Financial Gaslighting

Note: This is my 1,000^th post at Above the Market, which began publication nearly five years ago, in August of 2011.  I remain as astonished as ever at the attention it has received. I am grateful to each and every reader. Thank you.

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In 1821, a man named William Hart dug the first natural gas well in the United States on the banks of Canadaway Creek in my home town of Fredonia, New York. The well was 27 feet deep, was excavated by hand using shovels, and its gas pipeline consisted of hollowed out logs sealed with tar and rags. Natural gas was soon transported to businesses and street lights in town. These lights frequently attracted travelers, often causing them to make a significant detour to see this new “wonder.” Expanding on Hart’s work, the Fredonia Gas Light Company was formed in 1858, becoming the first American natural gas company.

Gas lighting is thus an inexorable part of my personal history. But I’m even more interested in gaslighting.

In the 1938 play Gaslight, a murderous husband is intent on inducing instability in his wife in order to accommodate his venality. When she notices that he has dimmed the gaslights in their house, he tells her she is imagining things—that they are as bright as ever – as a way to get her to question her senses and her sanity. The British play became a classic 1944 American film from George Cukor, starring Ingrid Bergman as the heroine and Charles Boyer as her abusive spouse, out to convince her that reality is not what she perceives. In this sort of story, our most dangerous enemies are always those closest to us, masquerading as lovers and friends. Gaslight reminds us how uniquely terrifying it can be to mistrust the evidence of our senses and of what we know to be true.

Taking off from the film, “gaslighting“ in contemporary usage means a form of intimidation or psychological abuse whereby false information is systematically presented to the victim, causing him to doubt his own memory, perception or even his sanity. As in the movie, gaslighting is a hallmark of domestic abuse, but one can see its use and impact almost everywhere. I wrote much of this while in Washington, D.C., perhaps the world’s gaslighting capital.

In the investment management world, the overarching priority for the vast majority of money managers is to gather assets and revenues and only peripherally to provide quality performance for investors. Gaslighting is routinely used to try to obscure those priorities and to convince investors that, despite the reality of what they see, investing in product X or with firm y is a smashing good idea. 

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Chris Rock Explains Bias Blindness

When the nominations for the 88^th annual Academy Awards were announced this past January and for the second year in a row included no minority nominees for any of the major performance categories, my first thought was here we go again. But my second thought was that Chris Rock would be hosting the Oscars’ award ceremony and that there might be fireworks.

I was not disappointed. Rock quickly let it be known that he would not be boycotting the ceremony (as he quipped during his Oscar monologue, “How come there’s only unemployed people that tell you to quit something?”) but also that his opening monologue would be addressing the #OscarsSoWhite controversy in a big way.

He sure did.

A Hierarchy of Advisor Value

I talk often with lots of advisors of all sorts and from a wide variety of firms. They are profoundly disillusioned an astonishingly high amount of the time. When the markets are strong, they are disappointed that they didn’t capture enough of the upside. When the markets are weak, they are apoplectic that they didn’t avoid the downturn. When markets are sideways, they’re just plain frustrated. When they try to anticipate these movements they usually fail and when they don’t – a very rare event indeed – their next moves inevitably don’t keep up the good work. They hate seeming to start from scratch every day and living from transaction to transaction, dependent upon the machinations of markets for survival.

This profound disillusionment is well-earned, of course, and is predicated upon three primary problem areas: execution; expectation; and erroneous priorities. The basis for each of these problems can be established in surprisingly short order.

In terms of execution, the trade ideas they offer rarely turn out well and the performance provided by money managers, when they go that route, almost never meet expectations such that it’s not unfair to say that much of the money management business has been an abject failure pretty much across-the-board, even for the mega-rich. Poor investor behavior makes that dreadful performance even worse — we trade too often, at the wrong times and into the wrong instruments. We chase returns via managers, sectors and trades that have been hot only to be disappointed when mean reversion inevitably sets in. Our inflated expectations make matters worse still because investors expect outperformance as a matter of course and investment managers tell them to expect it, implicitly and explicitly. That’s what makes the sale after all.

Erroneous priorities include a failure to manage to personal needs, goals and risk tolerances as well as “plans” that change with every market movement. It shouldn’t surprise anyone that clients with huge appetites and tolerance for risk when markets are rallying frequently want to go to cash at the first sign of trouble. At the advisor level, the priority problem is even more fundamental and encompasses each of these problem areas. Much of what tries to pass as “financial advice” is actually glorified (or even not-so-glorified) stock-picking. In my experience, most advisors and their clients wrongly think that the advisor’s primary function is to pick good investment vehicles.

Advisors are well aware of the failures of the money management business, of course, as well as the limitations of a transactional business model. That’s a big reason why their disillusionment is so existential. They have been let down again and again by the idea that they have (finally!) come up with a formula for success only for reality to crush those promises. Even worse, and consistent with that conundrum, a 2012 study from the National Bureau of Economic Research concluded that financial advisors reinforce behavioral biases and misconceptions – the problems outlined above – in ways that serve the advisors’ interests rather than those of their clients.

Still, many of these advisors keep hoping against hope. They routinely tell me that if they proposed a data-driven, evidence-based approach with their clients that actually had a reasonable chance for success, their clients wouldn’t perceive a need their services. Not so coincidentally, that’s a big reason why so many advisors are terrified by the proposed Department of Labor fiduciary rule with respect to retirement accounts. And that’s why the Dilbert cartoon reproduced below about index funds (one possible data-driven approach but hardly the only one) is so wickedly funny.

Proper advisor priorities begin with a recognition of what is important and what is achievable. That’s why I have created this hierarchy of advisor value, which was developed for a presentation I have been giving to groups of advisors. 

Managing to this hierarchy won’t make the markets any less infuriating, but doing so will make the financial advice business much more fulfilling and gratifying. It can even make that business more lucrative, at least over the longer-term. Simply put, it will require carefully and truly putting the client’s interests first, even when the client doesn’t see it that way. 

Five Years Ago Today

This past week has offered multiple chances for reflection and retrospective as we saw the 150th anniversary of the Gettysburg Address and the 50th anniversary of the JFK assassination.  Five years ago today was significant too, if not nearly at the level of those others.

Five years ago today, the markets were reeling. The most common emotions were fear and dread. Even though no less an authority than Warren Buffet had noticed the buying opportunity just over a month earlier, almost nobody was anxious to buy stocks.

But the Federal Reserve announced an $800 billion stimulus package in an effort to stabilize the financial system that day.  This announcement came on the heels of the federal government’s decision to spend over $300 million to rescue Citigroup by agreeing to shoulder possibly hundreds of billions in losses at the stricken bank and to inject $20 billion into the company.

Things would get worse before they got better (the low would come in March of 2009), but an investor who bought the market five years ago would be very happy indeed today.

Taking this sort of look back is a helpful reminder of how our emotions and biases can work against our best interests. Five years ago today, the predominant mood was panic, but buying would have been a very good thing. Today — at much, much higher levels — it’s hard to find many bears. My point here is not that the markets won’t go up from here. They may well go higher and perhaps a lot higher. My point is that market risks are much higher today that they were five years ago. For example, CAPE today is 25.43; it was barely above 15 five years ago. My analytical self tells me to be fearful when others are greedy and to be careful, to hedge, to lighten up or to take profits when others are doubling down.

Even though it feels like I should do exactly the opposite.

How the Markets Work (Visualized)

Sadly, this illustration shows only what happens in markets on the way up and doesn’t show how the markets work on the way down.  But you should get the idea.

Overrated

I was a Duke student before Coach K came on board. Duke basketball was a big deal on campus then, but its aura was very different.  We weren’t remotely a juggernaut or a national name.  In fact, within just a 25-mile radius, we were well behind both UNC and NC State in terms of basketball history and regard.  But we were very good fans, filling the seats and supporting our team.  We were aggressive too.  Our shtick was not just to be loud and intimidating but also to try to be funny and snide so as to unnerve our opponents.  Sometimes we were even offensive. Imagine that.

We invented the “Airball!” chant in 1979 for an opponent’s shot that misses everything. Thank you, Rich Yonaker. After I graduated it was chanted in German at future NBA star Detlef Schrempf who was, of course, German. We greeted the visiting USC Trojans by throwing condoms on the court in 1978. We always urged NC State’s then coach to “Have a drink, Norm Sloan, have a drink” because he had commented in the press about the alleged insobriety of Duke students in the stands.  We jangled car keys during his free throws in an otherwise silent Cameron Indoor Stadium at State guard Clyde Austin, later imprisoned for a Ponzi scheme, who was being investigated for having no job but two luxury cars, supposedly given to him by his bank teller girlfriend.  Pizzas were delivered to a State huddle because a Wolfpack player was in trouble for hassling a pizza guy.  When Maryland coach Lefty Dreisell (Duke, 1954) and his Terps visited, Lefty was greeted with a big sign and these words: “Richard Nixon [Duke Law, 1937]: Duke’s second biggest mistake. Welcome Lefty!”

A regular chant in our rotation was reserved for when a very highly regarded team or player visited Cameron and didn’t perform up to reputation. “OV-ER-RAT-ED!”  Sadly, and by any reasonable measure, it is impossible to conclude that the financial services industry is anything other than wildly overrated.  Chant away. 

Why Do We Hate Our Kids?

In honor of the 69th anniversary of D-Day, I am repeating this post from a year ago.

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We just celebrated the 68^th anniversary of D-Day, and well we should.  That day in western France was the pivotal day and the pivotal event of the 20^th Century.  As Omar Bradley pointed out, every man who set foot on the beaches of Normandy on June 6, 1944 was a hero – the men who took the cliffs to fight tyranny and took back a continent for freedom. I dare you to try to watch footage of and about that horrible, dreadful, wonderful day with dry eyes or a cold heart.

Here’s to the boys of Pointe du Hoc.  In the words of Stephen Spender, these are men who in their “lives fought for life and left the vivid air signed with [their] honor.”

What’s Next?

Heraclitus is said to have been the first to assert that nothing endures but change.  Yet I doubt that it was original even to him.  In life and in business, a major key to success is anticipating the changes that the future holds and adapting to them. 

Aaron Sorkin gets it, whatever you think of his politics.  In The West Wing (I’m still a big fan – my lovely bride and I just watched a couple of episodes again this week), when President Jed Bartlet asks, often brusquely, “What’s next?,” it means that he has made up his mind and is ready to move on, even if and when his subordinates are not (see below, from Bartlet’s first presidential campaign, as he is getting acquainted with his young staff).

Fuzzy Political and Investment Math

The great scientist E.O. Wilson created a major stink over the week-end via The Wall Street Journal by arguing (or at least seeming to argue, among other things) that math skills are less important to most scientists than imagination, theory, concept and intuition.  It reminded me of the 1976 SNL send-up of the Gerald Ford-Jimmy Carter Presidential Debate.  In the “debate” (shown below — the noted section is about 6 minutes in), Chevy Chase, as Gerald Ford, responded to a difficult economics question as follows.

President Gerald R. Ford: [ sweating ] It was my understanding that there would be no math… during the debates.

Investment Illusions

There is no getting around it. We are pattern-seeking generalists. The focus of the image to the right is a standard cinnamon roll, but we easily (eagerly!) see something more, perhaps Mother Teresa.  We like to think that we perceive things “as they really are,” but (uh-hem), in reality our perception is highly ambiguous. We often see what we expect to see, want to see, are primed to see or are conditioned to see.  This general problem is also a function of our tendency to seek excessive detail within complex systems. 

My favorite example in this regard is perhaps the famous Virgin Mary grilled cheese sandwich (see below left). Its story is improved dramatically for me in that it was sold via E-Bay for $28,000 back in 2004 to a casino in order to be displayed in Las Vegas and elsewhere. That alone is a remarkable commentary on modern American culture, but I digress. If you aren’t predisposed to see the Virgin, you might think it’s the late actress Jane Russell (right).

These pattern-seeking perceptual difficulties are especially common to investing.