - by working through bias examples in one’s own decision making including practicing alternative decision strategies – also appears to reduce biasing.
Escaping the Pull of the Herd |
Given what we’ve learned above – that IPOs lure naïve investors in due to hype and fear, that big data and social prediction is altering our future trajectory, that researchers have identified that moderate tonic dopamine levels can prevent us for falling for such hype and volatility as that around IPOs (and thus be better investors), and that our biases and Blind Spots are prevalent and explain some social trends and events like the financial crisis. The result of all this data and new understanding is a science of prediction (once called PsychoHistory by Isaac Asimov). Given all this, what are we as investors to do?
Based on emerging evidence of the role of genetics and hardwired biases influencing decision making and performance, in combination with awareness (always a first step), external behavioral “nudges” are the best tools we have for setting up an optimal bias-lite decision environment. Secondly is practicing self-awareness and working through biases in one’s own decision making (at MarketPsych we have developed workbooks for this practice).
Let’s consider an example of how we can use our knowledge of biases to improve our decision making. We know from Bazerman’s research that financial losses predispose us to violate rules (e.g., not honoring stop-loss rules, anyone?). One solution to this misbehavior is to plan ahead – one can enter automated stop-losses at the time a buy order is entered, before they are put in the position of biased thinking such as, “Will this falling investment rebound? Of course it will. Clearly there’s no need for that silly little stop-loss at this level.”
For financial advisors one application relates to their increasingly common role as an emotional coach for their clients. Advisors often need a nudge to engage with clients when they themselves are feeling beleaguered by falling markets. Advisors can set up their daily routine to incorporate simple tricks like seeing clients in the mornings or have interactions scheduled after refreshing activities like exercise or enjoyable activities. (We have many more ideas for advisors – contact us for more information).
We will be speaking in the San Francisco Bay Area next week (two classes at Stanford and two progressive corporations) as well as in New York at a Risk Management conference and in Chicago in February 2012. Contact us if you’d like to attend or you are in one of those cities and would like to meet.
We also have speaking and training availability for your firm or organization in late April. Please contact Dr. Peterson or Dr. Murtha for more information.
Best Wishes for 2012! Richard L. Peterson, M.D. and The MarketPsych Team
Books
Both books named "Top Financial Books of the Year" by Kiplingers.
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Disclaimer
This material is not intended as and does not constitute an offer to sell any securities or a solicitation of any offer to purchase any securities.
The information of the MarketPsych Report is presented free of charge. It is no substitute for the services of a professional investment advisor. Investments recommended may not be appropriate for all investors. Recommendations are made without consideration of your financial sophistication, financial situation, investing time horizon, or risk tolerance. Readers are urged to consult with their own independent financial advisers with respect to any investment. Past performance is no guarantee of future results. Screen and model signals and related analysis are for informational purposes only and should not be construed as an offer to sell or the solicitation of an offer to buy securities. Most financial instruments (stocks, bonds, funds) carry risk to principal and are not insured by the government. Anyone using this newsletter for investment purposes does so at his or her own risk. Data accuracy cannot be guaranteed. Opinions and analyses included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty, expressed or implied, is made as to their accuracy, completeness, timeliness, or correctness. We are not liable for any errors or inaccuracies, regardless of cause, or for the lack of timeliness of, or for any delay or interruptions in, the transmission thereof to the users. As a matter of policy, we may act upon the investment information that this newsletter provides prior to making it available to the public. We do not accept compensation of any kind from any companies mentioned herein. MarketPsych is not responsible for any special, indirect, incidental, or consequential damages that may result from the use of, or the inability to use, the Information contained on this newsletter whether the Information is provided or otherwise supplied by MarketPsych or anyone else. Notwithstanding the foregoing, in no event shall MarketPsych total liability to you for any and all claims, damages, losses, and causes of action (whether in contract or tort or otherwise) exceed the amount paid by you, if any, for accessing this newsletter. MarketPsych expressly disclaims all warranties and conditions with regard to the Web sites, their Content, and the Information, including, without limitation, all implied warranties and conditions of merchantability, fitness for a particular purpose, title, and non-infringement. By using the Web site, Content, and Information, I assume all of the risks associated with their use, and I release and agree to indemnify and hold harmless MarketPsych from any and all liability, claims for damages, and losses arising from or connected with such risks. IF YOU DO NOT AGREE WITH ANY OF THESE TERMS AND CONDITIONS OR FIND ANY OF THEM TO BE UNACCEPTABLE, SIMPLY UNSUBSCRIBE FROM THE EMAIL LIST. If you understand and accept these caveats, feel free to read the newsletter.  Using Reason+Emotion to Forecast 2012
| 2011: An Emotional Year |
Needless to say, it was an emotional year in the financial markets, and most investors underperformed substantially. Since emotional markets are why we're here at MarketPsych, this month's letter will share our latest insights, lessons, and fascinating charts to help our readers going forward.
First of all, uncertainty is guaranteed to continue, with Europe's debt unresolved, U.S. political gridlock, and a potential hard-landing in China. Fortunately, as you read below, you will see that uncertainty is predictive - in a counter-intuitive way.
Before we launch into today's discussion - while our schedules are filling, we still have availability for consultations and trainings in the first two weeks of February, so please reach out if you'd like some personal or organizational attention. |
| The MarketPsych "Awards:" Not What We Thought |
In December we launched the 2011 MarketPsych Awards: identifying the Most Trusted Bank (WTFC), Most Innovative Tech Company (SNPS), Most Loved Consumer Products (STKL), and others based on social media chatter in 2011.
But a word of warning for investors about these Awards. We ran a predictive analysis of what happens to top ranked companies going forward, and the results are mixed. In fact, past winners of the Most Loved Consumer Products award under-performed the market by -2% on average the following year, while least-loved consumer product companies outperformed by 10%. This effect - where loved stocks fall and the unloved rise - reflects an old Wall Street aphorism - a "great company" rarely makes for a "great investment."
So if loved companies aren't the best investments for 2012, then what does predict stock prices going forward?
Answering this question became our mission in December.
Our analytic team aggregated the past 13 years of social media chatter by year for 8,000 publicly traded U.S. companies. Then we identified the topics and psychological factors expressed online about the company that were most predictive of company stock prices in the following year.
Some Background: Over the past 8 years the MarketPsych team developed the most sophisticated financial textual analysis software commercially available. Every day we quantify hundreds of sentiments, topics, and tones in 1.8+ million social and news media articles. |
For our study we examined a universe of about 2,000 highly discussed stocks, each year since 1998, with market capitalization over $1 billion. We ranked each stock for each year relative to all other stocks using our Big 21 Macro Sentiment Indices. We then grouped the stocks into deciles for each year based on their sentiment rankings and averaged the returns for each decile over the following year, from 1998 through 2010.
We compared returns vertically (stepwise across deciles),horizontally (across sectors such as Materials, Tech, Consumer, Healthcare, etc...) and over time to ensure consistency. Nonetheless, this isn't a rigorous study, and it is susceptible to over-fitting. We did it for fun and not for trading (we use a different in-house testing technology for investment strategy research).
Investors are Smarter When They Think...
Our indicator FundamentalStrength, which measures the amount of positive versus negative accounting mentions in social media was most predictive of future returns. Stocks in the highest decile of positive accounting discussions (FundamentalStrength) showed 14% out-performance, while the lowest decile showed -5% market under-performance. The results were even stronger for tech stocks, with the highest decile of tech stocks outperformingthe market by an average of 18% annually in the subsequent year, while the decile with the lowest FundamentalStrength under-performed by -7%.
Another index with interesting results was EarningsExpectations, which measures online predictions of positive versus negative earnings reports. The highest decile - with most positive earnings expectations - shows 10% out-performance versus the overall market the following year, while the lowest decile shows -3% under-performance.
...But When Excited, Their Predictive Power Lags
Our initial results indicate that investors analytically discussing company fundamentals in financial social media can be predictive of future returns, but does their expressed emotion also predict future performance? First, an investigation into the seasonal dynamics of investor emotion. |
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| The Happiest Time of the Year |
December IS the happiest and most optimistic time of the year for investors, based on our data. The red lines below are the average optimism for every year over the past 13 in social media (using the X-12-ARIMA method and courtesy Aleksander Fafula, Ph.D.).
 To be sure we weren't just capturing mutual well-wishers on stock message boards and Twitter (Happy New Year!, etc...), we looked at the data again with only future-oriented statements - what we call Outlook (Optimism - Pessimism). December is at the top (although not as dramatically) in that graphic as well.
And what month contains the most distaste?
 In addition to being low in Joy, September sees the highest average of hateful, spiteful and angry language over the past 13 years. |
| Forecasting with Emotion+Reason |
Now back to forecasting with our Emotion Macro Indices. We have nine of them, including Anger Joy, Uncertainty, and others. The most striking predictive results across sectors and years occurred for Anger (sadly a common emotion among investors these days) and Uncertainty. High Anger stocks (top decile) underperformed the market by -2%. Anger is generally reactive, so perhaps bad news is priced-in quickly. Stocks with little angry drama among their investors (or at least little anger expressed in social media) outperform the market by 10% in the following year.
Another "emotion" category - defined as such for the anxiety it provokes - is "Uncertainty." The high-decile Uncertainty stocks outperform by 6% annually - perhaps due to investor reluctance to invest until the uncertainty is resolved ("probability collapse" in the jargon). Low-decile uncertainty stocks - perhaps swarmed by overconfident and too-certain investors - underperform the market by -7% annually as their cherished stability is revealed to be more fragile than expected.
When the best of our indices are combined into a single ranking index, their predictive power increases and becomes more robust, The combination demonstrates 9% outperformance and -11% underperformance for the top and bottom deciles, respectively, over the following year. We then used this single index to organize predictions for 2012.
Predictions for 2012 (SEE DISCLAIMER - PLEASE DO NOT TRADE THESE - WE DO NOT HOLD POSITIONS IN ANY OF THESE).
Potential outperformers based on our basic analysis are the following: 1. Royal Bank of Canada (RY). Canada has strong banks, the U.S. does not, what can I say? Opportunity here (but beware commodity bubble in Canada). 2. Seabridge Gold, Inc. (SA). Gold miner - underperforming industry this year. Rebound candidate? 3. Tessera Technologies Inc. (TSRA). Semiconductor Equipment. 4. MGIC Investment Corp. (MTG) - Mortgage insurance (really?). Stock down, housing market is recovering. 5. Natural Resource Partners LP (NRP) - high dividend (7.9%) coal mine leaser.
For 2012 we see a few surprises as potential underperformers. 1. Yum! Brands (YUM) is at the bottom of our list, perhaps due to China exposure, where a bubble is predicted to deflate over the next year. 2. McDonald's Corp. (MCD) is the second from the bottom. Chipotle and other upstarts are eating MCD's lunch. 3. Delta Airlines (DAL), Procter and Gamble (PG), and one I struggle especially to write, CenterPoint Energy, Inc. (CNP) round out the bottom five. Centerpoint has a 3.9% dividend, positive price momentum, and a P/E of 6. It's REALLY difficult to consider selling CNP short as a good idea.
Many of these were totally unexpected (verging on psychologically disturbing) stock predictions.
After creating our ranking system, we decided to test FundamentalStrength tempered by Joyusing ETFs. In the following study, you can see our thought process in deciding how to investigate the role of emotion in financial prediction. |
| ETF Performance: Buy Strong Fundamentals With Low Joy Expressed by Investors |
When we looked at the FundamentalStrength Macro Index (recall it is an aggregation of positive versus negative accounting-related conversation), we found that it had variable predictive capability- it was rendered less effective when positive emotion was associated with high values. Just as with the "Most Loved Consumer Products," investor excitement destroyed the predictive power of positive accounting news.
It turns out that when people are excited that they are going to make money, they have activation in the brain's reward system. After all, if we feel excited and happy, it must be coming from somewhere.
Importantly, that same excitement leads to a reciprocal deactivation in the "loss avoidance" areas of the brain. That is, when we're excited that we've found a good opportunity to make money, we become less able to detect risk. Just when we need it most, our ability to see and process potential dangers is turned down. All systems GO! with no ability to turn back. The following image demonstrates this effect in the lab.
We decided to explore this effect among investors, so we generated a hypothesis. Perhaps investors become too excited about the FundamentalStrength (accounting fundamentals such as earnings, returns, margins, balance sheets) for some sectors and industries, or perhaps their excitement about the sector causes them to project over-optimistic accounting results into the future.
To explore whether this was occurring, we gathered a group of the 40 most liquid long-only ETFsincluding sectors such as utilities and consumer staples, industries such as gold miners and clean energy, and indices such as the Nasdaq 100 and the Russell 2000.
We then looked at the performance of the ETFs over the next quarter for two cases. We looked at ETFs with an above average FundamentalStrength AND above average Joy (a.k.a. excitement, enthusiasm) VS. ETFs also with above FundamentalStrength BUT with below average Joy. The idea is that ETFs with happy investors are likely to have good news already priced in, and to have investors blind to risk, while the others are under-appreciated and more realistic.
Sure enough, we see exactly that effect among all ETFs with high FundamentalStrength - less-loved ETFs outperform over time.
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The Best Leading Indicator
As we watch financial news, it is common for our unconscious emotional state to shift from news story to news story - across a spectrum from joy to anger to fear - depending on the message of each story. As these shifts occur, the brain shifts its decision-making from primarily neo-cortex (analytical) to primarily limbic (emotional). And most importantly, this shift to emotional decision making is unconscious.
After such a shift, our rational brain (neo-cortex) believes that it is responding to financial circumstances and information as before, but in actuality it has been "emotionally primed" and is reacting to events from within an emotional frame.
We can see the consequences of this effect in our own behavior. After hearing frightening news, we react with more caution, after joyous news, we take more risk. The effect is evident in today's MarketPsych Report research. When investors are using their neo-cortices to formulate analytical decisions based on earnings and fundamental data, their forecasts are generally correct. When they use emotion to guide their decisions - buying a stock because they feel good about it - they underperform.
MarketPsych coach Richard Friesen uses "Mind Muscles™" exercises to help clients build on their decision strengths. The "Awareness Muscle" exercise will teach you to become aware of when the locus of your decision process is shifting from the neo-cortex to the limbic centers. Email info@marketpsych.com with "Awareness" in the subject line and we will send you the exercise.
Richard Friesen still has sessions available on Tuesday, January 10th at 11am ET and 1pm ET and on Friday January 13th at 4pm ET.
Next newsletter we will introduce "Extreme Event Mind Muscles™" which will teach you what to do once you've become aware of an emotional shift. Given 2012's financial and political risks, it's important to plan ahead now - no one wants to be the deer in the headlights!
We also have training availability for your firm or organization in the first two weeks of February. Please contact Dr. Peterson or Dr. Murtha at info@marketpsych.com for more information.
Best Wishes for 2012! |
Richard L. Peterson, M.D. and The MarketPsych Team
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DISCLAIMER
This material is not intended as and does not constitute an offer to sell any securities or a solicitation of any offer to purchase any securities.
The information of the MarketPsych Report is presented free of charge. THIS ADVICE IS WORTH WHAT YOU PAID FOR IT. It is no substitute for the services of a professional investment advisor. Investments recommended may not be appropriate for all investors. Recommendations are made without consideration of your financial sophistication, financial situation, investing time horizon, or risk tolerance. Readers are urged to consult with their own independent financial advisers with respect to any investment.
Past performance is no guarantee of future results. Screen and model signals and related analysis are for informational purposes only and should not be construed as an offer to sell or the solicitation of an offer to buy securities. Most financial instruments (stocks, bonds, funds) carry risk to principal and are not insured by the government. Anyone using this newsletter for investment purposes does so at his or her own risk.
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 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  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.  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.
'"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 info@marketpsych.com).
And my partner, Dr. Richard Peterson's amazing sentiment data over at http://www.marketpsychdata.com/ 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  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 www.marketpsychdata.com, 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!
Richard 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  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!
Richard 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.
MARKET PLUNGE
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.
LOSS OF CONFIDENCE
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 marketpsychdata.com)
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., 2005, Trujillo 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.
DEBT DEATH SPIRAL
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.
HONESTY IN LEADERSHIP
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).
UNPLEASANT REALITY
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 VERSUS STIMULUS
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.
RESTORING CONFIDENCE
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?
EUROPEAN OUTCOMES
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).
NEXT STEPS – INVESTING  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.
TRACK RECORD We're happy to say that our big (and publicized) macro calls, based on sentiment analysis, have been correct in the past 12 months: 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, Richard  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!
Richard  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!
Richard  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
 Quick MarketPsych Mention MarketPsych gets a quick mentino over at the Smartmoney blog, courtesy of Kelli Grant.
 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.)
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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.
 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.
NARRATIVES
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 DEBT NARRATIVE
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.
EMOTIONAL CLIMATE
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.
WISDOM OF THE CROWD 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:
WHAT'S NEXT? 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.  DOC HOLLIDAY... 
... 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. (Seriously.) -Dr. Frankenstock
Frank Murtha, Ph.D.  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:
ANGER AND PRICE ACTION
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).
THE TECH BULL
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).
THE PSYCHOLOGICAL TERRAIN
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.
U.S. IS LIKELY TO MISS THE DEADLINE
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.
DOOM 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.
DOWNGRADE?
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.
THE PSYCHOLOGY OF NEGOTIATION
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.
GAME OF CHICKEN
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.
IMPASSE, DOWNGRADE, SELLOFF, REBOUND 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.
SAFE HAVENS FOR $$
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.  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.  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 http://www.marketpsychdata.com/) 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 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  Is the Market Bubble Bursting? (see chart).
BUBBLE-OMETER
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.
PSYCHOLOGICAL PROFILE OF A MARKET TOP
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 CHARACTERISITICS OF A MARKET TOP
- 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”).
WHAT TRIGGERS THE IMPLOSION OF A BUBBLE?
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.
ARE WE AT THE PEAK OF A COLLAPSING SPECULATIVE BUBBLE?
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. 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): http://goo.gl/GnGQH.
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 www.marketpsychdata.com
Happy Investing!
Richard L. Peterson, M.D.  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.
 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- -marketpsych.com 
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