When I was training as a psychiatrist, I enjoyed taking overnight shifts in psychiatric emergency rooms. In the Psych ER my job was, in part, to ascertain whether patients were at risk of hurting themselves or others. If the odds of violence were high, then the individual was hospitalized. If not, their problems were further managed outside the hospital. At its core, it was an exercise in predicting human behavior - violent behavior.
If a patient was downcast, regretful, or hopeless, we were more concerned about suicide. If angry, bombastic, or contemptuous, homicide was more of a concern. By reading body language, asking the right questions, and contacting their associates, we could fit together a risk profile and take what we hoped was sensible action to keep the patient and the public safe. Since I was in training over a decade ago, mass casualty events have surged to epidemic proportions in the US.
Due to the high frequency of global violent incidents over the past few months, today's newsletter will review the psychological dimensions of such events. In particular, we examine how media reports about violence systematically affect our individual mindsets, create a contagion effect on the mentally unstable, and generate predictable patterns in financial market prices. The end of the newsletter focuses on investment opportunities related to violent media coverage in currencies and global stock markets. (Future newsletters will cover sunnier topics, I promise).
Violence and News Media
Lately the news media is saturated with violent news. I'm not just saying that - the data speaks. Below is a chart of the simple 500-day average of our Thomson Reuters MarketPsych Violence index (Violence TRMI from here on out). The y-axis represents the percentage of references to violent crime or war (as a percentage of all references) in a country, its cities, or its regions. The grey line is the Violence TRMI for the US, the green line is the index for the Eurozone, and the blue line is that of China. The date range is 1999 through the present.
In the period since 1999, the US Violence TRMI is near its highs. The Eurozone is at all time highs. China has remained relatively flat.
Note that during the financial crisis references to violence dropped, in part because economic issues dominated the news. These days the economy is growing, unemployment is dropping, asset prices are rising and the most dramatic attention-grabbing events the media focuses on are those created by terrorists and rogue gunmen. The problem with violence leading the headlines is that, like a virulent disease, violence is contagious.
Back to my psychiatry training. As a psychiatrist I had to understand what external influences might predict violence in the individuals I was examining. I often thought back to the phenomenon of suicide contagions. In a study of suicide statistics in the United States from 1947 to 1968, researchers found that media reports of suicide create chain reactions: "within two months after every front-page suicide story, an average of fifty-eight more people than usual killed themselves.... [A]nd the wider the publicity given the first suicide, the greater the number of later suicides" (Phillips, 1974)). Further studies found that there are more suicides in the vicinity of the prior one with diminishing frequency by geographical distance (Phillips and Carstensen, 1986). A recent case is the self-immolation of Mohamed Bouazizi, a Tunisian street vendor who set himself on fire on December 17, 2010, an act that was a catalyst for additional self-immolations, the Tunisian Revolution, and ultimately sparked the Arab Spring.
To prevent such suicide contagion, many countries legislated against media reporting on suicides. The World Health Organization asks media outlets to use extreme restraint in covering such deaths, to keep the word "suicide" out of headlines, and not to romanticize the death. This restrictions are necessary because societal violence can be inflamed by the media.
News coverage of suicide increases its frequency. It's similarly likely that reports on mass murders also create contagion effects, leading to more such acts. While overall violent crime has dropped dramatically in the US since the early 1990s, mass casualty events have increased in recent years, due in part to the contagion effect of media coverag. The data, when displayed in infographics is startling, and the increasing trend appears evident.
Media reports create emotional overreaction among the population. In some cases the overreaction compels unstable people to mimic the violence. For most people, the violence increases vigilance and social mistrust. We will be seeing such overreaction as strict anti-immigration policies gain credibility in Europe and the US. We know these reactions are overreaction because we see predictable price bounces in financial market prices after violent events occur (more on that in the next section), which implies that the initial emotional response is overdone.
What to do about rising mass casualty events? Media restrictions on reporting on mass murders - and even terrorist acts - are appropriate. Mentally unstable people exist and will continue to be among us (and I include terrorists under the mentally unstable). If all major media outlets agreed to tone down the drama of their violence coverage, then we have a chance of slowing or even stopping the acceleration of mass casualty events.
Aside from such regulatory actions, in the financial markets there are fairly clear guidelines for how to deal with such violence.
Profiting from Violence
On the day of the Newtown, Connecticut massacre of 26 kindergarteners and staff in 2012, my daughter was in 1st grade in a school about 30 minutes away. Her school was placed on lock-down. It was an unspeakable relief to have her delivered safely home by the school bus on that sad day.
A few days later I received a strong buy signal in my email inbox from our psychology-based trading systems. The buy signals were for gun manufacturers Smith & Wesson, Sturm Ruger, and others. Gun stocks had sold off due to fears of new gun control legislation, spreading fear in social media which our systems detected, and the investor panic seemed overdone. Yet I didn't want to own those stocks given the tragedy of what happened. I knew my feeling was shared, and since the most emotionally difficult trade is usually the best, the buy signal was almost a sure thing. But I didn't have the heart to act on it. And the stocks went on to rally enormously over the following weeks. (Traders sometimes benefit from having the conscience of a shark).
Trading signals like the above based on a mass shooting are not uncommon. In exploring our Violence TRMI over many assets, we see systematic patterns indicating that investors overreact to news of violence, and stocks (and currencies) subsequently recover.
Some assets respond differently to the Violence TRMI. Our book describes how the Violence TRMI is quite useful in predicting overreaction in crude oil prices over weeks and months. For example, violence associated with the ISIS take-over of Mosul in June 2014 marked the last peak in the oil price over $100 - an overreaction surge - before its historic decline in the Autumn of 2014.
In studying the effect of media violence on global stock indexes, we found that stock indexes in countries associated with higher levels of violence in their media outperform those with lower levels of violent references. Using a yearly cross-sectional analysis procedure in which we selected the 20 countries that were most Buzzed-about in the media (both news and social media), ,we then ranked those countries by their average values of the Violence TRMI over that same 12-month period. The primary stock indexes of the five countries with the highest average Violence scores were bought the next day and held for one year. To counterbalance those in an absolute return strategy, the five country stock indexes with the lowest values on the Violence TRMI were shorted and also held for one year. This created an annual arbitrage of media violence across countries from 1999 through July 2015. This strategy showed a doubling in returns, with reasonably low volatility. Its not worth investing solely on this signal, but it nonetheless does appear to contribute value.
Perhaps it will soon be a good time to invest in the Eurozone based, in part, on this indicator.
We also looked at currency price predictions after adjusting for interest rates. Taking the top 8 currencies Buzzed-about in the media (both news and social) over the past one month, we bought the two with the highest average Violence score and shorted the two with the lowest Violence scores. This process was repeated every month, and the below equity curve geenrated. Again, overreaction could be harvested, but not dramatically so, by this strategy. The equity curve from this monthly arbitrage of currencies from 1998- July 2015 is somewhat volatile and is visible below:
Again, it's not trade-able in isolation, but it is suggestive of overreaction by investors when media reports of violence are high.
Turning Fear into Investing Wisdom
Our lives are much happier when we aren't tuned into dramatic media portrayals of crime, terrorism, and violence. Many on the MarketPsych team deliberately cut the cord and don't own TVs. The data supports this approach, and we find ourselves more joyful focusing our attention where we have control over outcomes rather than fretting about events over which we have no or very little influence.
Learn more about improving your investment returns with insights from sentiment analysis of the herd in our new book, “Trading on Sentiment: The Power of Minds Over Markets.” 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.
Rest assured, the world is not as bad as the media make it seem,
The MarketPsych Team
Phillips, D. P. (1974). The Influence of Suggestion on Suicide: Substantive and Theoretical Implications
of the Werther Effect. Am. Sociological Rev., 39: 340–54.
Phillips, D.P. and Carstensen, L.L. (1986). Clustering of Teenage Suicides After Television New Stories
About Suicide. New England Journal of Medicine, 315(11): 685-9.