This morning I read two entirely different articles on the same thing. Michael Pento thinks we are going to have a recession worse than 2008. He makes a logical case for it in this article. He sees deflation. My friend economist Joe Brusuelas doesn’t see things playing out like Mr. Pento. He sees inflation.
That’s what makes a market but I think it is important to highlight something else.
Who you believe probably is made up by how you thought about things before you read the article. That’s confirmation bias.
Confirmation bias is rampant in society. It’s always been around, but because of social media it is much more prevalent. Friends and followers that think alike bunch together and you wind up in a giant echo chamber.
After the way the stock market started trading this year, Pento’s analysis is pretty believable. People might be primed to accept it. Dogs and cats sleeping together becomes within the realm of possibility. Makes your heart skip a beat.
No one actually knows and you will only be able to tell who was right looking in the rear view mirror. But, people that strongly believe in one side or the other will be able to look in the rear view mirror and give you excuse after excuse why their guy was correct. That’s how strong confirmation bias is.
I see that a lot in political analysis of the Obama administration. People choose to believe what they want to believe, and ignore what inconveniences them.
I do think having basic principles helps. This is why some VC firms have an investing thesis. Principles are broad enough to fit into almost any situation. They are flexible and bend, but don’t break. One principle I invest in is that people are always out to maximize their own utility. The easier some business makes it for them to maximize their utility, the better chance it has for success. It takes a while to develop principles. Often, you lose money and make mistakes. That’s painful. Having the discipline to follow principles you develop is also very hard.
Many times, things like pattern recognition can enable investors to get into profitable situations. How ever, that same pattern recognition can reinforce cognitive bias and get you into trouble.
Here is an example. In the late 1990’s, I noticed every time the Japanese Yen would drop in value, the US Treasury market would rally; and vice-versa. Once you saw the pattern, you’d test it with small trades. The more success you had, the larger trade you’d put on. But, when the pattern broke, usually traders would have more on than they could handle and the reversal was ugly.
This also can happen in startup investing. That’s why discipline is so important.
Confirmation bias makes investing really, really hard. It’s extremely difficult to suspend your preconceived ideas about how things should be. Often, all your friends in the herd will believe “one true thing”. They talk about it amongst themselves. They use peer pressure to get everyone to think like them. That one true thing leads them off a cliff. That’s why Marc Andreessen‘s motto, “Strong opinions, loosely held” is a great one for investing in the market, or startups.