MarketPsych Newsletter

MarketPsych Report: Affluenza, Anger at the Government, and National Renewal

January 06, 2016

Latest News

January 05, 2016 - We're excited to announce that our new book, "Trading on Sentiment:  The Power of Minds Over Markets" will be published in March 2016!  Using the latest research, the book describes how media sentiment predictably drives prices in global markets, from milliseconds to years.  It's an essential read for serious investors.

January 01, 2016 - Our very own CJ Liu is presenting on "Global Investment Strategies Based on Sentiment Analysis" at the Sentiment Analysis in Finance conference in Singapore March 10-11, 2016.

In With the Good

Whether a commitment to lose weight, get organized, or spend less and save more, most New Year’s resolutions have a common theme – they require self-control.  Our 2013 and 2014 January newsletters focused on personal transformation.  The changes working through the global financial system from 2015 to 2016 are broad-based - e.g., a dramatic decline in energy and commodities prices, a sharp rise in the U.S. dollar, and the increasing cost of credit.  Companies, industries, and entire countries are being impacted, but many are still in denial, hoping for a return to the good old days. Formerly-fringe politicians are gaining social support.  2016 promises to be an interesting year, one that will witness the spread of old challenges and the emergence of new ones. 

Today's newsletter explores social frustration, affluenza, underreaction in the S&P 500, and more to the point of behavioral economics, science-based evidence on how to change society for the better.  As usual, it's a long newsletter, and we recommend skipping ahead to sections of interest.

Diagnosing Malaise

All over the place, from the popular culture to the propaganda system, there is constant pressure to make people feel that they are helpless, that the only role they can have is to ratify decisions and to consume.
~ Noam Chomsky

For every witty tech company billboard along Highway 101 in Silicon Valley there is an entire region of the U.S. where billboards advertising pain clinics and personal injury lawyers line the highways.  Those billboards speak to the many left behind (or injured) in an country where a few have succeeded fantastically.  The social inequality in economic prospects is speculated to be a psychological driver -- via the anger and frustration it generates -- behind the popularity of U.S. politicians such as Ted Cruz and Donald Trump on the political right, and Bernie Sanders on the left. Economic frustration breeds anger, and that frustration often targets for blame ethnic groups, social groups, and government institutions.

Using a global comparison, anger expressed at the U.S. government in the news and social media is relatively high.  The following is a map of government anger expressed in English language media in 2015 (using the governmentAnger TRMI).  The U.S. doesn't have the most anger at the government (that honor belongs to Tajikstan, Venezuela, Myanmar, etc...), but it's angrier than most other developed economies.

Assuming that anger arises from inequality and feelings of stagnation, then based on current trends, it's likely that populations in many countries will grow angrier in 2016.  

GovernmentAnger Creates Opportunities (Not Only for Politicians)

While populist politicians take advantage of social anger, investors can profit from the same.  The following investment research is presented based on a cross-sectional rotation model.  CJ Liu performed an arbitrage using the governmentAnger Thomson Reuters MarketPsych Indices (TRMI).  Read more about the TRMI here. His code selected the top 20 most buzzed-about countries in the news media over the past 12 months. Countries without invest-able stock indexes, such as Afghanistan, Libya, and Iraq, were excluded. The remaining countries were ranked by the average value of governmentAnger over the prior 12 months. A hypothetical portfolio was generated in which the top five (e.g., angriest populations according to the news media) stock indexes were bought, and the bottom five (least angry) were shorted. The positions were held for 12 months. The portfolio was rolled forward monthly and updated with one-twelfth of the portfolio since 1999.  The equity curve derived from this research is below, depicting the return if one were to start with a hypothetical $1 (it grows to around $6, with a setback in 2015).

The positive results of this model are predominantly from buying the countries with the most anger at the government. Transaction costs were not included.  Currency fluctuations were not hedged out of this model.  Interest rate yields were not included, however when included, they actually boost the returns.  It appears that in most countries with functioning stock markets, government anger is actually a buy signal. But the buy signal should not be taken too early. Commodity producing countries that did not plan for a future of sustained low oil, copper, iron, etc prices are particularly vulnerable to government anger as they slash social spending to balance budgets. And the social unrest in those countries may snowball.  As seen in the equity curve above, the strategy lost money in 2015, and that losing streak may extend further into 2016.  More often than not, investors initially underreact to complex news.

Investors Underreacting and the S&P 500

In general there are two well-known sentiment-based patterns in financial prices: overreaction and underreaction. A price movement is called overreaction in hindsight - if prices mean-revert (bounce) in a predictable way, often following dramatic or emotional information, such as anger at a government, as taken advantage of to produce the equity curve above. 

A price movement is called underreaction if a trend (momentum) is born.  In the case of underreaction, routine or complex information may be initially overlooked by investors.  As they wake up to its meaning, they gradually buy (or sell), creating a gradual price trend.  Such underreaction creates price trends.  As a result, trends can be broadly predicted with simple sentiment moving averages.

Our Chief Data Scientist Aleksander Fafula found hundreds of interesting moving averages.  One of the most intuitive involves blanket media sentiment (embodied in the Sentiment TRMI).  This sentiment crossover strategy is: (1) Be 100 percent long the S&P 500 when the short-term (200-day) average of sentiment is above the longer-term (500-day) average -- that is, when good news outweighs bad over the recent period, and (2) Be 100 percent short the S&P 500 when the 200-day is below the 500-day.  This strategy buys when the sentiment tone of news is becoming more positive and sells short when it is drifting more negative.  See the image below.

This simple strategy earned 314% from January 1, 2000 (when the 500-business-day average was fully populated and the trading began) through July 31, 2015 with a maximum drawdown of 33%.  The S&P 500 itself, adjusted for dividends, earned 91% over that period with a maximum peak-to-trough drawdown of 57%.  Importantly, by following this model investors would have been short stocks during the drawdowns associated with the 2000-2002 tech stock crash and the 2007-2009 financial crisis.  The indicator is currently in the red zone.  When times turn bad, many see the warning signs but they don't react quickly enough.  


Behavior used to be reinforced by great deprivation; if people weren't hungry, they wouldn't work. Now we are committed to feeding people whether they work or not. Nor is money as great a reinforcer as it once was. People no longer work for punitive reasons, yet our culture offers no new satisfactions.
~ B. F. Skinner

Reflecting the profligacy of the recent good times, many commodity-producing nations, especially in the Middle East, have significantly obese populations.  Weight is an issue in most developed nations as well.  The U.S. is the 27th most-obese country with 66 percent of the population obese or overweight, and the most common American New Year's resolution is to lose weight.  Obesity is complex, being a mix of a biological (foods, hormones), psychological (self-control and behavioral regulation), and a social (contagious among friends and family) issue.  In this newsletter we are interested in the psychological -- specifically self-control.  There is an affliction of self-control in times of plenty, which the media has labeled "Affluenza," reinforced by behaviors learned during times of abundance.  

According to eminent psychologists as well as this research, children from wealthier families have higher rates of drug abuse, depression, and anxiety in adolescence. In some cases, children of the wealthy, like the Chinese "Fuerdai," are socially castigated as unproductive and petty.  Similar groups are evident globally, and in the media recently.  A greater proportion of wealthy children end up with addictions and mental disorders.  Wealthy adolescents often have underdeveloped problem-solving skills, little curiosity, and lack the motivation (or courage) to find solutions to problems (if there are no significant problems to solve during one's adolescence, then problem solving skills are difficult to develop).  Those with affluenza come to value pleasure from things and transactions (e.g., shopping) more than that from hard work, deliberate practice, and accomplishment.

The symptoms of affluenza - the inadequate self-control, lack of sustained effort, and absence of goal-achievement - can undermine the health and happiness of an entire population.  Some have attributed the decline of Western European and American economies to such.  Possibly some corporations suffer from it as well (e.g. the seemingly inevitable decline of dinosaur corporations such as GM, Xerox and Kodak).  Economies dependent upon oil and commodity revenues may soon experience the same.  

Low oil and commodity prices, among other factors, have already sparked democratic government turnover in Venezuela and Bolivia.  The demoncratic process is a social pressure-release valve, in some commodity-dependent nations there is no possibility of democratic turnover, and anger is likely to build to a dangerous boiling point.  Middle Eastern states can continue business-as-usual by tapping into cash reserves to support spending, but if commodity prices stay low (as is likely), then only a wholesale transformation in culture can sustain economic development and social stability.  Could policy changes transform commodity-sustained cultures for the better? 

Transforming a Culture

"Mater artium necessitas."
Translated as, "Necessity is the mother of invention"
William Horma, 1519

There are a few preconditions for cultural change.  First of all, one must be open and honest about what is wrong.  On a concrete level - high obesity rates, poor graduation rates, absenteeism from work - these is easy to measure and diagnose.  But to say that a culture is suffering from a deeper malaise of the spirit such as affluenza - in which motivation, discipline, and self-control are eroding - is bold and possibly alarmist.  But is it correct?  

Historically, when decadence threatened a population, religious scholars and moralists proscribed a return to basic values education.  While such education dictates proper behavior, it doesn't give students the psychological and emotional tools to deal with day-to-day life challenges.  Morally upright behavior is difficult to measure, so it's opposite - crime - is where most of the success and failure data was derived.  In several cases such as DARE (Drug Abuse Resistance Education), such education-based programs were found to cause harm by the U.S. Surgeon General with higher rates of drug abuse and incarceration following such education.  Problem-solving education was much more effective, especially when gritty real-world situations were part of the curriculum.  

In some cases, cultural change is resisted if one’s cultural identity feels under threat.  For example, if a culture self-identifies as idly rich, employing people of lesser cultures to do one's dirty work, then hard work is considered only for others, not for oneself.  Suggesting a member of such a culture "get a job" in order to learn the monetary value of hard work will backfire.   

National Renewal

Fringe politicians appeal to a sense of frustration that the country is no longer working.  In the spirit of the new year, this section explores strategies that have worked historically to change social outlook and behavior.  On the level of national behavioral change, such as in the pursuit of greater social self-control, one of the most common programs is anti-littering campaigns.  These usually combine fines, negative social comparisons, role models, and achievement awards for those who comply.

When I was a child growing up in Texas, I often saw drivers throw their trash - usually fast food packaging - out the window of their moving cars.  This practice was common in semi-rural Texas, and a public service campaign emerged to end the practice.  The campaign's motto was memorable and appealed to local patriotism -- "Don't Mess With Texas".  By its implications, those who littered were anti-Texas.  Texans are generally proud of their state, and very quickly the rate of littering declined.  

Negative social comparisons also motivated greater science and math education in the U.S. in the 1950s and 1960s.  Following the launch of the world's first satellite - Sputnik - by the rival U.S.S.R., Americans believed they were being surpassed in engineering skills by their arch-rival during the height of the Cold War. U.S. science, math, and engineering enrollment surged.  National values were re-aligned.  This event later entered the language as a  "Sputnik moment" - a realization that one is falling behind and faces a choice to either change or die.

Such cultural transformations require role models and clear goals.  Test pilots and, later, astronauts of the U.S. space program inspired generations of U.S. school children to look towards space.  Popular culture picked up the space theme with entertainment such as Star Trek and Star Wars.  Yet after walking on the moon, the space program lost its inspirational power.  Only recently has renewed enthusiasm emerged around the goal of creating a colony on Mars.

Short of a Sputnik-moment, how can groups of people change their values to become more productive and disciplined?  A live experiment is underway in the United Arab Emirates (UAE) and other Gulf countries.  In 2014 the UAE initiated a 9-month compulsory military service for "instilling loyalty and sacrifice" in young adults.  Emiratis who do not graduate high school are given additional service - 2 years total.  It is hoped that this extra training will teach discipline and other life skills to wayward youth.  

While the long-term value of military conscription programs is unknown, there is evidence that high school athletes have greater success in later life.  This agrees with evidence that age 16 is when children develop economic attitudes that will be reflected in their later investment habits and income.  The success of high school athletes could be a self-selection phenomenon - those who choose to play team sports may be more motivated to pursue business in general.  
As seen in the U.S. Surgeon General's report referenced above, training in problem solving skills facilitates better social behavior than moral education.  In an age of fast-declining energy prices and rapid technological and social change, perhaps a problem-solving boot camp would be appropriate in the UAE as well.

And finally, to transform a culture, obstacles ought to be anticipated, envisioned, and resolved on a daily basis.  Achievement is much more likely if realistic challenges are identified and solutions are mentally rehearsed.  (A form of pre-emptive problem-solving).

To rehash, when setting out to change oneself, one's family, an organization, or an entire culture, education does not work.  It helps to:
1.  Get to the problem being addressed (e.g. affluenza) with stories that inspire emotion.
2.  Emphasize the concrete negative consequences of business-as-usual (e.g., invasion by the U.S.S.R.).
3.  Generate negative social comparisons for those who continue the unwanted behaviors (e.g., unpatriotic Texans)
4.  Create narratives that reinforce the desired behavior, usually with emotional tales of role models doing the right thing and avoiding the wrong.  (e.g. the successes and sacrifices of astronauts).
5.  Describe the potential obstacles to change and techniques for working through them. 
6.  Develop habits of disciplined execution through athletics (or perhaps military training).

Housekeeping and Closing

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.

If you represent an institution, please contact us if you'd like to see into the mind of the market using our Thomson Reuters MarketPsych Indices to monitor real-time 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.

Wishing You a Joyous 2016!
The MarketPsych Team
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