The Story-telling Cycle in Markets

Almost 99 percent you realize is just stories in our minds. This is also true of history. Most people, they just get overwhelmed by the religious stories, by the nationalist stories, by the economic stories of the day, and they take these stories to be the reality.
~ Yuval Hariri, Historian and author of  the books "Sapiens" and "Homo Deus"

Money is probably the most successful story ever told. It has no objective value. It's not like a banana or a coconut. If you take a dollar bill and look at it, you can't eat it. You can't drink it. You can't wear it. It's absolutely worthless. We think it's worth something because we believe a story. We have these master storytellers of our society, our shamans — they are the bankers and the financiers and the chairperson of the Federal Reserve, and they come to us with this amazing story that, "You see this green piece of paper? We tell you that it is worth one banana."
~ Yuval Hariri

“It’s a motivated decision to say ‘no’ to learning available but unwanted information ....  People avoid information if it’s going to make them feel or behave or think in a way they don’t want to”—especially any evidence that could jeopardize their belief in their competence and autonomy or could require taking difficult or prolonged action." 
~ Jason Zweig citing Jennifer Howell, a psychologist at Ohio University, in his excellent column in the WSJ

On the first trading day of this year Valentijn van Nieuwenhuijzen’s laptop pops open.  He sees right away that something special is going on. The MarketPsych Indices, the system by which NN Investment Partners [formerly ING] measure sentiment in the market, are coming in…words that are associated with stress and gloom course through digital media...

The main strategist of the Dutch asset manager, with € 187 billion under management, taps the brakes: he reduces investments in shares and raises more cash. Later that week the stress spreads: worldwide stock markets went down sharply...

~ Lenneke Arts & Jeroen Groot.  February 28, 2016.  “Beleggen met big data wordt langzaam gemeengoed.” Financial Daily.  (Translated from the Dutch).

Switzerland, Neurofinance, and When to Sell in a Bull Market

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing."
~  Chuck Price (then CEO of Citigroup) to the Financial Times on July 9, 2007. 

"The current level of the CAPE ratio 'would suggest reducing your holdings of stocks, especially for a long-term investor. We can't time the market accurately, but we know that when it's this high, over the long term, it usually doesn't do great.'"
~ Robert Shiller quoted in CNBC, February 24, 2017

"Merchant: In this chaos of opinions, which one is the most prudent?
Shareholder: To go in the direction of the waves and not to fight against the currents."
~ Joseph De La Vega.  1688.  "Confusion de las Confusiones."  (The first book about the operations of a stock market, the Amsterdam Exchange).

Is Trump Playing Crazy? Negotiation, the Game of Chicken, & Dollar Sentiment

To achieve their mating goals, male elephants will sometimes play games of chicken, with one individual essentially giving the impression that he is crazy and has become an irrational player in a game premised on shared rationality and predictability.
~ Professor David Barash, Op-Ed in the NYTimes, 2011

Fittingly, this Year of the Rooster corresponds with a surge in a cock-inspired game in international negotiations: playing chicken.  

As a young man I occasionally stood on the bridges across the Rio Grande, practicing Spanish and watching Mexicans commute to work in the United States.  They bagged their clothes, paid a peso or two to a man with an inner tube, and were gently pulled across the river under the eye of inert border patrol agents. U.S. customs wasn't apparently concerned enough to intervene.  I myself climbed under the fence or waded the river a few times out of convenience or curiosity.  Even the Laredo, Texas INS chief's nanny was well-known to commute to work that way.  In subsequent years the border has obviously tightened.  And now we're hearing about The Wall, whose conception has badly punished the Mexican Peso and local stocks.

As active investors it is our job to predict trends and reactions in global economies and markets.  Donald Trump's spontaneity has introduced a degree of unpredictability to our work.  His negotiations around trade agreements, immigration policy, tax policy, military arrangements (NATO), and budgetary allocations are all going to be significant  to the markets over the next year.  Whether one agrees with Trump's proposals or not, it's important to know how he will pursue them, when he will go full force, and when he might back down.  

Trump's tactics are familiar - and perhaps predictable - to students of game theory.  Today's newsletter looks at this important topic - one we have addressed previously - the psychology of negotiation and playing chicken.  Later we look at a turn in U.S. Dollar sentiment around the U.S. election and its aftermath.

Game Theory in the Real World

John Nash is the subject of the Academy Award-winning movie "A Beautiful Mind" and the father of Game Theory involving multiple equilibria in non-cooperative games - exactly what we need to understand the psychology of playing chicken.  

It's a tactic that works surprisingly well, because male elephants can in fact become temporarily "crazy". One of the most terrifying sights in the animal world is an elephant in a state of must: Huge bulls, oozing a weird, foul-smelling, greenish glop from glands near their eyes, behave with violent abandon, taking risks and defying the basic rules of pachyderm propriety (and also giving rise to the term "rogue elephant"). Facing an elephant in must, other elephants — not to mention people — are well advised to get out of the way.

Dr. Barash explains that by playing chicken - as Donald Trump may be inclined to do as he renegotiates terms of existing trade agreements - low-power players can extract additional concessions due to their hardliner stance.  As he puts it, "The trick to winning is for one player to convince the other that under no circumstance will he or she veer off course."  Dr. Barash continues, "Another tactic, favored by the strategist Herman Kahn, is to "throw out the steering wheel," to demonstrate that you are locked into a certain path and can't swerve."