The Myth of Stock Market Electoral Honeymoons‏

Pls don’t fall for claims that post Presidential election returns will mechanically be positive.

New administrations do not signify as free lunches.

Stock markets are not merely about prices and price pumping. Stock markets are underpinned by claims on future income streams.  Besides, stock markets are also titles to capital goods. Therefore, prices should incorporate such capital formation process (and not bubbles which means price misalignments)

And it isn’t just statistics that matters (or presentations which shows election equals returns y-o-y) as all historical events had been underpinned by unique circumstances. Understand that most of these numbers have been cherry picked.

FVR’s electoral victory in 1992 which led to the 1993’s behemoth 179% rally in the Phisix emerged out of historical monumental low valuations due to the following factors (but not limited to them):

1) The Phisix collapsed in 1979 and stagnated until the Marcos regime was ousted in 1986.

2) The Philippine economy also suffered a balance of payment crisis in 1984 where external debt had to be restructured which had been signed in 1984 by president F Marcos.

3) The old central bank Central Bank of the Philippines which suffered sustained deficits (over Php 300 billion in liabilities) had to be replaced by the BSP in 1993 via the New Central Bank Act

4) The political economy had to endure repeated coups which hounded Cory Aquino regime

5) Natural catastrophe such as 1990 Baguio earthquake and the 1991 Pinatubo eruption 

These factors virtually kept very cheap stocks from advancing to reflect on improvements under the Cory Aquino regime. 

Dr Marc Faber in his book Tomorrow’s Gold (p 215) explained how incredibly cheap Philippine stocks had been in 1986 

I can recall several instances when stocks in high-inflation economies became dirt cheap: The Philippines in 1985/86, Argentina in 1989 and Peru and Brazil in 1990. In the Philippines during the early 80s, high inflation and poor economic, social and political conditions under the Marcos regime had driven down stock prices and the value of the Peso. By 1985, the Commercial Stock Index was down by 76% in US Dollar terms from its all time high of 1980. The Mining Index had declined by 94% and the Oil Index by 97%. The combined market capitalization of the six biggest companies (at the time Benguet, San Miguel, PLDT, Atlas, Philex and Ayala) had fallen to only US $340 million and the entire Philippine stock market amounted to less than US $500 million (today, even after the 1997 Crisis, it is around US $25 billion). PLDT was selling for less than US $40 million and at 1.7 times earnings. San Miguel had a market cap of only US$60 million—less than the value of its 75%-owned Hong Kong-listed subsidiary. By its peak over US $4.5 billion. So, if strategists wanted you believe that US stocks are looking cheap, just remember the valuation of Philippine shares in 1985!

Elections hardly played a role in the stock market in 1998. The PSEi was crushed from the Asian crisis even when Erap won by a 23% margin landslide (which was way bigger than the 2010 and 2016 version both at 15+%). 

There was hardly any stock market honeymoon for Erap 

Because the Phisix collapsed by a terrifying 68.6% in 19 months (!!!) from February 1997 to September 1998, the Phisix had a huge 145% dead cat’s bounce from the said September low to July 1999. [This cherry picked data has been interpreted by some as electoral honeymoon.] 

Yet such bounce eventually was totally eviscerated or wiped out by 2001 after Mr. Estrada was ousted!

GMA’s 2004’s rally came about because the PSEi emerged from the 7 year bear market brought about by the Asian crisis (1997-2003).   

The rally today, which has been a legacy from PNOY’s landslide triumph in 2010, developed in response to the crash of 2008.   

The Great Recession crash, which had little bearing on the economy, proved to be a wonderful opportunity. 

Most importantly, such rally has reflected on the BSP’s pivotal monetary easing in 2009 which served as automatic stabilizer against the global financial recession. 

In summary, GMA 2004 and PNOY 2010 stock market rallies were grounded on post bear market recovery responses. 1992 FVR’s 1993 rally emerged out of the clearing away of the various factors that suppressed the stock market rally during the Cory regime. 

1998 Erap’s magnificent massive landslide win which should have spurred C-O-N-F-I-D-E-N-C-E hardly delivered a honeymoon. 

Prevailing stock market sentiment has signified as a dominant force behind each of the post-election rallies. It was why the apprehensions from the Asian crisis had proven to be a key factor that inhibited any rally. A collapse happened first before the rally. 

More importantly, hardly any one of the stock market rallies from the post 1986 constitution elections had been rooted on ultra high valuations! 

Remember, new administrations are no free lunches.

The Fallacy of the Real Estate Sales Pitch "Buy Land — They’re Not Making Any More"

Back in the pre Asian Crisis boom during the mid 90s when I was a practicing licensed real broker, the common sales pitch by my contemporaries had been “buy land, because land supply is limited”. Even when I wasn’t into economics, I didn’t buy into this simply because I sensed something wrong with it. 

And given today's climaxing Philippine property bubble, aside from G-R-O-W-T-H, such spiel could most likely be part of the bubble promotion.

Anyway, at the Mises.org, Peter St. Onge eloquently explains the economic reasons why “buy land because supply is fixed” is a myth. (bold mine)

“Buy land — they’re not making any more!” is an old investing chestnut, and a common sense one to boot. Economically, it’s also completely false.

As counterintuitive as it may seem, we make land all the time. It just doesn’t look like land.

Why? Because land’s value doesn’t come from its ability to cover up the naked earth. Land’s value comes from its economic usefulness.   From the value of things that can be done using that land (Rothbard’s “marginal revenue product” of the land). And that value is, indeed, changing all the time. Economically, from a price perspective, then, we make land all the time.

Step back a moment and ask why land has value anyway. Why do people want land? Well, obviously, because you can put stuff there — including yourself — plus buildings, swimming pools, and factories.

Now, anybody who’s visited West Texas knows there is plenty of building space in the world. You could drive for hours and meet nobody. There’s lots of space for that factory of yours. But it’s not really space itself that makes land valuable. It’s location. As in, there’s only so much room in Manhattan. Or Central London.

Once again, though, it’s not the actual space that matters. It’s the access. Put a strip mall on Manhattan surrounded by crocodile-filled moats and snipers and it will have low value. The value is in access. So Manhattan is valuable because it’s easy to get to other parts of Manhattan. And it’s easy for other people to get to you. Customers, partners, and friends can all easily visit you if your apartment or office is in Manhattan, moatless and sniperless.

So if it’s the access that matters, are they making new access? Of course. They’re doing it all the time.

New highways, new exits, new streets, mass transit, pedestrian malls are being regularly constructed. These all effectively “make new land” because they offer access to existing space. They turn relatively “dead zones” into "useful zones," or new land.

What are some of the meta-trends on land as investment, then?

First: roads. This was a bigger value-driver a generation ago in the US, as new roads made the suburbs more accessible, helping to drain many cities even as US population grew. Outside the US (Mexico, Thailand, Russia), new roads are still a big deal, and even in the US, new highways can reshape values — draining old neighborhoods and building value in new ones. The decline of cities like Baltimore or Detroit are partly thanks to those beautiful roads that redistribute access to the suburbs.

Second: population. In the US “rust belt” of declining manufacturing, many regions have dropped in price simply because people are leaving. Detroit homes for $100 is emblematic, although of course there are also political reasons some cities are so cheap — in particular, taxes and crime.

And that brings us to politics. Real estate can be cheapened shockingly quickly by taxes and crime, and those traditional drivers have been joined in recent decades by environmental politics.

Environmentalists, by taking land off the market, effectively squeeze the remaining accessible locations. Driving up the price. Regions like Seattle or San Francisco are poster children of this environmental squeeze, with modest homes even in remote suburbs costing upward of a million dollars. On the other extreme, cities like Dallas or Houston have kept prices down despite exploding populations by allowing farmland to be converted to residential, commercial, or industrial use.

Beyond the access and political angles, land is also vulnerable to “network effects.” In other words, the neighbors matter. Gentrification or urban decay can be hard to predict. Even in a compact city with rising population like Washington, DC, it can be hard to predict where the middle class or rich want to colonize, and where they want to flee.

There are clues, of course — in large US cities, gays moving into a neighborhood, new coffee shops or art galleries are some leading indicators that property prices might swing up. But gentrification has it’s own mind; even in a booming city it might go into some other neighborhood. New York’s Harlem or Silicon Valley’s East Palo Alto are two very accessible locations with low prices because of perceptions of the neighbors.

So, while they’re not “making” land, they are constantly making things that affect land price. Access, regulations, changing neighbors. These are the kinds of factors that make land valuable, not it’s ability to cover the earth.

And so land comes back to earth, joining boring old commodities like wheat or copper. Just as vulnerable to changing supply and demand factors.

And if you are looking for something they’re not “making more of?” Well, gold does come close. Hence its appeal. They do mine new gold all the time, but the costs are high enough that gold is a very “inelastic” commodity. It comes close to “they’re not making more.”

Beyond that? Develop your ultimate resource: yourself.

Of course, land prices can also be influenced by central bank's cheap money policies.

 

Oh besides, technically speaking, it isn’t true that land is not being made.

United Arab Emirates looks like a "factory" of land through various land reclamation projects

A few notable examples…

UAE’s the Palm Island

UAE’s The World Islands

In short, technology allows people to expand or “make” land out from its economic usefulness.

The Philippines has its own land reclamation area the Bay City. 

It's not just economics, many controversial land reclamations have been completed or in near completion for political purposes. 

The above pictures are ‘before and after’ aerial shots of the contested Fiery Cross Reef at South China Seas (photos courtesy of Zero Hedge)

These have become tinderboxes for war.

Perhaps one day these islands will be sold and transformed as tourist destination…

“Buy land because they’re not making any more”?

Quote of the Day: The Illusion of Stock-Picking Skill

Professional investors, including fund managers, fail a basic test of skill: persistent achievement. The diagnostic for the existence of any skills is the consistency of individual differences in achievement. The logic is simple: if any individual differences in any one year are entirely due to luck, the ranking of investors and funds will vary erratically and the year-to-year correlation will be zero. Where there is skill, however, the rankings will be more stable…

There is general agreement among researchers that nearly all stock pickers, whether they know it or not—and a few of them do—are playing a game of chance. The subjective experience of traders is that they are making sensible educated guesses in a situation of great uncertainty. In highly efficient markets, however, educated guesses are no more accurate than blind guesses.

This excerpt is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his insightful book Thinking, Fast and Slow p.214

Well Mr. Kahneman’s thesis seems to have been recently validated as passive long term investment funds (via equity bond index) has trumped active fund management represented by hedge funds 

The Economist notes,

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds...

The widening disparity means that randomness or providence or lady luck has increasingly played a bigger role in determining the performances of the fast expanding hedge fund industry. 

The same Economist article subliminally acknowledges this,

The average hedge fund is a lousy bet, and predicting which will thrive and which will disappoint is a task that would tax even a Nobel prizewinner.

Yet in the finance industry where many of the participants believe that they possess presumptuous knowledge which in reality exhibits inflated egos, the role played by luck/randomness exists in a vacuum. 

Why? As Mr. Kahneman from the same book p 216 explains,

The illusion of skill is not only an individual aberration; it is deeply ingrained in the culture of the industry. Facts that challenge such basic assumptions—and thereby threaten livelihoods and self esteem—are simply not absorbed. The mind does not digest them. This is particularly true of statistical studies  of performance, which provide base-rate information that people generally ignore when it clashes with their personal impressions from experience.

Phisix: Choosing The Ideology behind Profitable Actions

We have been trained to look for godliness, virtue, direction, and truth outside ourselves, in some agency external to ourselves. Such beliefs have been generated largely by those who have either a religion or a political system to fasten upon the necks of their fellow beings. It is through such thinking that some have been able to control the thoughts and actions of others by attacking their victims' sense of self-capacity and worthiness to function in the world.-Butler Shaffer

There will be only 3 trading sessions in the coming week because of the extended holidays (on Monday Eidul Fitar and Tuesday Ninoy Aquino Day).

This means that the public will likely be in a vacation mode. So unless some externally driven event will incite unusual volatility that may trigger a local response, I expect the market’s mood to be largely lackadaisical. So whatever direction the Phisix closes the week, the average trading volume will likely be weaker.

Since momentum in the global markets appear sprightly; the odds for a shock seem unlikely.

But given the fragility of current conditions, no one can really tell.

Update on Holiday Economics

As a side note, the string of political holidays only depletes productivity from the economy. The mainstream will argue that “holiday economics” promotes tourism and tourism related industries from which should support the economy. But again, costs are not benefits.

While holidays indeed promote tourism and allied industries, such thinking ignores the unseen costs borne by such political holiday statutes.

As I previously wrote[1],

local policies are counterproductive, privileges one sector (4% direct 10% indirect) over the entire economy, raises cost of doing business, reduces output, promotes idleness, hedonism and wrong virtues (spending instead of saving) and importantly the "elitist" tendencies of the powers that be.

For an update, according to World Travel & Tourism Council[2], the direct contribution of Travel & Tourism to GDP was PHP194.7bn (2.0% of total GDP) in 2011, the total contribution of Travel & Tourism (meaning tourism related industries) to GDP was PHP830.8bn (8.5% of GDP) in 2011. In terms of employment, direct employment from the industry accounted for 778,000 jobs or 2.1% of total employment and the total contribution of the industry to employment, including jobs indirectly was 9.6% of total employment (3,547,500 jobs).

Back of the napkin calculation tells us that ‘Holiday economics’ means supporting 8.5% (of GDP) against the 91.5% of the economy, and in terms of employment, 9.6% as against 90.4% of the labor force.

Holiday economics has been premised on promoting the interests of the elite at the expense of the underprivileged or the ‘poor’.

Market Internals Suggests of Healthy Correction Phase

In the Philippine equity markets, part of what I expected occurred last week.

The recent selloff in the mining sector seems to have percolated into the broader markets.

The Phisix languished, down 1.07% this week, weighed by all major sectoral indices except for the mining and oil which defied the broad market correction

As I wrote last week[3],

I lean on condition (B) or where the bear market of the mining sector will likely percolate into the general market, due to growing risks of contagion.

However everything really depends on how and what future policies will be conducted, especially in the US, as previously discussed.

So the correction phase appears to be another rotational process which essentially shifts the flow of sentiment from the mining sector to the general market and vice versa.

I seriously doubt that the domestic mining sector as having reached an inflection point or has “bottomed” out. I would like to be convinced based on evidences from internal and external forces. Instead I suspect that this week’s rally has been more of a dead cat’s bounce, from a vastly oversold position, than from a recovery.

The correction phase can be seen in the modest deterioration of the market breadth. The rotational process, as well as, the modest decline of the general market should be seen as a healthy profit taking process.

The continuity of the benign conditions, as I have repeatedly been pointing out, will depend on external developments.

Superstitious Beliefs versus Rigorous Analysis

Many have assigned the current weakness in the local equity market as having been influenced by the Chinese tradition of the “Ghost Month” (August 17 to September 15, 2012)[4]

The tradition suggests that many activities such as evening strolls, traveling, moving house, or starting a new business or even swimming can bring about bad luck, thus believers refrain from doing them.

People’s beliefs are acquired mostly through three ways[5], through tradition (handed down through generations), through persons of authority (whose opinions people take as truth and accept or assimilate them, e.g. parents, teachers, religious leaders, politicos, experts and etc…) and or from reason and evidence.

Based on reason, there has been little empirical evidence to support such claims.

While I don’t have the exact figures for the said periods, I used the annual % monthly returns of August (left window) and September (right window) of the Phisix since 1985 to see its validity.

As one would note that in the above chart, from both August and September windows, negative returns have not been a predominant feature. Instead we see sporadic fluctuations between positive and negative zones.

Examining further, one would note that the direction of returns have largely been driven by the dominant trend of the marketplace: Returns have either been negative or marginally positive during cyclical bear market periods, while in bull markets, returns have mostly been positive.

One interesting aspect is that sharp market volatilities has characterized September returns, where gains and losses have been magnified.

I think this seem to square with the seasonal activities in the US where September tends to be the worst month for stocks as exhibited by the Average Monthly gain by the Dow Jones Industrials since 1950[6].

And the sharp volatility compounded by negative returns could have been due to the simultaneous large liquidations of savings, which includes sales of stocks, to fund major consumption expenses by US households, particularly spending for new school clothes for children, winter clothes and other weather related consumption activities. Fueled by tight monetary conditions, the massive outlays for consumption may have served as catalyst for the notorious September-October window which has been seasonally prone to market crashes[7]

The lesson that can be gleaned from the above is that beliefs based on superstitions and or the tendency of many to employ the availability heuristics—mental shortcuts based on what we can remember rather than from complete data[8]—are hardly useful substitutes for thorough investigation and rigorous analysis of the marketplace from which to project the future or even explain markets on an ex-post basis.

On the contrary, I would say that the recent weakness of the Phisix can be traced to a single axiom: NO Trend Moves in a Straight Line.

Given that the Philippine Phisix, which has outperformed most of the world’s equity benchmarks on a year to date basis, has shown signs of being overbought and overextended, then a salutary reprieve should be a natural state.

In short, profit taking is an inherent process of the financial markets.

Year-to-date, Thailand seems to have successfully passed the Philippines (19.37 versus 19.1% respectively) to take the region’s leadership. Yet both managed to keep some distance from last year’s leader Indonesia, as well as, Malaysia who remains the laggard among the ASEAN majors.

Meanwhile Malaysia’s year-to-date returns largely understates the real action—Malaysia has been the only bourse in the region (if not the world) trading at record highs.

I think that in as much as rotations occur within the domestic market, the same dynamic will likely influence activities of the region’s equity bourses.

As I previously noted[9],

given the rotational dynamics, we might see some “catch up” play or the narrowing of the recent wide variance between the laggards and leaders overtime. But this doesn’t intuitively mean that such gaps will close.

So far, only the Phisix has backtracked while Thailand’s SET has still been in high Octane. On the other hand, Indonesia has slightly narrowed the gap with the Phisix.

Risk ON Stands on Perpetual Promises of Rescues

The reason why the world’s bourses have turned conspicuously positive has been due to the recent return of the RISK ON environment.

The following represents mainstream media’s attribution of the strong performance of global equity markets for the week.

European stocks, from Businessweek/Bloomberg[10]

European stocks rose to the highest level since July 2011, extending gains for an 11th week, as investors anticipated policy makers will stimulate the euro-area economy and German growth retreated less than forecast.

Asian stocks, from another Businessweek/Bloomberg[11]

Asian stocks rose this week, with the benchmark index posting its longest weekly winning streak since March, after China’s Premier Wen Jiabao said there’s more room to adjust monetary policy and U.S. economic reports signaled strength in the world’s largest economy.

In spite of indefatigable pledges by Chinese authorities, China’s bellwether, the Shanghai index remains in doldrums seemingly unaffected by the global RISK ON landscape.

In fact, China’s authorities have admitted to recent signs of outflows of hot money[12] as domestic banks became net sellers of foreign exchange or 3.8 billion yuan ($597 million), which for me could be worrying signs of a popping bubble.

Meanwhile US stock markets according to the Reuters[13]

The S&P 500 held near a four-year high on Friday, and the market's key gauge of anxiety sank to its lowest since 2007, suggesting a belief that the problems stressing investors might be closer to a resolution…

The S&P 500 made a solid move above the closely watched 1,400 level in the last session, posting its biggest gain in two weeks. But trading volume remained low…

The S&P 500 has risen 2.8 percent in August and about 11 percent since a year low in June as traders eye some encouraging U.S. jobs data and highly anticipated policy meetings at the European Central Bank and the Federal Reserve in September.

In essence, the gist of today’s rally in the global stock markets has been galvanized around intensifying expectations that global central banks and governments will effectively rescue the markets.

And tidbits of good news are seen as signs of selective confirmation of a recovery. On the other hand, bad news have been interpreted as having to add pressure on governments to intervene, the result of which is to supposedly deliver good news—a recovery.

In other words, today’s global equity markets investors seem to have been strongly conditioned to carry expectations that markets can only move in one direction: UP. It can be said that the circularity of this logic entails a “heads I win, tails you lose” market environment from political guarantees. Such is the confirmation bias which intensely embodies the mainstream view.

Such has also been the reason why markets everywhere have increasingly been politicized as participants have been oriented to see rising markets as a form of political entitlement.

Divergences Aplenty

It has been interesting to note that, yes corporate fundamentals may have posted some positive signs but again everything depends on the reference points.

From the big picture, the positive signs emitted by the S&P 500 have not been convincing.

Aside from low volume, the divergences I previously mentioned, such as earnings, global economy, industrial and non-industrial activities[14], market internals, divergent signs on sub-sectors such as Transportation (Dow Theory)[15] or even the Russell 2000, have shown marginal and not substantial improvements, in spite of the near four year highs by the S&P 500.

A good example is the current divergence in the % of companies beating earnings and revenue estimates. While the above has shown positive results, it seems that US markets have been cheering what seems like diminishing returns or a decline in positive developments. (chart above from Bespoke Invest[16])

chart from Bespoke Invest

Again recent highs of the US markets have been accompanied by narrowing market breadth.

This means the drivers responsible for lifting the equity benchmarks have mainly been big cap issues. Yet the accounts of publicly listed companies at 52-week highs have also been diminishing. If such trend should continue then this entails limited upside for the S&P[17].

Finally the current rally in the US markets seems to have departed from the previous trend relative to gold.

In the past, rallying US markets (represented by the S&P 500) came at the heels of a more powerful run in gold (see lower window) and in other major commodities. So even as the S&P rose, gold climbed faster, thus the declining ratio between the S&P and gold.

The implication is that the RISK ON environment then had been broader which also meant that the rally had a firmer footing.

Today’s RISK ON environment seems to be concentrated on the equity markets and the junk bond markets where Gold and commodities has vastly underperformed, thus, the rising ratio between S&P and gold.

Junk bonds have been posting record issuance. Companies have been taking advantage of zero bound rates and strong demand which has brought down yields of speculative bonds to a few points away from the record lows reached during May of 2011[18]. Such yield chasing phenomenon exhibits the nature of today’s yield chasing rampant punting and speculations.

This means that gold’s modest rise has not been consistent with a strong RISK ON landscape.

The selective risk appetite and the apparent narrowing of asset selections mean that the markets could be highly susceptible to sudden changes of expectations or to mood swings: thus elevating the current risk profile of would be buyers.

Current Conditions Remain Highly Fragile

I have long been making this point: For as long as the US won’t fall into a recession or won’t suffer from a financial shock that could lead to a global recession, the recent decline in the Phisix extrapolates to a healthy profit taking process.

That said, a five to ten percent decline from the peak or the range at 4,825-5,080 could prove to be a spring board for the next record high. This is all conditional on the unfolding events abroad, and should not be read as one-size-fits all analysis.

Given the nature from which the recent global rally has been anchored, i.e. expectations from promises of rescues, I still remain highly apprehensive, or I will not write off the risks of possible sharp changes in expectations that may precipitate the current moderate RISK ON conditions to a swift and dramatic RISK OFF environment.

The contagion risks are real, which means current conditions remain highly fragile. Rising markets have not smoothened out all the underlying stresses.

Given the enormous distortions of the markets from repeated interventions, the best is to watch the interplay of stimulus-response between markets and policymakers.

To close, let us not forget our beliefs essentially drive our actions, rightly or wrongly. As the great Ludwig von Mises wrote[19],

In acting man is directed by ideologies. He chooses ends and means under the influence of ideologies. The might of an ideology is either direct or indirect. It is direct when the actor is convinced that the content of the ideology is correct and that he serves his own interests directly in complying with it. It is indirect when the actor rejects the content of the ideology as false, but is under the necessity of adjusting his actions to the fact that this ideology is endorsed by other people. The mores of their social environment are a power which people are forced to consider. Those recognizing the spuriousness of the generally accepted opinions and habits must in each instance choose between the advantages to be derived from resorting to a more efficient mode of acting and the disadvantages resulting from the contempt of popular prejudices, superstitions, and folkways.

---

[1] See The Economics of Holidays, October 22, 2009

[2] World Travel & Tourism Council Travel & Tourism Economic Impact 2012 Philippines

[3] See Philippine Mining Index: Will The Divergences Last?, August 13, 2012

[4] Mandarin Language Ghost Month and Ghost Festival About.com

[5] Green Alexander, The Noblest Expression of the Human Spirit, Early To Rise, October 6, 2010

[6] Chart of the Day Dow-Average Monthly Gains

[7] See Austrian Business Cycle and September Market Crashes, June 27, 2012

[8] Changingofminds.org Availability Heuristic

[9] See Phisix and ASEAN Equities in the Shadow of Contagion Risks July 22, 2012

[10] Businessweek/Bloomberg, European Stocks Rise for 11th Week on Stimulus Bets, GDP August 17, 2012

[11] Businessweek/Bloomberg, Asia Stocks Rise for a Third Week on Wen Comments, U.S. Economy August 17, 2012

[12] Wall Street Journal Investors Shift Money Out of China August 14, 2012

[13] Reuters.com US STOCKS-S&P 500 up for 6th week; fear index hits 5 yr low, August 18, 2012

[14] See Why Current Market Conditions Warrants a Defensive Stance, July 9, 2012

[15] See Phisix: Managing Through Volatile Times, August 6, 2012

[16] Bespoke Invest Final Earnings and Revenue Beat Rates August 17, 2012

[17] Bespoke Invest Wanted: More New Highs August 17, 2012

[18] Bloomberg.com Junk-Bond Sales Soar To Record In August: Credit Markets, August 17, 2012

[19] Mises, Ludwig von 2. The Role of Power XXIII. THE DATA OF THE MARKET Human Action, Mises.org

Brain Damage and Better Investment Decisions

Jason Zweig in his latest article at the Wall Street Journal cites a study which suggests that people with brain damage are likely to make superior investment decisions than normal people…

With computerized traders that "hold" stocks for only a few seconds at a time and markets that can swing wildly in a matter of moments, long-term investing seems to be on the verge of extinction.

Perhaps this is inevitable. It turns out that short-term thinking is deeply embedded in the workings of the human brain. New research suggests that in order to avoid trading your accounts to death, you must counteract some of the very tendencies that make Homo sapiens the most intelligent of all species.

In a study published last month in the Journal of Neuroscience, researchers from California Institute of Technology, New York University and the University of Iowa looked at how people use past rewards to predict future payoffs.

Directly behind your forehead is a region of the brain known as the frontopolar cortex. Much larger in humans than in other primates, this area is critical to such advanced mental functions as memory, exploring new environments and making decisions about the future.

In the new study, the researchers wanted to see how the frontopolar cortex contributes to predicting rewards. So they compared people with damage to the frontopolar cortex against two control groups of healthy people and those with injuries elsewhere in the brain (but not the frontopolar cortex)….

When confronted with the unpredictable, however, the frontopolar cortex refuses to admit defeat. It draws on all your computational abilities to search for patterns in random data.

In the absence of real patterns, it will detect illusory ones. And it will prompt you to act on them.

No wonder so many investors find it hard to muster the willpower to buy and hold a handful of investments for years at a time.

But if "buy and hold is dead," as growing numbers of investors argue, it isn't clear what else is alive. In the lousy markets of the past decade, various alternatives such as "tactical asset allocation" (or market timing), mathematical risk-reduction techniques and even plain old intuition haven't worked out all that well, either.

Most of the folks who say buy and hold is dead don't talk much about their long-term returns. Instead, they stress how they have done recently, a tactic that for many potential clients has the same irresistible appeal as the last couple of pulls on a slot machine.

The solution to short-term thinking isn't to bash yourself in the forehead with a hammer, of course. But you can use your brainpower to your advantage.

Every investing decision you make should be the result of a deliberate process.

The implication that it would take brain damage to make for a better investor would seem downright preposterous (the same goes with the theory of high IQs)

Pseudo scientific studies like the above disparages the individual’s distinctive capacity to deal with the ever changing circumstances we are faced with.

While it may be true that many people have the tendency to fall for cognitive biases, in reality all of people’s actions are driven by incentives

Incentives are shaped by the dynamic admixture of many factors—including genes and the environment, peer pressure and social status, educational background, culture, religion, technology and even to social policies such as zero bound rates—in relation to changes to the environment, social relations and the economy (even if some of their actions can be read as cognitive biases or heuristics—pattern seeking behavior).

This applies to short-term thinking.

Deliberate process is more about containing the urge for the dopamine to govern one’s action, or importantly, managing emotions through emotional intelligence (EI) to attain self-discipline.

Superior investing decisions can be attained even if you have a normal brain.