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MarketPsych Report: Belief, Rigidity, and the Power of Critical Thinking

April 05, 2015

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Belief is a mental representation … of a sentient being's attitude toward the likelihood or truth of something.
~ Eric Schwitzgebel. 2006. The Stanford Encyclopedia of Philosophy.

I have two daughters who looked forward to Easter Sunday with enthusiasm.  It wasn't religious enthusiasm.  They wanted chocolate eggs.

My 9 year-old still believes in the existence of a magical Easter Bunny who travels the world and hides candies for children.  But my 6-year-old has no such faith.  She is intent on finding evidence – material proof - that her parents are lying about this magical bunny.  She explains to her siblings the physical impossibility of a bunny traveling the world.  She notes her parents’ pauses as they struggle to answer her questions about the size, motivations, and clothing of the Bunny.  She digs through the garbage to find bulk Easter candy wrappers.  She is skeptical.  She would make an excellent short-seller.

Skepticism and belief - what is their value?  Where might they lead us astray?  On this Passover and Easter weekend our newsletter looks at the inspirational power of belief, the danger of rigid belief, and how we can use critical thinking to set our minds free.

An image of the Exodus.

“Israel in Egypt" by Edward Poynter (1867)

Magical Beliefs and Multilevel Marketing​

“Herbalife: the customers are fictitious, the business opportunity is a scam, the university degree is a fraud.”
~ Bill Ackman

Multilevel marketing preys on a suspension of disbelief.  The radio show “This American Life” ran a report on a multilevel marketing venture called “WakeUpNow” (WUN).  WUN’s business was very difficult for the reporters to ascertain.  It appeared to be cultivating a positive belief that one could convince others to hold the same positive belief (and pay for a monthly subscription while doing so).  The radio story about the company reveals the psychology behind the multi-level marketing of belief.  The company now appears shuttered.

Herbalife (HLF) is the best-known multi-level marketing company.  Bill Ackman, a successful hedge fund manager, took a $1 billion short position in HLF in 2012.  He claimed that Herbalife is multi-level marketing scam that preys on the poor and the ignorant.  Others joined him. Per The Atlantic magazine in 2014, critics claim “Herbalife is targeting groups who are easily victimized by false promises of riches.”  On the other side, Carl Icahn accumulated a 17% stake in Herbalife and claimed it was a legitimate business.  

Again according to The Atlantic, “Fundamentally, Herbalife targets our cognitive weaknesses, though which weaknesses is a subject of debate.”  HLF is not unlike many other businesses (payday loans, tobacco, etc…) that prey on biases.    HLF and WUN are selling positive belief – the belief that one can get rich through effort and chutzpah.  

When Investors Believe

We've long wondered how best to measure the positive belief of investors - their faith built without evidence - in a company.  One facet of such belief is expressed when they explicitly state their intention to buy or sell shares.  Stating one's intent publicly is the expression of a belief that a company will continue to perform (if stating the intent to buy).  We developed the LongShortForecast index to measure such publicly stated positioning.

Our index LongShortForecast is the net difference between all future-tense references to buying a stock versus selling that stock as reported in the media.  It also includes public statements of bullishness and bearishness.  For example, “I’m going to buy more shares” would lead to a positive score on the index.  A statement like, “I'm planning to sell before the earnings announcement” would be a negative weight on the index value.  

On an annual basis, the equity curve of a cross-sectional rotation model shows that it’s best to go against the publicly stated buying and selling of others.   This equity curve was derived by first selecting the top 20 stocks in the news over the past 12 months.  Then they were ranked by their average LongShortForecast index value.  The model went long the 4 companies with the most predictions of selling or shorting, and it went long the 4 companies with the most predictions of share buying.  Then it repeated this procedure annually.  The equity curve is below:

This is a contrarian finding.  When longs and shorts go public with their positions, it’s usually best to wait before joining the fray.  As an investor, believe when others are skeptical, and run away when others are true believers.  

Relative Right

There is a fear - first popularized by Allan Bloom in the 1987 book “The Closing of the American Mind” - that relativism, a lack of belief in enduring transcendent values, is behind American and European cultural decay.  From Bloom’s telling, accepting all perspectives as equal (multiculturalism) undermines critical thinking and decays the will to act based on principles.  Belief, founded in unassailable principles is the fuel of progress.  Without such conviction, society stagnates.

For young men who don’t feel at home in a society, the comfort of a big belief, even if it is a negative one, should not be underestimated.  Anger motivates us to break the chains of slavery and gain freedom, as in the story of Exodus.  But sometimes anger takes people into criminal thuggery, as in the case of Islamic State.

In this article about the European recruits of Islamic State, the New York Times examines a group of 8 recruits from the same town in Norway.  A local police officer noted of the eight Norwegians who traveled to Syria:

“The only thing they had in common is that they did not function in society”, he added.  “But they wanted to be able to do something, to be good at something.”  Radical Islam, he said, “offers a whole package.”

He could have added that Islamic State is the ultimate multilevel marketing for the hopeless and frustrated – eternal life, glory, and meaning await recruits.  And as its opponents fight this form of terrorism, they should fight it psychologically.  Bombs and bullets cannot kill an ideology, as we’ve seen with communist revolutions previously and jihadism now.  

Driven by anger, frustrated investors - including professional activist investors like Ackman - sometimes take to news and social media to shame companies into changing their operations.  But similarly to fighting global jihadism with bombs, such open fights may not lead to positive change in the near-term.  Anger is a sign that belief has become rigid and cannot tolerate doubt, and anger is one of the best signs for investment opportunity.

How Anger Undermines Us

Anger is a uniquely powerful emotion in how it influences trading.  Experiments on anger during financial transactions revealed that angry subjects reduced both their bid and offer prices for consumer items (Lerner 2001, 2004).  Investors overreact when angry, leading to 1) selling shares and 2) a reluctance to repurchase them.  What's more, online communities have made anger more virulent.  A study on the social media site Weibo found that anger disseminates faster through a network and farther across social connections than joy, disgust, and sadness (Fan, 2014).   Additionally, psychological research has found that venting anger (catharsis) increases innate feelings of anger (Bushman, 2002), thus creating a positive feedback loop in online environments where anger is vented.  Based on the evidence above, anger should be a consistent predictor of investors undervaluing stocks, especially from social media.

The following image shows the hypothetical returns to investors from a simple anger-based dollar-neutral investment strategy in U.S. stocks.  This equity curve results from an arbitrage within the top 20 stocks in the news.

The model selects the 20 most talked-about stocks in a given country in social media (soc) over the prior 12 months.  Every stock is then ranked by the average level of the Anger index (the Thomson Reuters MarketPsych Anger Index).  The highest Anger stocks (top 4) are bought, and the 4 with the lowest Anger value are shorted.  Longs and shorts are held for 12 months.  The model assumes zero transaction costs.  Below is the equity curve derived by arbitraging the annual average social media (soc) anger TRMI for individual U.S. stocks:

Now turning to global news flow, we also see evidence for significant anger effects in other countries.  Canada is especially interesting using the same style of arbitrage for news (nws) Anger:

We should be buying stocks that others are expressing anger about.  We see significant positive effects of anger for stock prices in countries including Germany, China, and Japan.  

When investor anger hardens into the belief that there are permanent fundamental flaws in a company, it creates a buying opportunity for those who can examine both sides of the argument dispassionately.  Ultimately prices - on average - drift higher as anger abates or bargain-hunters with less emotional sensitivity, such as Carl Icahn with Herbalife, step in to buy discounted shares.  As you can see in this chart of Herbalife (HLF), the stock price doubled in 2013 at the height of the accusations against it, but the price collapsed again in 2014.  The mental rigidity that anger spawns is destructive to stock investors, especially on a one-year horizon.

The Power of Not Knowing

What we need is not the will to believe, but the wish to find out.
~ Bertrand Russell 

As I mentioned about my daughters above, these two children are very different in their approach to mysteries like the Easter Bunny.  One wants to believe.  One wants to debunk. Each position has its merit, but perhaps the optimal approach is the synthesis performed by Ray Dalio.

Ray Dalio is founder of the investment firm Bridgewater Associates, the largest private hedge fund in the world with over $157b under management.  I’ve mentioned him previously as a practitioner of transcendental meditation.   He was recently interviewed by Institutional Investor on the evolution of his unique style of analysis.  Dalio recounted an episode in 1982 when he was convinced that the United States would head into a depression.  Back the he publicly - including in congressional testimony - announced a bet against the U.S. economy based on his beliefs about the likely outcome of the monetary tightening by Fed Chairman Volcker.  He was completely wrong:

“This episode taught me the importance of always fearing being wrong, no matter how confident I am that I’m right. As a result, I began seeking out the smartest people I could find who disagreed with me so that I could understand their reasoning. Only after I fully grasped their points of view could I decide to reject or accept them.”

Per Dalio, people who are able to process other’s contrary points of view “possess the ability to calmly take in what other people are thinking rather than block it out, and to clearly lay out the reasons why they haven’t reached the same conclusion. They are able to listen carefully and objectively to the reasoning behind differing opinions.”  (FYI, I found this piece about Dalio on the excellent Farnam Street Blog).

Like Moses, true leaders move people forward not with critical thinking, but with inspiration – the belief that they can transcend the limits of what they thought possible.

“Our belief at the beginning of a doubtful undertaking is the one thing that assures the successful outcome of any venture.”
~ William James 

As an entrepreneur or business owner, we need to use belief differently than a global macro investor like Dalio.  We need to inspire belief in our followers, because belief can be a self-fulfilling prophecy.  Steve Jobs and Elon Musk inspire their teams by uniting imagination and belief, and we can too.  


To free our minds – to lead ourselves out of slavery to our unconscious biases – we can openly and critically understand the merits of all arguments in order to fashion the most solid reasoning for ourselves.

To help free others we can inspire them to work beyond what they think is possible.   So on this holiday weekend take a moment to contemplate how can you inspire others as leader.  What are your unique big beliefs – your moon shots?  

Next month we'll look at statistics, their limitations, and how they both reveal and obscure the truth in investing.

Please contact us if you'd like to see into the mind of the market using our Thomson Reuters MarketPsych Indices to monitor market psychology and macroeconomic trends for 30 currencies, 50 commodities, 130 countries, 50 equity sectors and indexes, and 8,000 global equities extracted in real-time from millions of social and news media articles daily.

We love to chat with our readers about their experience with psychology in the markets.  Please send us feedback on what you'd like to hear more about in this area.

Happy Investing!
Richard L. Peterson, M.D. and the MarketPsych Team


Bushman, B.J.  2002.  “Does Venting Anger Feed or Extinguish the Flame? Catharsis, Rumination, Distraction, Anger, and Aggressive Responding.”  Personality and Social Psychology Bulletin.   June 2002 vol. 28 no. 6 724-731.

Fan, R., J. Zhao, Y. Chen, and K. Xu.  2014.  “Anger is More Influential Than Joy: Sentiment Correlation in Weibo.”  PLoS ONE 9(10): e110184.

Lerner, J. S., D. A. Small, and G. Loewenstein. 2004. “Heart Strings and Purse Strings: Carry-over Effects of Emotions on Economic Transactions.” Psychological Science.  15, 337–341.

Lerner, J. S., and D. Keltner. 2001.  ”Fear, Anger, and Risk.” Journal of Personality and Social Psychology. 81, 146–159.

Schwitzgebel, Eric (2006), "Belief", in Zalta, Edward, The Stanford Encyclopedia of Philosophy, Stanford, CA: The Metaphysics Research Lab.
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