“Wall Street dips after data clouds view on Fed” was a headline from Reuters today. Sounds good, right? Think again.
Daniel Kahneman, in his book, “Thinking Fast and Slow,” describes two modes of mental processing: System 1, which is primal and automatic, and System 2, which is slower, and more methodical and analytical.
The use of System 1 simplifies decision-making, allowing us to preserve scarce mental resources. Speedy decisions were probably effective from an evolutionary perspective; if you saw an animal with sharp teeth glaring at you, System 1 would manage the surprise by immediately directing you to run, without any need to sit back and contemplate the situation, which could be dangerous.
System 1 works fast to help you manage the unexpected, and can also work backwards. Craving coherence and causality in a complex world with abstract features, it will attempt take observed outcomes and ascribe causes to them. It will attempt to “fit” a story to events. The search for causality and impressions of causality, however, can be inappropriate in some contexts.
Nassim Taleb describes a manifestation of the effect in his book, “The Black Swan”:
We harbor a crippling dislike for the abstract.
One day in December 2003, when Saddam Hussein was captured, Bloomberg News flashed the following headline at 13:01: U.S TREASURIES RISE; HUSSEIN CAPTURE MAY NOT CURB TERRORISM.
Whenever there is a market move, the news media feel obligated to give the “reason.” Half an hour later, they had to issue a new headline. As these U.S. Treasury bonds fell in price (they fluctuate all day long, so there was nothing special about that), Bloomberg News had a new reason for the fall: Saddam’s capture (the same Saddam). At 13:31 they issued the next bulletin: U.S. TREASURIES FALL; HUSSEIN CAPTURE BOOSTS ALLURE OF RISKY ASSETS.
Obviously, these statements are contradictory, but each appeals to System 1, as a rational explanation for observed events in the treasury markets. As Taleb demonstrates, financial news outlets can be influenced by System 1, and simply make up a story that fits the news of the day.
Dave Barry is a humor columnist who intuitively understands the inherent silliness of many such stories, which pass for “financial news” today. In his book, “Money Secrets” he recounts an episode of an imaginary financial news show:
Host: Welcome to Inside Wall Street from the Inside, the program where Wall Street insiders, with inside information, give you, the investor, the “inside scoop” on what’s really going on inside the stock market. Today the Dow Jones Industrial Average fell 13 points, so let’s go straight to our panel of insiders and see “what’s cooking.” John, we’ll start with you.
First Expert: Well, Bob, I think what we’re seeing here is investors reacting to developments in the Middle East.
Host: What, exactly, were those developments, John?
First Expert: Beats the sh*t out of me, Bob. Foreign affairs are not my specialty; I’m a Wall Street insider. All I know is, they are always having developments over there in the Middle East, and in my inside opinion, investors are reacting to them.
Second Expert: Bob, I would have to agree with John to a degree, but I think investors are also feeling a deeper sense of unease.
Host: Over what?
Second Expert: Oh, I don’t know if it’s anything specific, Bob. Did you ever just wake up, and you feel a sort of, you know, unease? I think that’s what’s going on with the investors. They’re like, “Whoa! I’m uneasy!”
Host: Norm, do you agree?
Third Expert: I have no earthly idea, Bob.
Host: All right, then. Now let’s ask our Wall Street insiders to “put on their prognostication caps” and give us their assessment of what we can expect to see from the market in the coming days and weeks. John?
First Expert: Bob, I look for the market to continue to experience downward pressures. But by the same token we could very well see some trends that could tend to exert countervailing pressures. Which of these factors will dominate remains to be seen.
Host: So you’re saying the market could go either down or up?
First Expert: Don’t put words in my mouth, Bob.
Second Expert: I’m afraid I’m going to have to disagree with John on this. I think what we’re seeing here is a number of forces at work.
Host: What forces would those be, Mary?
Second Expert: Dark forces, Bob. Powerful forces. Forces that threaten not just the city of Gondor, but the whole of Middle Earth.
Host: But…isn’t that the plot of the Fellowship of the Rings?
Second Expert: Whatever.
Host: Norm? What’s your take on the direction the market is going?
Third Expert: Reply hazy, Bob. Try again.
Host: Are you reading from a Magic 8 Ball?
Third Expert: (putting something behind his back): No.
Host: All right, then! We’re out of time, but our panel of insiders will be here again once again tomorrow night to offer their insights on whatever the market does tomorrow. So be sure to tune in! Or, you can just watch this show again.
Third Expert: Signs point to yes, Bob.
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