“If attention is directed to the unconscious, the unconscious will yield up its contents, and these in turn will fructify the conscious like a fountain of living water. For consciousness is just as arid as the unconscious if the two halves of our psychic life are separated.”
Carl Jung
We live in a world of big and growing data, where investors are “forward guided” to focus on particular areas, like unemployment, corporate earnings and regulations. But are we at risk of missing something even bigger, exactly because we have confidence that we have it all covered with our advanced analytical tools?
Suppose you watch a video of a basketball game and suddenly a gorilla would appear, dancing around the court. Would you notice it? Roughly half of the subjects in a famous experiment, called The Invisible Gorilla, did not. There were mitigating circumstances though. Specifically, subjects were instructed to concentrate on carefully counting the number of passes between members of one particular team. This and similar experiments confirmed a psychological condition called inattentional blindness, the failure to see an event because all your conscious mental resources are heavily committed to paying attention to a particular activity. In some situations that can turn into an expensive payment.
In broad terms, the relevance of this phenomenon for our profession was exemplified by her Majesty the Queen when, regarding the credit crunch, she asked economists why they hadn’t “seen it coming”.1 Moreover it points again to the striking similarities between minds and markets, for example in terms of psychological dynamics versus portfolio dynamics. In this case it highlights the risk of ‘overpaying’ attention to single events, the mental equivalent to having ‘all your eggs in one basket’.
In a moment I will list a number of overlooked gorillas that either are already dancing on the green shoots of the economy’s lawn or may trespass later, possibly disrupting the party inside (inside the capital markets, that is). First, at least as interesting is the realistic assumption that subjects in the experiment actually did perceive the gorilla, but at a subliminal level. This leads to the broader issue of the role of the unconscious. After referring to the pioneering work of Jung, physicist Leonard Mlodinow2 points out that
If until recently academic psychologists have been reluctant to accept the power of the unconscious, so have others in the social sciences. Economists, for example, built their textbooks theories on the assumption that people make decisions in their own best interests, by consciously weighing the relevant factors. If the — unconscious is as powerful as modern psychologists and neuroscientists believe it to be, economists are going to have to rethink that assumption.
Consequently, I would argue that the unconscious is, by definition, the true invisible gorilla in investment research. At the same time, it is treated as an elephant in the room. Following Mlodinow’s point, it is important to break this taboo.
Source: https://3.bp.blogspot.com/-f4URflj6Pyw/TdcesaYQI2I/AAAAAAAAFeg/b9YV4Ccjh...
Although new insights are being added by the other mind sciences, they generally acknowledge the earlier contributions made by Jung regarding the role of the unconscious, particularly concerning collectively derived mental imbalances3. Unfortunately this credit is not extended yet into investing; mainstream behavioral finance has decided that intuition and other aspects of the unconscious, what Daniel Kahneman calls “System 1”, is bad for decision making. The unconscious is a remnant of a bygone era and not suitable for our modern times, or so the consensus goes. System 2, on the other hand, is considered superior in that respect. Below is an overview of some of the psychological functionality involved in both systems.4
| Unconscious, experiential system 1 | Conscious, rational system 2 |
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On that note, the dispute between Kahneman and Gerd Gigerenzer, an advocate of System 1, seems to have gone in favour of the former, at least as far as behavioral finance is concerned. This dispute is regrettable and distracts from further progress. In fact, based on the principle of complementarity I believe a bridge can be build between their views5 by:
- Acknowledging that comparing the unconscious with the conscious system is not like comparing apples with pears but rather like comparing an oenophile with a chemist. However, their relative ‘performance’ is currently measured by using research methodologies associated with chemistry. Specifically, both the oenophile and the chemist are judged by how they convey the quality of a wine when using a microscope, tubes, and a distiller.
- Acknowledging that, consequently, it is no wonder the chemist is considered “superior”. But it is unfair to judge the unconscious as inferior if that judgment is based on using methods and tools that are not suitable to it. Specifically, we use analysis and spreadsheets to bring out the best in our conscious abilities but they fail to do the same for the unconscious abilities because they have a different modus operandi.
- Acknowledging these points means the initial judgment is deemed premature and incomplete. We need to develop new tools and methods which specifically appeal to the psychological functions involved in System 1, thereby facilitating research into the unconscious domain.
Complex psychology, as well as other disciplines, has a long tradition in such methods, although they and the tools that support them will need to be tailor-made for investment research.6 In summary, the key issue is that we currently do not treat our unconscious as a system of abilities we can train to use in a disciplined way, like we do system 2. We use analytical methods to train ourselves in using our conscious mind with the support of external tools such as Excel but we have no such approach for our unconscious mind. Jung always argued for this type of active engagement with the unconscious. Not only to balance our natural tendency to rely on analysis but also to channel the unruly unconscious in a disciplined way. In other words, to actually go and taste the wine, but in moderate amounts and with a clear purpose!
Coming back to the mind in terms of a portfolio, the current bias is that we underweight the unconscious. But the risk attribution follows the 20/80 rule: a 20% weight can have an 80% impact. In other words, the unconscious can swamp behavior if it is not managed in a disciplined way. This phenomenon is particularly apparent at the collective level. A consensus strategy that seems to be emerging is to remove this exposure completely, for example via mechanical trading. This raises the question of whether eliminating the unconscious influences is actually possible, let alone whether it is wise? It also assumes that the mechanical approach is appropriate and able to benefit from fallacies assumed to be made by non-mechanical investors. You can probably guess my answers, particularly in the context of Lehman’s Lesson. Of all the quotes (from William James to Pink Floyd) which would beautifully capture the essence, I have decided for Heraclitus:
Many fail to grasp what they have seen,
and cannot judge what they have learned,
although they tell themselves they know
We need to complement our investment analysis to get a balanced view on our big data.7 Exclusive reliance on analysis and ratio involves risks. Jung, for example, pointed to an inflated ego, which in turn is the source for overconfidence. Instead, we should aim to be more modest by respecting the unconscious and how it has served humans across all time, not just our time. If you agree that you may have overlooked something and that there is a possibility that somebody or something ‘uninvited’ can spoil the game, you better take your exclusive focus off the ball. Relax a bit more, look around the audience and take in the atmosphere. To get a sense of what this would entail, the BBC documentary “Out of Control” discusses the influence of the unconscious on our behaviour and decision making. Towards the end of the documentary, one of the neuroscientists discusses the generation of, what he calls, ‘”a-ha signals”8. He describes the non-analytical state of mind which facilitates such signals: “when looking at these images, the best thing to do is relax; you’re getting into a zone.” In our case, such an approach does not mean that we replace investment analysis but rather that we complement it by using data in a different format.
Another strategy altogether, of course, is to be skeptical upfront of the instructions provided by the supervisors of our investment game. In fact, some of them have been moving the goal posts, almost like an open invite to angry gorillas. On that note, and as promised, my candidate for the scariest gorilla out there is misallocation. We generally don’t see it yet but it is already on the court and will spoil the game for a long time to come. It is closely followed by the ‘damaged’ gorilla, representing the cracks in the foundation for the recent build-up in asset prices. That foundation is the trust in central banks and their policies but its cracks are difficult to discern by most. Finally, the price for the ugliest gorilla goes to financial repression which is gradually encroaching in the global economy and will likely enter center stage once those cracks open up.
Some stampede that could turn into!
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1 Currently, this applies for example to Janet Yellen, the next chairperson of the Fed: https://www.zerohedge.com/news/2013-08-14/janet-yellen-financial-crisis-i-didn%E2%80%99t-see-any-coming-until-it-happened
2 Leonard Mlodinow; Subliminal: How Your Unconscious Mind Rules Your Behavior; 2012.
3 For example, Jung’s statement that “Masses are always breeding grounds of psychic epidemics” is obviously applicable to hypes and panics in markets.
4 See Daniel Kahneman; Thinking Fast and Slow; 2011, as well as Seymour Epstein; “Integration of the Cognitive and Psychodynamic Unconscious”; American Psychologist, August 1994.
5 Following on from and in the spirit of Kahneman and Klein; “Conditions for Intuitive Expertise”; American Psychologist, September 2009. However, they are sceptical as far as “the intuitions of a trader about a stock” are concerned. In my view the challenge is, to use their words, to develop the “subjective marker that distinguishes between correct intuitions from intuitions that are produced by highly imperfect heuristics.”
6 Something I am working on.
7 Talking of wine, some will argue we remain exposed to the “bucket of sludge” theory: if you take a bucket of sludge and add a teaspoon of wine, you end up with a bucket of sludge; if you take a bucket of wine and add a teaspoon of sludge, you still end up with a bucket of sludge. (Clever readers will recognize that for compliance reasons I had to replace the original word with “sludge”.)
8 As an irreducible element of discovery, I have regularly written about a-ha experiences like here.
