Why politics and investing don’t mix
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Why politics and investing don’t mix
Washington Post
Sunday, February 6, 2011; G06
Barry Ritholtz
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Washington, I’m here to tell you, politics and investing don’t mix.
Yep, I thought I’d begin our conversation about investing by rocking your most cherished beliefs. Many of you are active in party politics, work for government or are involved in related fields. Well, I have some bad news: Your politics are killing you in the markets.
In my work, I use behavioral psychology, statistics, cognitive biases, history, data analysis, mathematics, brain physiology, even evolution to make better investing decisions. Indeed, these are all key to learning precisely what not to do. While making good decisions can help your portfolio, avoiding bad ones is even more important.
We humans make all the same mistakes, over and over again. It’s how we are wired, the net result of evolution. That flight-or-fight response might have helped your ancestors deal with hungry saber-toothed tigers and territorial Cro Magnons, but it drives investors to make costly emotional decisions.
And it’s no surprise.
It’s akin to brain damage.
To neurophysiologists, who research cognitive functions, the emotionally driven appear to suffer from cognitive deficits that mimic certain types of brain injuries. Not just partisan political junkies, but ardent sports fans, the devout, even hobbyists. Anyone with an intense emotional interest in a subject loses the ability to observe it objectively: You selectively perceive events. You ignore data and facts that disagree with your main philosophy. Even your memory works to fool you, as you selectively retain what you believe in, and subtly mask any memories that might conflict.
Studies have shown that we are actually biased in our visual perception – literally, how we see the world – because of our belief systems.
This cognitive bias is not an occasional problem – it is a systematic source of errors. It’s not you, it’s just how you are built. And it is the reason most people are terrible investors.
How does this play out in the world of investing? Let me share two examples. I don’t pick favorites: Both Democrats and Republicans are implicated.
Back in 2003, the dot-com crash had about run its course. From the peak of the market in March 2000 to the March 2003 trough, the Nasdaq had gotten crushed, losing 78 percent of its value.
As Federal Reserve chief Alan Greenspan took rates down to 1 percent, the Bush administration passed $1 trillion in tax cuts. As someone else once said about the stock market, “Give me a trillion dollars, and I’ll throw you one hell of a party.”
Yet many of my Democrat friends on Wall Street – fund managers, traders and analysts – were highly critical of the tax cuts. At the time, I heard all the reasons why they were so bad: They were deficit-busters, unlikely to create jobs, giveaways to the wealthy.
While those critiques may have been true, they were also irrelevant to equities. As armchair policy wonks obsessed over these issues, they missed the bigger picture: Liquidity is a major factor in how the economy and stock markets perform. Trillions of dollars in fresh cash was very likely to goose equities higher. (Sound familiar?) Indeed, the impact of the tax cuts did just that. Combined with Greenspan’s ultra-low rates, you had the makings of a cyclical bull market rally. From 2003 to 2007, the Standard & Poor’s 500-stock index – the usual benchmark for equities – gained 100 percent.
And my politically active friends on the left missed most of it.
Fast-forward six years to the recent credit crisis. The S&P 500 had fallen 57.69 percent. By March 2009, op-eds in the Wall Street Journal blamed the crash on President Obama.
But conditions were forming that would hasten the end of the sell-off. Markets were deeply oversold. Once again, the Fed chair was cutting rates – this time, it was Ben Bernanke, and he took rates down to zero. In a panic, Congress forced the accounting rule-making body to be more accommodative to the banking sector. FASB 157, as it is known, ended mark-to-market accounting – essentially allowing banks to hide their bad loans.
All these factors suggested that a substantial rally from the market lows was coming. Historically, average gains in post-crash bouncebacks were 70 percent. The easy money to the downside had been made, and it was time to stop betting that the markets were heading south. If history held true, we were looking at the mother of all bear market rallies.
By that March, I was explaining this to clients, the news media and co-workers. But the greatest pushback this time around came from across the political spectrum. My GOP pals were lamenting the occupant of the White House. I heard things like “Obama is a Kenyan, a Muslim, a Socialist. He is going to kill business.”
What followed was the single most intense two-year rally in Wall Street history. As of Friday, the S&P 500 has gained 93.8 percent.
And my politically active friends on the right missed most of it.
Remember, the cycle of booms and busts are surprisingly regular occurrences. What some people all a “100-year flood” actually happens far more frequently – since 1929, there have been 18 crashes.
It’s just as important that an investor participate in the cyclical bull markets, capturing the rally as well. All things considered, missing the downside and catching the upside makes for a pretty decent investment strategy.
You need not be a mathematical wizard to learn this lesson. When you are in the polling booth, vote however you like; But when you are reviewing your investing options, it is best to do so with a cold, dispassionate eye.
Understanding how your own biases impact your investing process is a key step. If you want to avoid making certain errors, you must at least be aware of them.
And now you are.
Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, The Big Picture.
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February 12th, 2011 at 9:33 am
But Barry-
You left out a hugely important aspect of this whole cycle which is inflation/deflation.
Let’s say you invested $100K in 2003 and then cashed out in 2007 with $200K. Well – you paid 15% off the bat leaving you with $85K. But now everything costs more…MUCH more. Gas prices nearly doubled eating a good $1,200 out of that profit. Heating ate another $1,500. Food $1,100 etc.
So….who really ‘won’? Well – the rich dude of course. Because he can turn that $20 MILLION into fixed income and he really won’t care if inflation goes up will he? Nope. He doubled his ‘yield’.
Fast forward to today. Let’s say you turned $50K into $200K by playing both sides. Great. Now you cash out and eat ~$23K in taxes. Then you get to watch your home value decline once again, your cost of living go up sharply etc.
Unless a person’s net worth exceeds $10 million, they are essentially screwed when bubbles burst. And in a credit-driven system, they all must burst once debt levels become unserviceable which is why cheap money cannot work over the long haul. Money has to originate from the bottom up, not the top down.
~~~
BR Your math sucks (and I wont even challenge your silly inflation figures).
The person who sat in cash has a $100k, while the investor has $200k
Next.
February 12th, 2011 at 9:57 am
Thanks, Barry. There are people who will write lots of words here in the comments section explaining this or that about why you are wrong or possibly right, but the fact is that your article is an investing pearl. Interested investors fight through mounds of articles and data that is widely acknowledged to be noise and entertainment. Why? To find something like this a couple times a year.
February 12th, 2011 at 10:01 am
Perception is a tricky thing. Does one WANT to believe that the illusionist’s trick is real, or does one cling to the rational understanding that a trick is being performed? Must one accept the illusion as reality in order to profit from it (more importantly, does the acceptance of the illusion lead to a real reward, and if so, what does the illusionist gain from his real and costly contribution supporting his illusion)? What about questioning the need/motive for a trick to be performed in the first place? Is one’s belief or need to believe in the illusion further strengthened by making a wager that the illusory is actually real?
Perception might warp our understanding of, and reaction to, reality, overtly or subliminally, but it cannot change the reality.
Never forget that someone is paying to see the illusion (and paying even more if they think acceptance of the illusion will return real gains), and someone else is making money, or will eventually reap a windfall, from it. Both cannot gain. Someone will be fleeced.
Fool me once, shame on you.
We have been fooled more than once. The reality is that being a customer in a gambling parlor is no way to make money. If you disagree, and you accept the huckster’s illusion that both the house and the mark make money in the end, keep on doubling down — even if you have to mortgage the farm to feed your perception and stay in the game.
P. T. Barnum had it all figured out.
February 12th, 2011 at 10:13 am
Petey,
As did Grete de Francesco, in his 1939 The Power of the Charlatan. A snippet: “The followers of the charlatan greedily absorbed his emotion-soakced verbiage, and most readily when he painted visions of the future.”
Barry,
Great article, individual actors following biases (individual or mob-driven) is a key cause. However we also have pundits and demagogues that urge the mobs (“Buy Gold” or “Buy Stocks” are their refrains) which either feed, replace, or supplant their biases.
February 12th, 2011 at 10:26 am
You don’t pose an exact equivalence—liberals were right (the Bush tax cuts were budget-busting gifts to the wealthy) and conservatives were wrong (Obama isn’t a Kenyan Muslim socialist)—but you make an excellent point about cognitive biases.
FWIW, I don’t know any liberals who pulled out of the market because of Bush’s tax cuts, but I do know conservatives who did so due to fears about Obama’s economic program…
~~~
BR: That my trading buddies on the left were correct about the politics is irrelevant — they were wrong about the investing aspect — that was what I was trying to emphasize.
February 12th, 2011 at 11:09 am
Great article. That said, with the run-up in the markets where do you see us being in the cycle? Range bound with increasing volatility from here? thoughts?
February 12th, 2011 at 1:56 pm
cognitive dissident
Ritholtz actually did pose an equivalence — but its not his fault that its not very flattering to the wingnuts.
It looks to these eyes that he stated the legitimate concerns of the left about the Bush tax cuts — concerns that were rational and well founded and turned out to be very prescient.
On the other hand, the concerns of the right — Obama the muslim/kenyan/socialist/destroyer of liberties/despoiler of the economy — were just so much more of that wing’s scare tactics and cheap populist appeal to the lowest common denominator.
As Stephen Colbert has said, Reality has a Liberals bias . . .
February 12th, 2011 at 4:03 pm
BR says, “…When you are in the polling booth, vote however you like; But when you are reviewing your investing options, it is best to do so with a cold, dispassionate eye…”
Hey, I’ve got an idea. Why not VOTE without all that emotional nonsense too?
February 12th, 2011 at 5:14 pm
BR- I think you posted this previously as I read the article a few days back-
also- here’s little ol’ Ahab’s knowledge learned over the past two years or so-
the men at the Fed Reserve are professional serial bubble blowers. We’re talking Real Pros! And regardless of a person’s personal disgust by their antics- when they say they intend to inflate stock prices- best to blind your eyes and plug your ears from that point forward and bet it all on black . . .
VennData-
joking right? You are the most political person on this blog by far . . .basically all you ever talk about
February 12th, 2011 at 7:17 pm
VD,
w/this: “Why not VOTE without all that emotional nonsense too?”
aside from http://search.yippy.com/search?input-form=clusty-simple&v%3Asources=webplus&v%3Aproject=clusty&query=e-voting+hackable+stolen+elections
tis’ a good suggestion..
maybe, even, one of these daze, we might be able to pull a receipt, as at ATMs, after ‘e-voting’…
or, if we dared, do away with the whole Wad, and, go Paper, recountable, Ballot..
February 12th, 2011 at 7:35 pm
@ahab re. VD, it seems a close competition with DeDude…
February 12th, 2011 at 8:14 pm
An investor who can figure out what the politicians are going to do in a particular situation is likely to gain an edge as a result.
February 12th, 2011 at 11:27 pm
The overwhelming majority of people, visit investment sites such as Barry’s not with the purpose of learning anything but with the purpose, mostly unconscious, to satisfy some psychological need. Their dysfunction is the need to find dysfunction in others. Finding actionable information, the intended purpose for the better managed sites, is not important. “The market is rigged, the Fed is pulling a charade, bubbles all around, etc, etc, blah blah blah. These are not serious people and they are not serious about the crafting of trading or investing. They are the suckers at the poker table willfully pushing away a pile of chips even though they pretend to know the cards everybody else is holding.
A special kind of therapy required that even Barry can’t provide.
February 13th, 2011 at 12:51 am
BR, Well said. Thanks for sharing.
February 13th, 2011 at 7:51 am
We are genetically wired to wanting to understand our environment so we can predict the future – it has a lot of survival benefits. There is even an endorphine reward – you know that good feeling of accomplishment you get when “the bulb goes on” and you think you understand. Some people get outright addicted to that.
Ideology and dogma is simply part of our attempt at making enough sense of the world to understand, predict and be able to influence our own future. For some people the security of “understanding” is so important that they are ready to ignore reality, even if in the back of their mind they understand the peril of doing so. One example is the dogma of “the invisible hand”. No matter how often it fails, some people refuse to give up this simple model for a much more complicated reality full of doubts and uncertainty.
Problem is that a lot of things in modern society get very complicated and require multi-factorial modeling way beyond what our little pea brains can handle. Unfortunately, we are only wired to understand simple linear models and paradigms of cause and effect. If multiple inputs can have effects on a parameter, and the certainty of each effect is different, and the effects are conditional on other parameters, that in some cases can only be measured within wide uncertainty ranges – then we tend to give up and guess instead.
I agree that the blanket statements that one or the other political party is good or bad for the economy or the stock market, is a very simple and extremely poor guide for investments decisions. You have to look at the policies but also look at the specific content in which they are being implemented. Tax-cuts in the context of a severe downturn with consumers and businesses in survival mode will not create growth (just deleveraging). Tax-cuts in the context of a slow but well-established recovery give substantial increases in consumption and investment. So the same policy can give radically different short-term results dependent on when it is implemented.
A good test of ideologically poisoned policy views is to find out what people said about the Bush tax-cuts of 2001 & 2003 and what they say about the Obama tax-cuts of 2009 & 2011 and then have them explain their views. Both were instituted during an economic decline followed by a timid recovery. They were structured differently and that does make some difference. However, if you were 100% for those made by one president and 100% against those made by the other president then your mind and judgment has been ideologically poisoned. You can do the same test with respect to peoples views of the health care expansions implemented under Bush and under Obama.
Another example of remembering the context when making investment decisions is that everybody would agree that if the Fed purchase large amounts of bonds then bond prices should go up. However, if their purchases are in response to or in the context of the exit of many foreign and domestic bond investors, then even simple (single cause linear) investment laws may not be working.
February 13th, 2011 at 8:46 am
Congratulations on being a real stock picker that doesn’t let your biases control you. But IMHO you are playing in the wrong sand box, which is a biases in a way isn’t it.
What you say is very true about the human condition of letting beliefs, biases control them , no doubt. But so is this: With tax cuts, increasing spending and wars (costing trillions) , the real future was and is more reflected by commodities (like gold, silver, platinum , grain, farm land and oil). Here’s gold for example, going from less than $300/oz in 2001, to some thing over $1300/oz now. The real investment opportunities have been in things like farm land, corn, and oil. These little gems have had all the characteristics of a bubbles, but with all of the factors going on, bubbles were inevitable.
http://66.38.218.33/scripts/hist_charts/yearly_graphs.plx
What has the S and P done during that time period? For those of us (maybe 99%plus) that can’t predict the short term profits in stocks, commodities has done much better than buy and hold stocks, no?
So the stock market is your thing, no problem. I think you have been playing the penny slots. You are missing the forest for the trees.
When the tax cuts were put in place, with a couple of wars being waged and spending going nuts, then the future looked very clear to me. Yes, I’ve also made money in stocks, but the biggest bang has been in commodities and things related to commodities like farm land. I’ve done much better at picking commodities than in picking stocks. My advice, of course you won’t take it, is that investing in the stock market is a skill who’s time has past, like the real future (without government money) of large investment banks, the future doesn’t necessarily look too bright in stocks, you just might haved missed the real important investment stuff.
February 13th, 2011 at 8:56 am
This column was about human behavior and investing and biases for a general, very mainstream audience — not performance maximization.
But we can play that game: Did you buy deep out of the money SPX calls in March 09? (monster winner). What about betting against mortgages via Credit default swaps? Huge wins. How about shorting the ABX ? AIG puts? Lehman CDS? All ginormous winners that suggest many people (with the benefit of 2020 hindsight) were playing on the wrong sandbox
The column wasn’t whether I recommended Apple at $7.50 on the iPod, or Oil post 9/11 at $32 or Gold at 1% Fed rates at $300 — I did — it was about behavioral bias.
There is always another trade thats bigger/better/badder. And if you want to write a column about that you should!
I chose to write about behavioral biases. I hope the column made its point to those readers who may not have been aware of them
February 13th, 2011 at 9:27 am
Awesome, Barry … you nailed it. The column may not have been “about” maximizing performance, but one of the keys to better long-term performance is awareness of the cycle effects. (And it ranks among one of the most challenging things for all humans to recognize.) Remember when the auto execs said “we’ve never seen anything like this before?” That version of a 100-year flood was pretty well matched back in 1975 and before that, 1938. We believe that history is full of powerful investing lessons, if you can brush back the emotions long enough to notice.
February 13th, 2011 at 10:24 am
Again I think this your comments were dead on. Thanks for the post. Didn’t mean to insult you by the way. But I believe all people have biases and at best as you said we should be aware of them. Just part of the human condition. They are just a shortcut for thinking, and analyzing things that are way to complex or happen too often to spend the time and energy if you have the ability to understand, which I often do not.
The point I was trying to make was it was easier to make money in commodities than it has in the stock market for the last ten years and probably for several more years at least for me. I’m not a trader (as in day trader) and try not to buy stuff (over the counter derivatives for example) I don’t understand, so no CDS. Also very rarely use puts, no shorting ABX for me that’s a sand box I don’t play in. I fall in with the other 99% plus of the people that probably shouldn’t be in those kind of games. No doubt you have made a ton of money over the last 10 years, other wise I wouldn’t spend my time reading your stuff. I’m just a farmer, and have been investing in stocks and other things for several decades. I’ve done OK. But I’m pretty plain jane investor. A few home runs but probably as much by luck as anything. I’ll leave most exotic stuff to the pros.
February 13th, 2011 at 10:37 am
No insult taken — I just want people to understand what the focus of the column is –
February 13th, 2011 at 10:44 am
Very good article.
I tried subscribing to Investor’s Business Daily a while back, and when I cancelled my subscription my message was the same as the one in this article – politics and investing don’t mix. It was interesting that IBD advertised itself as unbiased. The fundamental data contained in IBD was good, but I had to avoid pretty much every article.
February 13th, 2011 at 11:43 am
“…I hope the column made its point to those readers who may not have been aware of them..”
-BR, above
…the column made its point…
“Well said. Thanks for sharing.” –mservat
x2
February 13th, 2011 at 12:18 pm
The GOP media machine can’t sweep the data under the rug any longer…
“… the U.S. private sector were far greater than the mistakes made by Fannie and Freddie. For example, private-label mortgage securities, which are not government-backed, have performed more poorly than those backed by the mortgage giants. Nearly 45% of private-label loans originated in 2006 had been 90 days past due at least once, compared with 13% for Fannie and Freddie, according to a report from the firms’ federal regulator published in September 2010…”
http://online.wsj.com/article/SB20001424052748703786804576137942242796306.html
CRA, Fannie and Freddie weren’t the problem. Out -of-control leverage made by Bush’s decision to allow the ibanks to leverage was. The data is irrefutable. The Right is wrong, again.