The Tyranny of Behaviorism

Really? Just a second, how about: oil prices (data from the St. Louis Fed on West Texas Intermediate [WTI]) are down 20 percent from where they were 10 years ago, the 10-year U.S. Treasury market yield was around 2 percent in November of 2011 versus 1.7 percent today and the evidence is pretty compelling that we have a demand crisis, not a supply crisis (another popular overused descriptor in the media). For a long-term historical perspective, I should add that in my first job after school we traded the bellwether 10-year Treasury, which at the time were the eights of ʼ86 (i.e., a coupon of 8 percent maturing in 1986). So, even 2 percent was incredibly low by historical standards. Then we can recall the summer of 2008 when WTI crested at almost $140 per barrel. But then, I forgot, the world did cease to exist and here we are having survived another world-ending event, the pandemic (with much left to be done, however), despite being constantly reminded of the imminent crashing and burning of humankind’s economic success.

Tyranny: “An act or pattern of harsh, cruel and unfair control over other people”

The purpose of this brief piece is not to in any way take on the media or belittle its importance to a free society, but rather to remind readers that its objective (ostensibly, to entertain and inform with quick 30- to 60-second bursts) of keeping your remote control tuned to their station in the face of ever-increasing options to stream is often in conflict with providing the perspective necessary to make educated judgments on many important, and often unimportant, matters. Additionally, our goal is to enable investors to parse the proffered information to improve the segmentation of what is relevant — the stuff that matters. We’ll come back to the tyranny idea, so keep the definition handy.

Behavioral finance

Behavioral finance is basically the study of economic decision-making with the conclusion that humans — get ready for an amazing insight — do not always act as self-interested agents seeking optimal outcomes, but are often less than rational and selfish. Gobs of books have been written on the topic and myriad studies of actions and reactions have successfully demonstrated this quite commonsense notion. These have expanded on a large number of biases that are actually relatively predictable, which many of us exhibit quite unconsciously. Unfortunately, those who seek to keep us tuned, bend us to a point of view or sell us something, understand these biases quite well and again, no shock, have created all sorts of ways to communicate so as to influence our decision-making for the benefit of their own interests. Let’s look at some examples:

• Anchoring — The initial exposure to a number influences anchors judgment. Ah, how about our WTI example. Pick a time period. Tell us oil prices are up 50 percent and we are anchored on the notion that energy prices are through the roof. How about if we were told — despite all of the issues with recently increasing demand and with supply having moderated as production has not yet ramped up from the dark days early in the pandemic — prices are down over 40 percent from the high levels of the prior economic expansion? Maybe even provide a graph representing oil prices showing the volatility over time and the fact that WTI prices have averaged a fairly modest 5 percent rise over the last 20 years or so, despite a world that is rapidly growing in energy demand. I guess I would just change the channel on that good news.
• Scarcity bias — Things that are thought to be scarce are perceived to be of more value (even if you don’t want them). There was a study done where two different sets of ads were used to market the same watch. One said “Exclusive limited edition. Hurry, offer limited” and the other said “New edition, plenty in stock.” Consumers, on average, would pay 50 percent more for the former. In the news today: We are going to run out of XY popular tech present, better get to those stores now! And we have a self-fulfilling prophecy as consumers grab stuff off the shelves (toilet paper makes such a nice gift these days) and normal demand was stocked by the retailer so shelves get emptied even though the actual need hasn’t changed — and then we get the follow-on “story” about how shelves are bare and retailers can’t get supply.
• Herding — This is the tendency to follow the crowd without sufficient rationale. It’s one of the many reasons that markets tend to become overbought and then oversold, resulting in booms and busts. Market observers with a platform love to use words like “skyrocket” and “leapt” or “collapse” and “crash.” Have you noticed that the preference is to refer to changes in points on indexes like the Dow rather than to percentages? The announcement that the market had the fifth largest single-day collapse in the last 10 years doesn’t account for what matters — the percentage gain or loss — and misleads given that the market in points is dramatically higher than a decade ago. And there are those beginning and endpoint biases as well — market returns can look completely different depending on which dates you use to frame the time period. Unfortunately, this type of herding often results in bad decisions as investors look to buy so as not to miss the moon shot or to sell to avoid disaster. But, again, the news story that stock markets can be pretty volatile, but for the long-term investor a good strategy of diversification, consistent rebalancing and assessing liquidity needs should be effective — doesn’t seem to result in more viewers.

Recency bias, optimism bias, confirmation bias, the variations of behaviors go on and on. Sometimes it is a wonder that humans can actually survive, especially given that many of our information sources understand our collective susceptibility and are eager to exploit it. Do you know why, for example, car salespeople almost immediately get you to test-drive that new car? The endowment effect — once you own/hold something (like that steering wheel) you are reluctant to give it up. Naturally, they also put you in a car with “everything” at the start, which then makes the car you actually wanted look less expensive (that anchor affect).

Close to tyrannical

Is that tyrannical? Well, there are numerous examples of patterns to exert control over other people. The question remains as to whether it is harsh, cruel and unfair. That most likely depends upon the intent and the intensity of the action. Regardless, it seems wrong and unjustifiable.

Fighting the tyranny

There are four things that can be done to mitigate the impact of these biases, however:

1. Be aware of the existence of these biases and how others might exploit them and why.
2. Do independent homework and broaden your information sources to gain a deeper understanding.
3. Adopt a contrarian approach to information — go with why it might not be accurate rather than just assume it is.
4. Ask yourself why that time period was used to display data — in particular, the start and end points — and what is relevant about the information?

As Daniel Kahneman, one of the leading architects of behavioral finance, said, “The assumption that individual investors are rational leads to serious mistakes.” Recognize our human natures, but do what you can to make better-informed decisions.