MarketPsych Newsletter

MarketPsych Report: The Psychology of Terrorism and the Price Impact of Mistrust

December 06, 2015

Yes, a Jedi’s strength flows from the Force. But beware of the dark side. Anger, fear, aggression; the dark side of the Force are they. Easily they flow, quick to join you in a fight. If once you start down the dark path, forever will it dominate your destiny, consume you it will....
– Yoda

Today's newsletter examines a serious theme -- the psychology of terrorism.  Social anger has been relatively high -- and stayed high -- since the financial crisis (as depicted below).  Recent terrorist attacks, a spike in the homicide rate in the United States, and the rise of populist politicians globally may be signs of such anger seeping into social behavior. Anger promotes extremist thought, the argument goes, so this anger ought to fuel more social unrest -- a turn to the dark side, if you will.

On a lighter note, we are also undergoing one of the most sensory-assaultive marketing campaigns ever witnessed - the hype in advance of the seventh Star Wars movie -  The Force Awakens (Lucasfilm in now owned by Disney, hence the hype machine is in full force).  Coffee-creamer, potato chips, tape, and airplanes have all been Star Wars-branded.  In honor of this juggernaut, and the hope of overcoming the dark side, Yoda's wisdom is sprinkled throughout this month's newsletter.

Today's newsletter examines the psychology of terrorists, the role of anger and trust in driving asset prices (and perhaps societies), and revisits the role of trust in driving stock prices. Typically, feelings of mistrust and anger provoke temporary overreactions, and prices rebound.  But perhaps these are not typical times.  

National Anger

Fear is the path to the dark side. Fear leads to anger. Anger leads to hate. Hate leads to suffering.
– Yoda

​Terrorist attacks and rising homicides fray social trust.  The decline is trust is not restricted to one ethnic or religious group.  Since 2001 among the 16 people arrested for terrorism in Southern California are Irish, English, Spanish, Arab, and Vietnamese surnames.  Obviously, terrorist behavior crosses ethnic and religious lines, so we need to look deeper for explanations.  First, we 'll look at the social forces and emotions that fuel terrorist thinking, starting with anger.

When all media anger is added together, we see the following plot of anger expressed in relation to the United States as a whole (superimposed on a chart of the S&P 500).  To generate this chart, all specific references to anger in relation to a physical location within the United States were collected and quantified from 1998 to the present.  Note that anger as a percentage of overall U.S.-focused chatter is now much higher than 1998 through 2001, and it is also higher than it was in 2007-2008 (the two anger averages plotted are 200-day and 500-day averages, so they are very lagged).  

First following the Sep 11 attacks on the World Trade Center, and again after the financial crisis, American anger has risen and remains high.  However, the United States has a fairly middle-range level of anger on a global basis, as seen in the below heatmap of anger for the month of November, 2015 (El Salvador, Zimbabwe and Uruguay stand out as particularly high in anger):

In a past newsletter we described the role of anger in driving prices.  Across cross-sections of stocks trust has an inverse relationship with future price action (low trust stocks tend to rise).  Investors ought to buy the angriest and least trusted stocks.  Such stocks' prices are more likely to rise going forward.  

What Fuels Terrorists?

Hmm. In the end, cowards are those who follow the dark side.
– Yoda

In my early career as a psychiatrist I occasionally evaluated and treated mass murderers  My work was intended to offern an opinion on their sanity (did they know the difference between right and wrong?), to restore their sanity, or to otherwise help them change in a positive way.  One mass murderer I treated was hyperreligious, paranoid, and generally psychotic (he thought he was a messiah).  Another was a contract killer, a mercenary who worked for an organized gang (he almost got away).  The religious zealot was disorganized, ranting, tangential.  The contract killer was rational and coldly calculating.  A rational mass murderer may seem like a rare thing, but terrorists have more in common with assassins than raving religious fanatics.  

Organized terrorism typically isn't caused by the insane (they would be too disorganized or paranoid to work effectively).  one off massacres, yes, but the insane cannot navigate the complex social structures of terrorist organizations.  And terrorism isn't only caused by criminal sociopaths.  Sociopaths may be leaders, but they tend to value their own lives too much - they are too narcissistic - to sacrifice their own lives for any abstract cause.  The typical terrorists are inspired by the sociopaths, they have a tinge of insanity, although they can get along in society and keep their plans secret.

In addition there is often a psychological logic - perhaps a grudge, disillusionment, disenfranchisement, feelings of alienation.  But these feelings are not uncommon in modern societies.  Many teenagers feel these daily.  Going over the line to becoming a mass murderer is a large step.  Swearing allegiance to Islamic State, stockpiling weapons with accomplices, planning mass murder.  Those actions are complex, immoral, and inconceivable to most.  Almost no one does these.  But some do.  Why?

There is a social-psychological background for most terrorists.  Terrorism appeals to people who:
1.  Feel humiliated.  Dignity is a peculiarly human feeling.  "Loss of face" is another expression for humiliation.  One's social standing is considered worth dying for -- it is one's core identity -- in social (non-individualistic) cultures.  What better way for the humiliated to gain social standing than to join a seemingly glorious new state?
2.  Feel trapped.  Social rigidities, dead-end jobs, and persistent unemployment cause feelings of being trapped, cornered, and hopeless. All of these lead to depression, a low serotonin state.  People may lash out violently when serotonin is low.  ISIS recruits typically feel that they do not belong in a secular world that often mocks their religion and identity as Muslims.  Exeriencing multiple failures and dead-ends also explain why terrorists don't take the initiative to make their lives better - they think they're trapped.
3.  Have little sense of purpose.  Living without purpose is disorienting.  And it's a inextricable and stressful feature of living in a free society.  In free societies we can choose our purpose or be given meaning by social structures. Immigrants or those who feel outsiders are between social supports, sometimes adrift, and extremist groups provide clear goals and direction.  Also, having no opportunities for meaningful activity such as starting a business or being employed in meaningful work also creates fertile ground for terrorism. This may be an explanation for why some extremists come from backgrounds not of religious faith, but of petty criminality and unemployment.  It also may help explain why areas with high unemployment and heavy regulation on religious, travel, and business activity may predispose to terrorism.
4.  Can intellectualize.  Extremists see the world in terms of concepts and categories that divorces them from engagement with others.   They can intellectualize killing others are a necessary part of an abstract cause.  They are detached from their shared humanity with others.  Killing someone from the persecuting culture is thus ridding the world of the criminals who caused one's bad feelings.
5.  Are lonely.  The social community of others with a cause is powerful, it's an adventure, it's exciting, and they are supported.  Social contact and community - belonging - is essential to a healthy life.  Yet as noted in the other causes above, alienation is only one part of the story - as the British writer David Aaronovitch once joked, “Why don’t black lesbians blow up buses? Aren’t they alienated enough?”

Extremists don't want to be caricatured as alienated loners.  They want to seem confident and motivated.  Consider this quote from an ISIS recruitment video: “Before I come here to Syria, I had money, I had a family, I had good friends. It wasn’t like I was some anarchist or somebody who just wants to destroy the world and kill everybody. I was a regular person.”  Likely that quote is not entirely true.

A phenomenon that we've seen in the San Bernadino attack is the contagion of terrorism through the media.  Although the San Bernadino attackers may not have met anyone officially with ISIS, the idea to go on a shooting spree could have been stimulated by news of other attacks, and Malik (the wife) expressed her allegiance to ISIS on Facebook.  Mass murder can occur in epidemics.  There have been epidemics of suicide - as if suicide were a disease spreading with the transmission of the idea itself.  Micronesia and other islands of the South Pacific were subject to significant suicide epidemics.  In fact, suicides are no longer widely reported in the media because after high profile suicides (like jumps from the Golden Gate Bridge in San Francisco), more suicides tend to follow in the same manner and the overall rate of suicides increases.  

For Islamic State, killing Westerners in the most televised way possible - to spread terror - is coldly logical.  It's logical because of the Kardashian effect, which was like the Star Wars marketing push for the past three (terrible) Star Wars movies -- becoming famous because you're in the media, not due to any compelling talent.  High profile crimes are a tried-and-true strategy for unravelling the social fabric, damaging interpersonal trust, instilling anger and a backlash, and creating more terrorists.  This WSJ article indicates that the social damage from terrorism may be long-lasting.  There may be a self-propagating effect in which renewed social disenfranchisement sows further seeds for terrorist activity.  Hate crime incidents against Muslim targets more than quadrupled in frequency after 9/11 in the U.S. (but remain below those targeting many other ethnic and sexual-preference groups).  High profile murders are a growth strategy for a terrorist organization.  Or as Yoda put it:

To answer power with power, the Jedi way this is not. In this war, a danger there is, of losing who we are.
– Yoda

Mistrust and Prices

The fear of loss is a path to the Dark Side.
– Yoda

Trust is damaged by terrorism, but feings of mistrust appear to be overreation.  As a state of mind trust is a complex emotion, and measuring it in text is challenging.  Trust is embodied in such descriptors as confidence, belief, and faith, and it is an abstract state of mind reflected through behavior.

Researchers have found that countries with lower levels of interpersonal trust have slower economic growth (Zak and Knack, 2001).  Conversely, increasing levels of trust predict greater economic activity. (Bjørnskov, 2012) Interestingly, the mechanism by which trust increases growth is very long-term in nature: “[T]rust affects schooling and the rule of law directly. These variables in turn affect the investment rate (schooling) and provide a direct effect (rule of law) on the growth rate” (Zak and Knack, 2001). 

The Trust TRMI was designed to quantify the trusting media references associated with a country or a company versus mistrustful references. A trusting reference includes phrases such as “Their new product is reliable” and “The CEO is an upstanding individual.” Mistrustful references include “Their customer service department is underhanded and sneaky” and “The product warranty is deceptive.” The difference between trust and mistrustful references over time is captured in the Trust TRMI. 

Trust generates yearly, monthly, and weekly arbitrage opportunities across stocks.  Below is a monthly equity curve derived from arbitraging Trust in the news about the top 100 U.S. stocks by Buzz - going long the quintile (20) least trusted and shorting the quintile (20) most trusted for one month, and repeating each month since 1998.  The equity curve is based on using all equity to go long (100%), and then borrowing against it to go 100% short. 

It appears advantageous to buy low trust stocks and short high trust stocks on a monthly rotation.  This “trust arbitrage” is simple and does not account for timing considerations.  

The same effect appears to be true in arbitraging trust across countries on an annual basis (12-month holding period).  Taking the top 20 countries in the news, the strategy bought the 5 least-trusted countries and shorted the 5 countries most associated with trusting references.  It repeated the same process monthly with one-twelfth of the portfolio.

This shows that country stock markets and stock prices that fall when trust is damaged -- whether after a scandalous event or geopolotical conflict -- will tend to rise back up.   The annual return from this one-year holding strategy, excluding transaction costs and borrowing costs, is a theoretical 7x.  Because this is a long-short arbitrage, it should also be noted that shorting the most trusted countries also adds profits.  More discussion of this trust arbitrage is in our June 2015 newsletter.

Housekeeping and Closing

If no mistake have you made, yet losing you are . . . a different game you should play.
– Yoda

Just as bodies heal after an injury, human psychology rights itself after trust is damaged.  This is true of stocks, and long-term it is likely to be true of society as well.

There are policy efforts such as gun control that can turn the social psychology away from accepting gun violence (apparently worked in Australia 20 years ago).  And there are ideas such as media restraints on sensationalizing threats.  But ultimately the battle against terrorism is a complex psychological, social, and economic uphill battle.  An angry population backslides into intolerance, which is precisely the goal of the terrorists (terror, after all, is a state of mind - dread of the future).  Creating a positive vision for the future along with economic opportunity will inspire and reduce the ranks of terrorists.  Creating this vision - and the social engagement and excitement that goes with it - will be the next great leadership challenge.  The escapism of Star Wars and Elon Musk and Jeff Bezos vision of Mars travel is, unfortunately, not broad enough inspiration for the disaffected.  Widespread economic opportunities and social tolerance are a prerequisite to ending alienation.

Cycles of trust and anger ebb and flow.  Fortunately, low points such as the past month often mean-revert back to more tolerant, secure, and prosperous times.

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.

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Trusting in the future,
The MarketPsych Team


- Paul. J. Zak and Stephen Knack, "Trust and Growth," Economic Journal 111(470), (2001), pp. 295–321.
- Christian Bjørnskov, "How Does Social Trust Affect Economic Growth?" Southern Economic Journal 78(4) (2012), pp. 1346–1368.
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