“It takes a huge investment in introspection to learn that the thirty or more hours spent ‘studying’ the news last month neither had any predictive ability during your activities of that month nor did it impact your current knowledge of the world.” - Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb
I discovered this for myself well before Taleb wrote about it in 2008, but long after Amos Tversky and Daniel Kahneman first published their findings on the matter 32 years earlier, in a piece entitled, “Judgement under Uncertainty” in Science. They explained that in order to make decisions when the outcome is uncertain, we rely on our beliefs to assign probabilities to each of the potential outcomes. What they discovered is that very often the heuristics, or mental shortcuts we employ lead to biased expectations which can result in “severe and systematic errors.”
They describe a phenomenon known as judgement by representativeness through a series of examples and experiments, one of which is particularly applicable to Taleb’s point. In it, they tell subjects that a group consists of 70 engineers and 30 lawyers. Without providing any additional information, they asked the subjects what the probability is that a particular individual selected from that group is an engineer. They correctly judged it to be 70%.
They then provided the following personality sketch of the individual in question.
“Dick is a 30 year old man. He is married with no children. A man of high ability and high motivation, he promises to be quite successful in his field. He is well liked by his colleagues.”
The description was meant to convey no information relevant to the question. Therefore, when asked again what the probability is of him being an engineer, the answer should have remained 70%. However, the subjects now judged the probability to be 50% after reading what was essentially worthless information.
“Evidently, people respond differently when given no evidence and when given worthless evidence. When no specific evidence is given, prior probabilities are properly utilized; when worthless evidence is given, prior probabilities are ignored.”
Armed with the evidence that even perfectly innocuous information can have a detrimental impact on your ability to make rational decisions, does it make you question the real cost of all that free research flooding your inbox? Will you take action? If so, when? As I mentioned in “Do Not Read This” (Seeds of Thought, Issue 15-6, 2/11/15), an information portfolio with 100 components that are 60% correlated offer the same diversification as one with 4 components that are 40% correlated. If you find yourself skimming everything and absorbing nothing, re-build your information portfolio, intelligently and deliberately, with publications that deliver unique content and improve your performance in different ways.
Risk (Aversion) Seeking by Stephen Duneier
Published March 17, 2015
Lately, whenever I mention my bullish view on large cap US equities, someone inevitably steers the conversation toward European equities. For me, that’s a surefire indicator that Euro equities are en vogue. What seems to take many by surprise is when I point out that US equities have generally outperformed. If you’re like most, you’re thinking I’ve made a mistake, especially after looking at the table above.
When I mentioned to a Euro equity bull today that US equities have actually outperformed since the USD began to rally, her impulse response was, “Well, that just means they have room to catch up.” That’d be a sound thesis if European equities hadn’t actually outperformed their US counterparts by almost 2x over the last year. Truth is, Euro equities have crushed it in local currency terms. In order for them to “catch up” then, we’d really need to see the USD sell back off. What would drive that? Well, it’d probably be either higher European rates or lower US rates. Either of which would also likely be accompanied by reasons for US equities to outperform in local currency terms. The point I’m trying to make here is that comparing returns in local currency terms is like comparing apples and oranges. You can’t isolate the investment in equities and ignore the consequences of the currency. So let’s look at those same returns, but in US Dollar terms. I’m told that the demand for European equities is a function of regulations having trapped money in Europe and with the ECB depleting supply of sovereign debt, that trapped capital simply must flood into European equities. Fair enough, but if the capital is truly trapped, why did the EUR collapse?
My argument against investing in European equities over US equities is directly related to my argument against choosing any risk asset over US stocks. At the heart of it is the fact that we have been, and continue to be in what can only be characterized as one of the most risk averse environments in nearly a century. As evidence of that, ask yourself this. With all the money that flooded into the USD over the last year, pushing its value up 25% against the EUR, where did that capital land when it got here? The answer is, it went into the most risk averse instruments available. So the real question is, if it moves away from that safety will it go back overseas or squeeze out to fill in the lowlands along the risk curve, e.g. large cap US equities? My argument has been, and continues to be that its first port of call should be US equities. One should be careful to make a distinction between capital seeking risk and capital being crowded out of the most risk averse instruments. I believe the latter to be the more accurate description of what we are witnessing. If that’s the correct assessment, then it doesn’t make sense to take on risk beyond large cap US equities until they are overvalued, and I don't believe that to be the case yet.
"While everyone else is scrambling to answer who, what, where and when, Duneier is focused on explaining the 'why'."
About the Author For nearly thirty years, Stephen Duneier has applied cognitive science to investment and business management. The result has been the turnaround of numerous institutional trading businesses, career best returns for experienced portfolio managers who have adopted his methods, the development of a $1.25 billion dollar hedge fund and 20.3% average annualized returns as a global macro portfolio manager.
Mr. Duneier teaches graduate courses on Decision Analysis in the College of Engineering, as well as Behavioral Investing, at the University of California.
Through Bija Advisors' coaching, workshops and publications, he helps the world's most successful and experienced investment managers improve performance by applying proven, proprietary decision-making methods to their own processes.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America, Managing Director in charge of Emerging Markets at AIG International and founding partner of award winning hedge funds, Grant Capital Partners and Bija Capital Management. As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world for more than 20 years on topics including global macro economic themes, how cognitive science can improve performance and the keys to living a more deliberate life. Each is delivered via highly entertaining stories that inevitably lead to further conversation, and ultimately, better results.
His artwork has been featured in international publications and on television programs around the world, is represented by the renowned gallery, Sullivan Goss and earned him more than 50,000 followers across social media. As Commissioner of the League of Professional Educators, Duneier is using cognitive science to alter the landscape of American K-12 education. He received his master's degree in finance and economics from New York University's Stern School of Business.
Bija Advisors LLC In publishing research, Bija Advisors LLC is not soliciting any action based upon it. Bija Advisors LLC’s publications contain material based upon publicly available information, obtained from sources that we consider reliable. However, Bija Advisors LLC does not represent that it is accurate and it should not be relied on as such. Opinions expressed are current opinions as of the date appearing on Bija Advisors LLC’s publications only. All forecasts and statements about the future, even if presented as fact, should be treated as judgments, and neither Bija Advisors LLC nor its partners can be held responsible for any failure of those judgments to prove accurate. It should be assumed that, from time to time, Bija Advisors LLC and its partners will hold investments in securities and other positions, in equity, bond, currency and commodities markets, from which they will benefit if the forecasts and judgments about the future presented in this document do prove to be accurate. Bija Advisors LLC is not liable for any loss or damage resulting from the use of its product.
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