Standard Deviations with Dr. Daniel Crosby

It's human nature to worry about low probability/high salience things and ignore threats that are far more immediate and pervasive. Tune in to learn why and what to do about it.

Feedback loops exist in relationships, nature and especially in financial markets. In today's episode, we examine how capital markets operate in boom and bust cycles due to our subjective perceptions.

Can you trust your gut? Well...sometimes. Today on the podcast we look at the two conditions that must be met in order for intuition to be useful. Even the best-informed intuition is only as good as the milieu in which it finds itself and environmental cues remain the best predictor of whether or not intuition can be trusted. In the absence of a certain level of predictability and rapid feedback, neither of which are present in financial markets, intuition lacks soil fertile enough to take root. We have reason to trust the intuition of a NICU nurse, a physicist or a mathematician, but very little reason believe the instincts of a therapist or stock picker (sadly, I am both). Such intuitive shortcomings are not the fault of the experts in question but rather the discipline in which they ply their trade. As Murray Gell-Mann correctly noted, “Imagine how hard physics would be if electrons could think.” Intuition is powerful in many domains but ill suited to the vagaries of allocating capital.

Listen in this week to learn: Why positivity brings about more lasting change than negativity How making lists of "not to do" can have a paradoxical effect Why labeling ourselves and others can blind us to the true state of things

It is often assumed that there is a positive, linear relationship between information and market efficiency. It stands to reason, at least to a point, that the more publicly available information we have about a security, the greater our ability to accurately price that security. But is it possible that too much information can be as bad for efficiency as too little? As reported in Scientific American, the amount of data that we produce doubles each year. To put it more concretely, in 2016, humankind produced as much data is in the entire history of the species through 2015. The publication’s best estimate for the future of data is that in the next decade there will be 150 billion networked measuring sensors, 20 for every man, woman and child on Earth. At this point, the amount of data that we produce will double every 12 hours. We are a culture in love with data and tend to take a “more is better” approach when it comes to measuring and reporting on every part of our world. But the glut of information flooding our lives has real consequences, many of them negative.

We’re all familiar with the term “keeping up with the Joneses” but it’s doubtful that we understand just how deeply ingrained this is in our concept of wealth and success. Each year, a Gallup poll asks Americans to determine “What is the smallest amount of money a family of four needs to get along in this community?” Gallup finds that the answers to this question moves up in line with average incomes of the respondents. A recent Princeton study set out to answer the age-old question, “Can money buy happiness?” Their answer? Sort of. Researchers found that making little money did not cause sadness in and of itself but it did tend to heighten and exacerbate existing worries. For instance, among people who were divorced, 51% of those who made less than $1,000/month reported having felt sad or stressed the previous day, whereas that number fell to 24% among those earning more than $3,000/month. Having more money seems to provide those undergoing adversity with greater security and resources for dealing with their troubles. However, the researchers found that this effect (mitigating the impact of difficulty) disappears altogether at $75,000. For those making more than $75,000 individual differences have much more to do with happiness than does money. While the study does not make any specific inferences as to why $75,000 is the magic number, I’d like to take a stab at it. For most families making $75,000/year, they have enough to live in a safe home, attend quality schools and have appropriate leisure time. Once these basic needs are met, quality of life has less to do with buying happiness and more to do with individual attitudes. After all, someone who makes $750,000 can buy a faster car than someone who makes $75,000, but their ability to get from point A to point B is not substantially improved. It would seem that once we have our basic financial needs met, the rest is up to us.

Momentum has existed for hundreds of years and has persisted for two decades post discovery. This sort of staying power in capital markets full of hungry arbitrageurs is always the mark of human psychology. Many experts consider momentum to not just be a factor but THE factor. Fama and French don’t mince words, “The premier market anomaly is momentum. Stocks with low returns over the past year tend to have low returns for the next few months, and stocks with high past returns tend to have high future returns.” As James O’Shaughnessy says, “of all the beliefs on Wall Street, price momentum makes efficient market theorists howl the loudest.” In a perfect world, there would be no good reason to pay more for a business today than yesterday simply because of positive price action. But this isn’t a perfect world, it’s a world ruled by human behaviour and thus exhibits all of the attendant quirks. Like peanut butter and chocolate, momentum and value are wonderful on their own, but even better together. Cliff Asness says it best in his piece, A New Core Equity Paradigm: “Value and momentum remain the two strongest findings of academic and practitioner research of the last 30 years. While academics continually identify new market anomalies, which purport to offer significant risk-adjusted excess returns, and the Street routinely spins new stories to sell them, value and momentum stand head-and-shoulders above the rest-no other styles have performed so well, for so long, and in so many places. Both value and momentum have long histories of providing attractive returns, have performed well across markets and across asset classes, and have persisted for decades after their discoveries. Importantly, the two strategies perform even better when combined.” Value and quality work, independently and in concert, precisely because they exhibit the three hallmarks of an investable factor: empirically evidence, theoretical soundness and a behavioral foundation.

In this episode we look answer: How do financial bubbles form? How likely is a bubble to burst? How can I know a bubble when I see one?

What seldom-uttered phrase can make you wealthier and more likeable? Why did a bank robber use lemonade to commit crimes? Why don't dumb people know how dumb they are?

Your brain is a miracle unrivaled by even the most sophisticated technology, but it is a miracle equipped for a different time and place. After millennia of fighting famine, war and pestilence, we now live in a society of greater and greater ease that is increasingly left to fight psychological battles. Obesity will kill more people this year than hunger. Suicide claims more lives annually than war, terrorism and violent crime combined. Your brain is still fighting a war won eons ago and you must steel it for a new battle that rewards patience and consistency over speed and strength.