What Good Are Parasites? Greek historian Herodotus reported that the ancient Egyptians used enemas three days per month along the lunar cycle because they are 'convinced that all the diseases incident to man have their origin in the food that he takes'. ~ Gaisford. 1846.  The nine books of the history of Herodotus. (Cited in Intestinal microbiota, probiotics and mental health.)      The first time I visited Russia was in 1992, and the U.S.S.R. had recently broken apart.  I overstayed my visa - I had entered on a visa for the Soviet Union, but it no longer existed - so I was able to wander around Russia and Central Asia for a few weeks enjoying the fascinating disorganization of the political transition.    Toward the end of my travels in Russia I encountered an old woman sitting on the sidewalk who was selling a single basket of dirty strawberries.  That's all she had - one basket of red, dirty, strawberries sitting in the middle of an otherwise empty tablecloth.  I hadn't seen any fresh fruit or vegetables up to that point - these were still the years when all fruit and vegetable production went into State-owned factories and emerged peach-colored and flavorless in brown jars.  (All jarred fruit in the USSR - regardless of whether it entered the factory as a strawberry, pear, or mango - emerged from the cans peach-colored and flavorless).  So craving fresh fruit, I quickly bought the dirt-covered strawberries, scraped off a few chunks of dirt, and popped one into my mouth.    The strawberry seller said something urgently to me in Russian, but I didn't understand.   I smiled at her.   I proceeded to gulp down another strawberry.  At this point several of the vendors around her were also talking to me rapidly.  I smiled bigger - my default traveler strategy when not comprehending what was happening - and ate a few more strawberries.  They looked at me with a mixture of astonishment, mirth, and concern.   I was accustomed to being watched with astonishment and mirth, but their concern was unsettling.  Nonetheless, I had no idea what they were trying to tell me, so I left with a spasiba! and a wave.  As I walked away the vendors tried to smile at me, but I thought I could see their smiles distorted by underlying grimaces.  They were trying to tell me something, I realized.  Something was wrong, but what?   The next day I felt a sharp pain in my abdomen, and I involuntarily doubled-over while walking.  The stabbing pain went away for a few minutes, but then three stabs of pain returned.   Within an hour I was hosting a knife-fight in my gut.  By the end of the day each wave of pain led to an explosive event.  And as I soon discovered, I had eaten a strawberry covered in human feces.    But more on that later.   This month's newsletter is inspired by a paradigm shift underway in modern medicine.   Research into the complex relationship between our diet, our gut microbiome, and our mental and physical health is redefining how we understand human biology.  This new understanding has profound implications for how theorists model financial markets and investor behavior.   This newsletter first examines the science of the microbiome-gut-brain axis.  We then go on to explore implications of this new understanding for how we think about markets, regulations, and insider trading.  In the Researcher's Corner we example an often neglected side of the feedback loop between market prices and investor behavior.  We then discuss what you can do to optimize your own health based on the latest science.  And finally we review recent psychology-based investment ideas.

Youth on the Rise   "The very basic core of a man's living spirit is his passion for adventure. The joy of life comes from our encounters with new experiences and hence there is no greater joy than to have an endlessly changing horizon, for each day to have a new and different sun." ~ Christopher McCandless, subject of Jon Krakauer's documentary novel and dramatized film "Into the Wild."   Christopher McCandless was intelligent and accomplished, yet after graduating from Emory University in 1990 he abandoned his material possessions.  McCandless adventured in the wild areas of the western United States for two years, and like a modern-day Thoreau, he journaled his thoughts on life, nature, and love.  In 1992 he hitch-hiked to Alaska, where he spent a summer living off the land in a remote wilderness.  It was in that place he died.  His writings often explore a return to simplicity, and for that he remains an inspiration to those disillusioned with the rat-race.   McCandless adopted a free-spirited, non-materialistic existence during a time of economic malaise in the United States - the early 1990s recession.  The S&L crisis had exposed a deep vein of banking mismanagement.  College graduates had difficulty finding employment, with Physics PhD's working as baristas to make ends meet.  Some disillusioned youth hit the road like McCandless, wandering off-the-grid.   Youth in emerging markets such as Turkey and Brazil are disillusioned in a fashion similar to what American youth experienced in the early 1990's.  Street protests and capitalist-backlash are a symptom of such economic malaise.   As our S&P 500 Bubbleometer showed in our last monthly newsletter, the U.S. market was vulnerable to a catalyst that would trigger a downside reversal.  Bernanke's comment was the trigger.  Our weekly commentary reported that the sell-off was likely to extend, as the flames were blown from market to market ... and they did, hitting Brazil especially hard.  Now we're nearing a short-term turning point.    The key to MarketPsych's unique research is an empirical understanding of how information and emotion affect investor behavior.  To understand social unrest, it helps to peer inside a disappointed brain.  In today's letter we examine how disappointment is generated on a brain level to explain the psychology of the protest movements in Brazil and Turkey.  Then we move on to discussing the nature of bubble formation and trends.  Finally, we examine how understanding the psychology of under-reaction and trend-formation can make you a better investor.   We are very excited to launch our new website!  We encourage you to explore the site to make the most of our research and tools.  On the basic level, our top lists identify hot spots for fear and optimism across equities and markets.  Dashboards allow rapid comparisons and analysis of sentiment and macroeconomic themes across assets.  For professionals, our charting tools allow users to investigate how sentiment and macroeconomic themes affect prices, and help users avoid over-crowded investments (saavy investors avoid the consensus).  Our researcher platform offers research white papers, weekly updating U.S. equity, currency, and country investment strategies, and a daily-updating 12 country PMI model to help traders see global economic activity in near real-time.  We are continually adding new content.  Please reach out with any suggestions that would make the site more useful for you.

Betting Against the Trend   "On August 18, 1913, at the casino in Monte Carlo, black came up a record twenty-six times in succession [in roulette]. ... [There] was a near-panicky rush to bet on red, beginning about the time black had come up a phenomenal fifteen times. In application of the maturity [of chances] doctrine, players doubled and tripled their stakes, this doctrine leading them to believe after black came up the twentieth time that there was not a chance in a million of another repeat. In the end the unusual run enriched the Casino by some millions of francs." ~ From FallacyFiles.com: Darrell Huff & Irving Geis, How to Take a Chance (1959), pp. 28-29.   A precious metals bullion dealer called me last year inquiring if I'd do an interview on his radio show about the psychology of precious metals prices.  He explained that his customers are irrationally fearful of buying, and he was hoping I would soothe his listeners using something out of my psychological "bag o' tricks."  (Note:  before you email me that this is unethical, yes, I'm aware of that, and I don't do it).   The broker said he was extremely bullish on metals prices.  When I asked why he was bullish, he explained, "Silver is at three-and-a-half year lows, it can't go any lower..."  So I asked, "Why not?" and he barraged me with aggressive and profoundly confident assertions: "The U.S. Mint ran out!  The demand is far greater than the ETF is holding - they own futures!  Silver is an industrial metal and is not recyclable!  Retail demand in India and China is just beginning!"    This was the same biased reasoning about silver (and gold) that I heard from others in 2011.  When such projective statements are asserted aggressively and without self-consciousness, it is a sign the bubble hasn't fully deflated.   The broker expressed a number of cognitive biases in his thinking about precious metals.  I'll discuss one here - the Gambler's Fallacy - since it is being uttered by true believers in many quarters currently:  the U.S. stock market ("can't go any higher"), precious metals and Brazil ("can't go lower"), and the Euro ("can't break up") to name a few.   The Gambler's Fallacy is a bias in which investors underestimate the ability of a streak to continue, and as a result, they begin to forecast its reversal based on the length of price action in one direction alone.  The reasoning of those embroiled in the Gambler's Fallacy sounds like, "It can't keep on going like this." It is a deeply ingrained bias, and as seen in the opening quote, enriches casinos in Roulette and other games such as Blackjack: "my losing has to turn around!"    On the market-level, the Gambler's Fallacy may influence group behavior, as evidenced by price action around series of events, such as earnings surprises.  The authors of this experimental study show how prevalent the Gambler's Fallacy is, and they differentiate it from the "Hot Hand Fallacy" in which streaks are expected to continue due to a talented human with a lucky "hot hand."    Today's newsletter examines how the Gambler's Fallacy permeates reasoning about current market activity in the U.S. stock market, Brazil, and the Euro.   Join us for a free webinar on Friday May 24th at 8am EST on Sentiment-Based Global Investing:  "Inside the Global Brain: How sentiment trends in news and social media influence global equity and currency values."  Register here.

Fake Tweet and Tremor in Markets "Rothschild coaches careered down highways; Rothschild boats set sail across the Channel; Rothschild messengers were swift shadows along the streets. They carried cash, securities, letters and news. Above all, news---latest, exclusive news to be vigorously processed at stock market and commodity bourse." ~ Frederic Morton (1962), "The Rothschilds: Portrait of a Dynasty"   There are many stories and legends surrounding the Rothschild family, and probably most are untrue.  It is widely acknowledged that Nathan Rothschild was the first Londoner to receive the news that Wellington had defeated Napoleon at the Battle of Waterloo in 1815.  Rothschild received this information through his network of fast carrier pigeons, which one of his agents released from Waterloo when the battle was known to be won.    News of the outcome of the Battle of Waterloo was breathlessly awaited in the British financial markets.  As legend has it, when Nathan Rothschild entered into the Exchange the day of the victory, he was already known as a master of speedy information. As such he took up his usual trading position and began quietly selling British Consols (bonds) into the market.  Traders quickly identified his selling, spurring a panic.  It was assumed by traders that Rothschild had heard Wellington was defeated.  Then, legend has it, in the midst of the panic Rothschild began stealthily buying Consols.  He purchased a sizable position before traders realized they had been fooled and drove prices higher.  Rothschild increased his profit from the victory dramatically by engineering a short-term panic and then buying into it.   This legend serves to illustrate that there are two primary ways to profit as an investor:  1) Get important information fastest, and 2) Know how the herd will react.   If you know what the investing herd believes, fears, and expects, then you know how it is likely to react to new information and events.   Back to point 1).  Getting relevant information fastest has always been the most straightforward key to successful investing.  And the hunt for the fastest information has spawned the term "Algo Wars" to describe the arms race among HFTs for faster servers, co-location, re-engineered routers, and other accoutrements of light-speed trading.  The time advantage HFTs use is incredibly narrow.  For example, the May 1, 2013 WSJ profiles how HFTs use a 1-10 millisecond advantage to rapidly detect order-flow and front-run larger orders.   At MarketPsych Data our clients include the largest hedge funds in the world, and we can't say exactly how our clients are trading off our sentiment feed.  The TRMI are published minutely as a 1440 minute (24-hour) rolling average.  And several of our indices do show evidence of the #HackCrash event as you can see below.   To be clear about the title question, I doubt the minutely Thomson Reuters MarketPsych Indices (TRMI) data feed contributed to Tuesday April 23rd's HackCrash in which the S&P 500 plunged 1% and then recovered all within the span of 4 minutes.  But I can't be sure.  The TRMI both show fast evidence of the event and also give an excellent read on the beliefs and expectations of the investing herd.   Today's newsletter looks at the role of information speed and herd impact.  We'll first take a look at a famous failure related to United Airlines, then we'll visit how our systems dealt with the hacked Associated Press tweet and its aftermath, and finally we review a few investment ideas for the week.

What Gold Drives Us To... Man: "You talk as though you struck it rich sometime or other, Pop. How about it? Then what are you doin' in here, a down-and-outer?" Howard: "That's gold, that's what it makes of us. Never knew a prospector yet that died rich. Make one fortune, you're sure to blow it in trying to find another. I'm no exception to the rule..." ~Treasure of the Sierra Madre (1948)   Treasure of the Sierra Madre ranks among the best movies on speculation and its damaging effect on the psychology of men.  And there-in lie lessons for gold investors.   In 2009 and 2010 virtually every investment conference I attended included a speaker extolling the virtues of diversifying a portfolio into gold.  That advice went over well as the price of gold rose.  But gold has declined 25% from its 2011 peak, especially as the market experienced a rush to the exits with a 10% drop over the past 2 weeks.      Events of the past 2 weeks, including an emerging consensus that gold is over-valued, triggered a panic in the gold market.  First, two weeks ago Goldman Sachs formally reversed a bullish forecast for gold.  Then a rumor spread that Cyprus was dumping its 14 tons of gold reserves onto the market. Paul Krugman wrote an article summarizing the evidence that there has been unsustainable investment in gold (Lust for Gold).  Krugman cites a 2011 Gallup poll in which one-third of Americans called gold the best long-term investment.  Barry Ritholtz debunks some of the cult-like rationalizations of gold hoarders in this interview.  The gold consensus has rapidly turned bearish.   Back to Treasure of the Sierra Madre (1948): Howard: Gold itself ain't good for nothin' except makin' jewelry with and gold teeth. Aw, gold's a devilish sort of a thing anyway. You start out to tell yourself you'll be satisfied with twenty-five thousand handsome smackers worth of it, 'so help me Lord and cross my heart.' Fine resolution. ... Ten you want to get twenty-five. Twenty-five you want to get fifty.  Fifty, a hundred.  Like roulette. One more turn, you know, always one more.     The historical lust for gold has affected all of us, in ways obvious and subtle.  To give one example, Latin America was permanently shaped by the Spanish search for gold.  Conquistadors such as Coronado spent their family fortunes searching for Cibola - the lost city of gold - from Patagonia to as far north as the plains of present-day Kansas.  In fact, a high school in my home town was named after Coronado. Gold has an allure that drives people to fantasy and wild speculation - often to the point of ruin.  And the psychology that drives its pursuit is common across the human treatment of all similar assets. In this week's newsletter we take a look at gold, the psychology driving its prices, make a few forecasts, and revisit crypto-currencies.

What is Value? "There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose." ~ John Maynard Keynes, "The Economic Consequences of the Peace" (1919). In 2008 MarketPsych's CTO Thomas Hartman worked on a secretive software project in Panama.  The goal of that project was to disrupt and supplant the global banking system.  The fruits of such efforts are emerging in the increasing importance and acceptance of cryptocurrencies.   Last week Eurogroup chief Jeroen Dijsselbloem revealed that the Cypriot bank bailout package is a template for future euro rescues.  European bank depositors can expect seizures of uninsured deposits if their bank becomes insolvent.  In Cyprus today, bank account holders are limited to a withdrawals of 300 Euro daily or up to 5,000 Euro monthly. The freeze of Euro-denominated bank accounts in Cyprus corresponded with a spike in the price of gold and a massive bull run in the value of cryptocurrencies such as Bitcoin, LiteCoin, and Namecoin.  As the realization dawns that similar seizures could happen in Portugal, Spain, and Italy, capital will continue searching for a haven away from the sticky fingers of banking and government officials. Cryptocurrencies are currencies without a government sponsor, composed of unique cryptographic codes (solutions to complex mathematics problems), and consensus legitimacy.  Their conversion value to national currencies depends entirely on supply, demand, security, confidence, and the whims of the investing crowd and businesses who accept them.  The most secure and popular cryptocurrency is Bitcoin.  Bitcoin was released in 2009 as the financial crisis smoldered, and there is now over $1 billion of Bitcoin in circulation today and hundreds of legitimate (and many sketchy) businesses who accept it.  In the first three months of 2013 Bitcoin has appreciated 6-fold versus the U.S. Dollar.  Cryptocurrencies are benefitting from the loss of public trust in fiat currencies issued by currency war-prone governments. We are in a unique position to comment on cryptocurrencies and the psychology of currency valuations. For one, our software team includes early crypto-currency speculators and of course our very own CTO Thomas - an evangelist in the development of alternative currencies. Secondly, our psychological data is the world's largest database of currency-related sentiment, and we have been mining that data for currency predictive models.  And thirdly, and unfortunately, one of our team members is a Russian living in Cyprus who is frozen out of his Cypriot bank account.  Needless to say, this week's newsletter strikes close to home. This week we'll take a look at the amazing rise of the world's first viable cryptocurrencies.  Then we briefly review our research on the psychological drivers of currency valuation, and we touch on a future where currencies are no longer solely under the control of governmental and banking officials. 

Pump and Dump We've had a busy 6 weeks since our last newsletter, and we have many new discoveries to write about.  As U.S. equity markets reach new highs, today's newsletter looks at a key factor that both drives poor trading behavior and creates profitable patterns in the markets: price forecasts in the media.  First we'll start with a look at a primal, but instructive, form of influence over market prices - the pump-and-dump in social media.  Then, by quantifying and backtesting media price forecasts using the Thomson Reuters MarketPsych Indices, we see that investors who follow predictions in both the news and social media lose significant amounts of money.  Inversely, those who play against the media do much better. ____   Two days before receiving a subpoena from the SEC, 15 year-old Jonathan Lebed posted the following pitch 200 separate times on Yahoo! Finance stock message boards.  He was promoting the stock of a company called Firetector (ticker symbol FTEC):   Subj: THE MOST UNDERVALUED STOCK EVER Date: 2/03/00 3:43 pm Pacific Standard Time From: LebedTG1 FTEC is starting to break out! Next week, this thing will EXPLODE. ... Currently FTEC is trading for just $2 1/2! I am expecting to see FTEC at $20 VERY SOON....   According to Michael Lewis, author of Liar's Poker and Moneyball, Lebed gradually honed the appeal of his promotional messages. Through a trial-and-error process, Lebed learned which aspects of his stock appeals drove investors to buy in spite of any conscious misgivings.   In a 2001 press release, the SEC accused Lebed of touting stocks so that he could make a quick profit on the price jumps he himself had engineered: On eleven separate occasions between August 23, 1999 (when Lebed was 14 years old) and February 4, 2000, Lebed, of Cedar Grove, New Jersey, engaged in a scheme on the Internet in which he purchased, through brokerage accounts, a large block of a thinly-traded microcap stock. Within hours of making the purchase, Lebed sent numerous false and/or misleading unsolicited e-mail messages, or "spam," primarily to various Yahoo! Finance message boards, touting the stock he had just purchased. Lebed then sold all of these shares, usually within 24 hours, profiting from the increase in price his messages had caused.   Jonathan Lebed settled out of court, reportedly for a minor fine, and kept the bulk of his trading profits.  He continued operating as a paid stock promoter through the 2000s at lebed.biz. When Lebed predicted an explosive gain in a stock price, readers experienced a surge of dopamine.  The dopamine increased motivation to act, bolstered confidence, and led investors to discard rational analysis.  Interestingly, this is a similar strategy to that employed by the ex-wife (and assorted family members) of late Nigerian President Sani Abacha.  You may have received emails allegedly from them offering you a multimillion dollar payout if you agree to hide their billion dollar fortune in your personal bank account (a.k.a. the Nigerian 419 scam). The vast size of the reward blinds gullible respondents to its absurdity. 

Global Violence and Fear   "Buy on the sound of cannons, sell on the sound of trumpets" ~ Nathan Rothschild, 1810   Maybe you haven't heard the above quote, but you've certainly heard this variation with the same meaning - "buy on fear and sell on greed."    Easy to say, hard to do.  It is far easier to speak those words in a sedate lecture hall than it is to execute on them during a civil war.    Fear is one of our oldest emotions.  First we must nourish ourselves to live.  Second we must avoid danger in order to survive.  The biological fear response saturates our bodies and brains with hormones and neurotransmitters and throws our rational prefrontal cortex offline.  In the midst of fear, our breathing, heart rate, circulation, muscle tone, digestion, and sensory interpretations all change.  As our fear prepares us for fight, flight, or freezing, it creates an involuntary physiological response that we have little conscious control over.  Fear turns our bodies into unthinking survival machines.    I like the cannons in the opening quote because the fear that war and violence cause are significant to our predictive models for countries and currencies.  It is difficult to measure expressions of fear in the news - reporters are trained not to express their own emotions.  But they can report on the images and interviews that stir fear in them, and those interviews are usually around the topics of violence, chaos, and social breakdown.   Last newsletter we introduced the idea of buying stocks in countries with the greatest government instability as reported in the news flow.  In this newsletter we introduce a rotating model of global equity investing.  First we describe our automatically updating global investment risk map.  It is a counterintuitive fact that but the least risky countries for investing are those that are perceived to have the most risk - the risk is already priced in.  Then towards the end of the newsletter we identify the sentiments that are most influential over currency prices.    We'll be in San Francisco on February 13th for a company meeting.  If you're interested in learning more about our company, please get in touch.

Heart of Darkness "He has to live in the midst of the incomprehensible, which is detestable. And it has a fascination, too, which goes to work upon him. The fascination of the abomination--you know. Imagine the growing regrets, the longing to escape, the powerless disgust, the surrender, the hate." - Joseph Conrad, Heart of Darkness   When a government fails - whether due to warfare, failure to provide services, or insolvency and cutbacks - the citizens of the country go through several psychological stages.    Unfortunately I've witnessed these stages, and gone through them myself.   I used to enjoy off-the-beaten path travel and journeyed to places in transition such as post-Soviet Central Asia in 1992 and Central Africa in 1996 (inspiration for the Heart of Darkness quote above and throughout today's letter).  The particulars of my experiences are too lengthy and surreal to write about here, but suffice it to say, when the lights go off, the bugs come out.   When a government first falls - when the President flees the country or a brand new group enters power - there is at first hope that business will continue as usual.  This represents the stage of denial.  In the second stage, as laws change or law and order break down entirely, citizens enter a stage of paralysis.  I saw this in the post office in Kisangani, Zaire, where well-dressed postal workers came to work every day despite not having been paid in 2 years and having no work to do.  Paralyzed citizens protect valuable possessions and listen to every rumor for signs of danger.  Their indecision is broken when they realize that inaction will cost them dearly, often leading to the third stage:  disorganized panic and escape. They run away or, if they don't have the resources to run, they bunker down.  In the fourth stage, they become accustomed to the new order, either learning to live as a refugee or accepting the new authorities and laws (or the arbitrariness of the laws).   In Africa in 1996 I traveled from Uganda to Cameroon overland.  In Zaire (now Congo) the government was absent - warlords and bandits were dividing the country.  And when I was in the Central African Republic, a rebel army was camped outside the capital, regrouping for a second assault.  Adventurous diamond and gold traders remained in Zaire, despite the danger, buying up gold nuggets and uncut diamonds at bargain-basement prices from local miners.  Nothing good came from those African failed states, which remain troubled today, but those hardy entrepreneurs profited handsomely - if they survived.

Resolutions, Honestly "New Year's Day now is the accepted time to make your regular annual good resolutions. Next week you can begin paving hell with them as usual" ~  Mark Twain   It's 2013.  Lot of resolutions have been made: "this year I'll exercise more, eat better, be more patient, etc..."  Yet as behavioral economists we know that most resolutions won't be kept.  Those resolutions that are honored are usually simple and straightforward - goals that would have been achieved even if not articulated.   In my experience behavioral economists are some of the worst resolution-keepers.  I won't cast stones, as I'm in a glass house of my own construction.  Remember our weekly newsletter?  That's right, the one that comes every two weeks?  Or sometimes every four weeks?...  Despite heroic weekly efforts, we're not weekly newsletter goal-achievers.    So we set about to get it right this year.  Why is the resolution failure rate so high, even by "professionals" who design behavioral guides like this one?  What can we honestly do to make sure our newsletter is published weekly?  As we dug into this, we realized we had entered a vault in the collective unconscious.   Resolutions aren't what we think they are.  

The Happiest Day "During holidays, [Norman Vincent] Peale once suggested, you should make 'a deliberate effort to speak hopefully about everything.'" ~ Oliver Burkeman   Our in-house psychologist - Dr. Frank Murtha - recently asked me, "You've got all this data on emotions so tell me, what's the Happiest Day of the year? And as a matter of fact, what's the Angriest Day?  And the Most Pessimistic Day?"   I had no idea.  Based on work by Aleksander Fafula, our data genius, we know the happiest month is January (when we control for holiday greetings) and the Angriest month is September.   But days?  We hadn't thought to look.   To investigate, we ran an analysis using the Thomson Reuters MarketPsych Indices social media-based sentiment indices for the S&P 500.  These indices cover every year from 1998 through November 2012.   What did we find?  First of all, and fortunately, the next few weeks don't contain extremely Angry or Pessimistic days.  The next 3 weeks do, however, contain the Happiest and the Most Optimistic Days.  Norman Vincent Peale's advice has possibly been taken to heart, but perhaps more for unconscious biological reasons (seasonal neurochemical and hormonal shifts) rather than people consciously taking Peale's words to heart (the advice itself is useless).   Interestingly, over periods of weeks we see clusters of days or weeks being generally of the same emotional state.  When we look at weekly patterns alone, we see that investors express the most Joy and Optimism in the first week of January (approximately 3rd through 6th), with the second week of January close behind.  Also important, Gloom, Anger, and Fear levels are the lowest during those weeks - not only are positive emotions high, but negative emotions are low.  In summary, investors are generally happiest at the beginning of the year, when enjoying a fresh start (perhaps this has something to do with the January Effect in stock markets)   For specific days, the 23rd of December is the Most Joyful (today!!!), and January 9th is the Most Optimistic.  Note that market holidays are excluded from the analysis.   So... we hope you have been enjoying Financial Happiness Day today!   In honor of Financial Happiness Day (and the Fiscal Cliff), check out Dr. Murtha's zany video spoofing the struggles of financial advisors around the fiscal cliff with our old friends, Bob (an individual investor) and his financial advisor Helen.    But now on to more serious matters...

Prison Yard Dominance   "You have to remember one thing about the will of the people: it wasn't that long ago that we were swept away by the Macarena." - Jon Stewart   Leading group therapy for mentally ill prisoners is never boring.  But is it dangerous?  Not really.  Humorous?  Yes, sometimes.  Enlightening?  Nearly always.  In one fascinating group, a mutiny against my leadership was led by a psychologically saavy gang-leader.   I bring up this experience because it mirrors the fiscal cliff drama playing out in Washington.  While I was confronted by a different league of bully in prison, the techniques I used to regain control of the group may be used in Washington to restore legislative momentum, and if we see them emerge, we will know compromise is near.   The mutiny in my group occurred minutes into our first group therapy event of the season.  Before we were more than two minutes into introductions, an intense young man stood up, look straight into my eyes, squared off before me, and loudly informed the group:  "He's just some rich kid doctor from Santa Monica.  He doesn't know %$#&@ about what we've been through!"   I looked at him, knocked back by his outburst.  I protested, "No that's not right..."    He went on, "Let's go guys, we don't need this, we're done with this &$#*&@."  He walked out with his fellow group members, staring me down as they filed out of the room.    I was left alone, embarrassed and befuddled.  After all, I was in fact a well-to-do young doctor from Santa Monica, and the fact that he - a powerful gang leader with an outside network - knew about my personal life was truly disturbing.  I needed professional advice about how to handle a situation like that one, so I turned to a wise mentor.

Puppy Dog Tails Slugs and snails And puppy-dogs' tails, That's what little boys are made of. Sugar and spice And everything nice, That's what little girls are made of.   - Nineteenth century English nursery rhyme.  _____________________________________________________   "Honey, what happened to our retirement savings?"   If you're a man, your partner may have asked you this at some point in the past few years.    "Hmmm, I'm not sure what you mean?" you may evasively answer.  (The truth is, you're very aware that you invested too much in that awesome small cap tech stock.  Sure it's down 50% since you bought in, but it is such a GREAT story, it HAS to work out.)   She persists, "I mean, how come the account has less money than last year?  The market was up this year."   Now if you're like most men, you want to please your wife (and yourself).  And you probably believe what you say next:  "Um, well, I invested in CyberNanoTech and they had a bit of a setback this year because of the FDA, but their long term prospects are amazing, everyone says so, so I'm holding tight."   "What is CyberMamoSpec?"   "Well, Joey at the Club was saying they have this world changing...."    "Honey, what does Joey know about investing, isn't he an orthodontist?"   This is why men need wives, to pop their unreality bubbles. It's at this point in the conversation that his wife may pick up the phone to call a financial advisor.   And if all goes according to her plan, which is likely, their financial relationship dynamics will become the domain of a financial advisor, which is another story (and one I often speak to advisors about).

Hormones in the Markets "If taking female hormones actually helped you do your job, they would simply hire women here...But they don't. They don't think women are aggressive enough." ~ New York Post, citing an SAC employee and reprinted here.   A couple years ago I began coaching a trader with a hormonal problem.   He told me, "When I trade at my best I'm aggressive and decisive.  Ready for whatever the market throws at me."   "And how have you been trading lately?" I asked.   "I'm none of those.  I'm indecisive and cautious.  I'm just sort of limp when I need to be strong and fast.  And I just keep losing money. You know, it's as if I've lost my mojo."

Man Problems While forecasters predicted Hurricane Sandy would be the worst storm in New York history, many people did not prepare adequately.    OK, to be perfectly honest, I did not prepare adequately.  In response to a question posed by my New England-born wife before the storm, "Shouldn't we buy a generator?" My response, "Generator? Who needs a generator?" will probably rank as one of the more egregious on my Clueless-Man-Responses List,  just ahead of #6 "No, I know where I'm going, I don't need a map," and just behind #4 "Anniversary?  You mean today?"   In my (and my wife's) quest to understand the Clueless-Man-Responses List and why it continues to be populated, I did a bit of research.  Turns out that due to a mental mechanism called the "projection bias," people's intellectual assessments of a danger ("worst storm ever") conflict with their emotional experience ("I'm fine right now, those forecasters must be exaggerating.")  In these scenarios, most people go with their gut - "It'll be fine, it always is."   As a result, there is inertia in their preparations.     In fact, as I write this letter I am warm and cozy (and a tad humiliated) at my wife's parents' house in Maine.  A couple days without heat and power was enough to turn us into storm refugees.  Thank goodness for the kindness we've encountered since the storm.  One thing I was impressed by after the storm was the tremendous goodwill and comraderie of neighbors in affected communities. 

Breaking the Bank When George Soros "broke the Bank of England," famously earning him $1.1 billion on a single trade, it was not only the Bank of England who was rocked by losses.  Some ambitious and formerly successful traders had bet against Soros - traders such as Bob.     Some background:  In 1990 the Britain's Thatcher government decided to join the European Exchange Rate Mechanism (ERM).  The ERM was a system to reduce exchange-rate variability.  With U.K. inflation at three times the rate of Germany's and interest rates at 15 percent, the conditions for remaining the ERM were not favorable.      Due to its inherent impossibility, as well as short-selling by an international group of currency speculators led by George Soros, the UK was forced to withdraw from the ERM on September 16, 1992 ("Black Wednesday").  Soros' trade was virtually guaranteed to be successful due to the large interest rate differentials between the U.K. and Germany.  Not all central bankers learned the lesson - Soros and others profited from similar trades put on before the Asian Currency Crisis of 1997. 

The School of Life   Street craps - played with two dice on a sidewalk - is little like its casino brother.  The odds are different, the pace is much faster, and your dealer is typically a hustler or worse, a psychopath.  As for me, I learned how to deal street craps in prison.    As a psychiatrist I've evaluated competency and treated mental illness among prisoners, some of whom were hustlers or psychopaths.  Street hustlers in my experience are usually quite engaging and reflective, able to gain insights and do productive psychological work.  Psychopaths are cold and heartless - mimicking the emotions and social styles they have seen expressed by others.  Typically psychopaths don't see a psychiatrist voluntarily, and when they do, they spend a good deal of time looking for angles - how to game the system and get what they want from the doctor.   When a psychopath offered to teach me street craps in a prison, I knew from my clinical training that he was being friendly only because he wanted something from me - information, medications (some medications are used as currency in prisons), or to learn some therapeutic tricks he could use on others.  Nonetheless I was riveted as he explicitly taught me how to spin the dice to get the numbers I wanted and how to tap and blow on them to distract unsuspecting clients.  At the same time, I told myself, I was gaining valuable insight into the mind of a psychopath.   After the tutorial -- and alas too late to do anything about it -- I realized to my horror that my pen was missing.   He wasn't interested in passing time with some friendly banter or in gaining some psychological insights while he was teaching me how to roll the dice - the dice lesson was for distracting me while he swiped my pen.

Optimism, Bind Optimism, and Balance "The intelligent investor is a realist who sells to optimists and buys from pessimists." ~ Benjamin Graham, Jason Zweig in The Intelligent Investor, Rev. Ed.   As a psychiatrist I've born witness to many extremes of mood.  I've tried to steer manic venture capitalists away from spending their life savings on cocaine and sports cars.  And on the other extreme I've born witness to the deep pessimism and despair of suicidal clients, trying to help them choose life over oblivion.  My efforts are not always successful, and I've learned a lot about the limits of rationality when faced with extremes of mania and despair.  At both extremes many of the people I've worked with are highly intelligent and believe they are acting with perfect rationality.  Yet despite their innate intelligence, deeper emotions occasionally sweep away their anchor to reality.   In Ben Graham's quote above, one could be mistaken for thinking of the "intelligent investor" as a robot or algorithm.  Human investors feel the extreme optimism and pessimism of the markets.  And the effect of this optimism and pessimism is, almost universally, to bias their interpretations of real events.  While the best investors feel the moods of the market (that is, they are empathic), they also have the almost super-human ability to act contrary to their emotional biases.  Graham's vision of intelligence in the 1950s is what we today call emotional intelligence.    Warren Buffett called Graham's book, The Intelligent Investor, "By far the best book on investing ever written."  I think it's worth looking for lessons in Graham's thoughts on optimism.   Today's letter will examine the nature of optimism in the financial markets:  How we experience it, how it distorts our investing, how it plays out in markets, and how we can succeed while being both optimistic AND realistic.  As we go through these themes, we will look at French and Dutch optimism in the Euro-zone, the delusional optimism at the launch of the Facebook IPO (see Dr. Murtha's hilarious Part 2 video), how portfolio managers can use optimism to their advantage, and visit some tools and techniques for making ourselves better investors.   But first, some housekeeping...

Collapse of Dreams "[T]he values to which people cling most stubbornly under inappropriate conditions are those values that were previously the source of their greatest triumphs." - Jared Diamond, Collapse: How Societies Choose to Fail or SucceedIn Collapse: How Societies Choose to Fail or Succeed, Jared Diamond (UCLA professor of Geography) described the collapse of civilizations as a gradual environmental process, fueled by systematic behavioral weaknesses evident in inertia and short-term thinking, culminating in a rapid unwinding too rapid to stop.  As he describes it, as environmental stress increased in prior failing societies, social and economic disparities widened. Rather than looking to identify empirical causes and create functional solutions to save themselves, these societies fractured along political and class lines. As stress increased, the various factions hardened their tactics, ultimately physically attacking internal political enemies and igniting civil wars which destroyed the social and cultural mores that upheld institutions. I was reminded of Diamond's thesis a few weeks ago in Canada, of all places. I was in Toronto's financial district when I was handed, with a direct and sincere look, a manifesto on the evils of capitalism.    Now, when I lived in San Francisco and Austin (two cities I love), I often received such manifestos - usually followed by some unsolicited recommendations regarding marijuana cultivation or freeing Tibet. It was all fairly benign. But the Toronto pamphleteer was not unhinged, malodorous, or intoxicated - he was sincere, healthy, and appeared overtly rational. His apparent reasonableness shocked me more than the manifesto itself: A reasonable man pushing an overthrow of capitalism. That same night, student riots in Montreal over tuition increases led to the arrest of 122. Democratic governments in the developed world have borrowed money to finance their promises.  Without displaying adequate performance.  As a result, voters are disappointed and angry, and now inclined to try extreme alternatives. While I'll discuss social collapse in light of Greece this week, I think we should also take this opportunity to look at our own societies. The unraveling has already begun. What can we do to prevent a similar meltdown? I consider myself optimistic, so it pains me to return to the topic of collapse. That said, I'm of the opinion that facing an ugly truth sooner allows us to have a happier life later. Sadly politicians have the incentive to avoid hard choices in the short term, and as a result the pain of collapse will be that much greater.     New public policies that account for human (and elected official) psychological weaknesses are desperately needed.  Fortunately, such an effort has begun.  Read on to learn more.   But first, some housekeeping... 

Shorting Bubbles - Ouch! I've made many unfortunate investments over the years, but one in particular still bothers me.  In 1998 it was very clear that the technology sector was in the midst of a historic bubble.  There were many overvalued stocks - with no earnings, high debt, too-good-to-be-true stories, and extremely high valuations.  I picked Amazon.com due to its high level of hype, and I sold short some shares.   A few months later I had lost 40% on that investment.  Then a few months after that 80%.  By the time I had lost 120%, I bought back my shares.  (And good thing I did, the stock continued much higher before it finally peaked).  I learned a lesson best-articulated by John Maynard Keynes:  "Markets can remain irrational a lot longer than you and I can remain solvent."   In the post-mortem analysis of that investment I looked back on my thought process.  My conviction had been high, I knew I was right.  Diagnosis:  Overconfidence.  And as a result of overconfidence, a weak risk-management plan.  This trade changed how I think about trading timing and risk management.  (It's ironic how improving risk management always becomes urgent AFTER a big loss).    Steamrolled by the crowd, and my lesson learned, I turned to the study of timing bubbles.  I wondered, how could I time the expansion and ultimate collapse of market sentiment around hot tech stocks like Amazon.com?   I decided to start by looking inward - what were investors in Amazon thinking (or not thinking) when they bought in?  And what triggered the ultimate fall in the price?  In fact, my senior research project in medical school was on "The Social Psychology of Bubbles and Panics" (I was extremely privileged to work with a pre-eminent researcher on impulse-control - Ernest Barratt, Ph.D.).   It turned out that expectations are key to bubbles, and expectations are rooted in the brain's emotional circuitry.  That circuitry is easily activated by extraneous events.  In fact, researchers have found that completely unrelated positive events (movie clips, pictures of happy faces, pornography) prime us toward taking excessive financial risk (Read more in today's Researcher's Corner below).   We've had a similar sort of timing problem the past several newsletters.  And from our research, we know that a key success trait of investors is good timing - rapid execution on high conviction ideas.  Our monthly newsletter takes about 10 days from conception to publication, and during that 10 days our forecasts often become stale, rendering the monthly recommendations less profitable (e.g., the oil and copper short hints last month worked out a few days before publication - fortunately the decline in oil and copper prices continues).    Before we jump into how to time bubbles, first some housekeeping.   

Shopping Carts and Playing Chicken When I was a boy in Texas the neighborhood children enjoyed playing chicken, usually with speeding shopping carts.  Two children were pilots and two children were bombs.  The pilots dutifully ran their bombs up to full speed, released them, and ... CRASH.  Ideally your shopping cart remained standing after the collision, in which case you won.  Fortunately, two shopping carts crashing sounds much more painful than it actually was.   But this newsletter isn't about bored suburban kids.   This month we look at a much more deadly game of chicken between Iran and Israel (and by proxy, the U.S.A.). Mirroring the escalating tensions, oil prices are up over 10% in the past five weeks.  Higher oil and gasoline prices are already impairing our economic recovery.   This newsletter will examine Behavioral Game Theory as it applies to Iran and Israel.  What is the best strategy to deter a foe who may be crazy, short of war?  We will then look at the current sentiment snapshot of news and social media as it relates to Oil, Iran and Israel, which reveals some surprises about global mood.  The psychology behind Oil's recent price rise reveals whether the rally is sustainable (hint:  fear is rarely sustainable).   In addition to our usual haunts of New York and Los Angeles, we will be speaking in San Antonio, western Pennsylvania, a CFA webinar, and San Francisco in March - we're look forward to catching up with our friends in those cities!