Steer clear of ‘mass market investing’

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It’s public opinion that makes people go to war, buy houses they can’t afford, invest in mortgage-backed derivatives they know nothing about, and jump into the market because a stock tout on TV tells them to. People who sell you a war are using the same methods of manipulation as those who urge you to buy tech stocks at the top of a market or sell them at the bottom.

Ms Lilla Rajiva, co-author of ‘Mobs, Messiahs, and Markets’.
Ms Lilla Rajiva, co-author of ‘Mobs, Messiahs, and Markets’.

Being able to rethink your strategy in a heartbeat is far more vital to your financial health than holding onto things until rigor mortis sets in.

Though there is nothing inherently antisocial about genuinely free markets, you should look at the language of politics and the markets with suspicion and examine things for yourself, cautions Lila Rajiva, co-author of Mobs, Messiahs, and Markets (Wiley, 2007).

“If ethical and productive individuals produce ethical and productive societies, then we all have much more power than we think,” she adds, on a reassuring note, during the course of a recent e-mail interaction with Business Line.

Excerpts from the interview:

Your book seems to show a more than healthy disrespect for conventional wisdom.

I don’t think the book says anything terribly revolutionary. If it sounds as if it does, it is only because the public debate is so restricted. Even differences between the Right and the Left are sometimes no more than variations on the same one-note samba. Most popular experts have backgrounds and training that are very similar, and they tend to feed us the same warmed-over ideas.

So, although I support free markets and individualism, I realise that labels can be deceptive and conventional wisdom often plain wrong.

What we really have in the US, for instance, isn’t so much a capitalist as a managed economy, in which the managerial class controls the creation and dissemination of money and also the creation and dissemination of public opinion.

Money and opinion?

The financialisation of the economy and information control go hand in hand. That was actually the gist of my first book, a study of mass thinking in the Abu Ghraib prison scandal.

In Mobs, the new book, I look at the same issue from a different angle and in a very different vein, in collaboration with contrarian financial writer, Bill Bonner, who has behind him a lifetime of observing mob behaviour in the money business.

Is there an overdose of politics in Mobs?

Some people have suggested that we should have steered clear of politics. I disagree. The financial and business world actually has a pretty serious civic duty to follow, since it has a ringside view of politics.

And while writers should consider reviewers’ sensibilities, they should consider their own integrity even more. The need for aesthetic distance does not excuse them from ethical action in the real world. To be a libertarian always presupposes ethics. Otherwise, what you end up with is licence and criminality.

Recommending fiscal prudence, limited government, and humility to the political class — a revolutionary proposition?

But so it is. Today, even major economics departments endorse extensive state intervention and cultural Marxism and call that the free market and liberalism. Naturally, when you bring up the real thing, people act as if they’d found a hand grenade in their lunch bag.

Look, academics can cultivate whatever school of thought they want, but the more limited the information they work with, the more out of touch with reality they become, and the more inaccurate their reading of the world. That is the problem with the intellectual caste system that presumes that unless economic theories come out of the Ivy League, they have nothing to offer.

The book might sound outrageous, also, because our positions were not partisan. Of course we wrote it — with important reservations — from an Austrian perspective on economics. But we criticised Republicans as well as Democrats. We poked fun at communists and imperialists.

Government programmes are styled like off-the-rack maternity dresses — big enough to cover any act of nature, with room to expand. Political debate is a Mafia hit job. Its goal is not to open conversation but to terminate opponents. You simply bludgeon them to death with whatever comes to hand.

Do you see parallels between wartime messages and market cant?

A great deal. In-group bonding requires self-deception. The obvious example is wartime propaganda, but there is also the way we manipulate memory in our personal recollections and collective histories.

It is the manipulation of memory that allows propaganda to work and messianic leaders to hustle their way into office, whether through democratic elections or the barrel of a gun. And it is what blows up hot-air balloons in the market that we take for genuine booms.

We are not, obviously, equating the president of a constitutional republic, like Bush, with a despot like Mao. We are simply showing how delusion surrounds statesmen of all types, even those spouting the highest sounding motives. Once you strip them of the rhetoric, they’re all neck-deep in bamboozles and blunders that bring nothing but disaster for ordinary people.

The Iraq war might have been about strategic and oil interests, but the propaganda about it was all about thwarting tyranny. That was what the public believed. And it’s public opinion that makes people go to war, buy houses they can’t afford, invest in mortgage-backed derivatives they know nothing about, and jump into the market because a stock tout on TV tells them to.

People who sell you a war are using the same methods of manipulation as those who urge you to buy tech stocks at the top of a market or sell them at the bottom.

And the investment advice we offer is geared to make you understand this and steer clear of what my co-author likes to call mass market investing. Our varied excursions into politics, history, economics, socio-biology and finance are all meant to reinforce that piece of common sense.

How would your suggestions and findings serve those who prefer to be active in the investment market?

We’re not suggesting that Rip Van Winkle is our ideal for a portfolio manager. In fact, we argue that relatively passive investments such as mutual funds are rarely as safe as they’re advertised to be, since high fees can offset any expertise you get from the managers.

Beyond that, we differ in our approaches. Bill advises the classic strategy of pursuing assets with grossly undervalued fundamentals and holding them for the long-term. My research into market history over the last few decades convinces me otherwise.

Long-term investing now often poses risks as great as or greater then mid-term trading because the investment world has become several orders of magnitude more volatile and fragile.

Sell and buy orders that go off at pre-programmed levels in stampedes, ever more complex derivatives, risk and reward so intricately repackaged that buyers no longer know what they are playing with, a global flood of credit, massive leveraging and trans-national financial flows have made the market a kaleidoscope.

One shake, and a stable pattern breaks up, slides all over the place and reshapes itself into something stunningly unexpected, all in no time at all.

So, being able to rethink your strategy in a heartbeat is far more vital to your financial health than holding onto things until rigor mortis sets in.

Briefly, we recommend the following: Study your investments close up; tune out most of the “white noise” of day-to-day market commentary; get a plan and stick with it. And know yourself - why you invest, what your goals are, and what risks you can tolerate.

Your views on some of the recent developments in Indian finance world — the race for mergers, the Sensex leaping, rupee appreciation, bulging forex reserves, and the participatory note issue.

The race for mergers in India seems to follow a general trend in the market. In the past few years, the major banks have been more and more involved in M&A activity — and have made quite a high proportion of their profits from it.

Rupee appreciation is only to be expected, as the dollar is relatively overvalued against Asian currencies. The next major leg down in the dollar index should be against them, since the other major currencies have already made sizable gains.

The Sensex? The general feeling is that there is less of a bubble here than in the Chinese market, although here too valuations are probably full. But since the Indian market is probably not as intertwined with US consumption as the Chinese seems to be, it might have more strength long-term. On the negative side, however, social unrest, mass migration of labour, environmental damage, infrastructure failure, and security risks could all become serious obstacles.

As for the participatory note issue, I think it is an excellent thing to keep out big speculative players such as hedge funds, as they are largely unregulated. The quick in and outflow of speculative capital is what caused the series of financial collapses around the world in the nineties.

Now it looks like those might have been only preliminary shocks at the periphery and that tremors might have worked their way to the epicentre of the financial system in the US. When even institutional investors like pension funds and university endowments are tied up in risky securities that no one wants to touch, emerging markets should be extremely wary.

On the trigger for the book. Also, how you went about writing it.

When Bill got the idea for the book, he was looking for someone with a background in mass psychology and globalisation, who could also write humorously. Although I was worried that we wouldn’t agree on enough for the writing to work, he was more sanguine. He was right.

We managed to write the book long-distance, without a mishap, in little under a year, while we were both mostly on opposite sides of the globe, en route to some other place. That is entirely to his credit, I’m sure.

On the other hand, I take the blame for all our crimes. I confess to parts of chapters 3, 9, and 17, most of the material on propaganda and panics (4-5), on globalisation (10-11), as well as on Friedman’s methodology, the CIA, and the British Empire in India. And, of course, any errors in research are mine.

I point this out not only because of the controversial nature of our positions in those sections, but because putting our writing together in a viable form was a challenge, intellectually and stylistically. I had to preserve — and for long stretches imitate — the colourful style of Bill’s very popular daily column, in such a way as to reach out to a general readership without alienating his financial audience.

Would we be wrong to say that the nearly 400-page book could have been condensed to 150 pages and still retained the essence of your prescriptions?

If the book really could be cut in half and stay the same, we will have failed, since one of our central points is that humans must understand themselves through felt experience, not through theory and abstraction.

We wanted the book to read like a novel, not an investment manual. Pared down, it seemed to lose its flavour, so I left some meat on the bones. I may be biased, though, since I grew up on sprawling nineteenth century novelists such as Hardy, Bennett, and Sholokhov. If it is any consolation, the original thing was a thousand pages.

Take one cut we mulled over — the section on the abortive British raid on Kabul in 1842. For one thing, it is hilarious and for another, how do you write about the atrocities of communism and pretend that imperialism hasn’t any? If you cared the slightest bit for the integrity of your argument, you couldn’t. Besides, the Kabul story parallels what’s happened in Iraq in some ways.

Similar parallels crop up throughout. There are several images of rivers, for instance: The bloody river of history, the River Liffey in Ireland, the rising Nile of credit under Greenspan, and many others. The images occurred spontaneously as we wrote, but they also prefigure our concluding discussion about the tides of history.

Another example. In Chapter 7, we talk about Calpurnia’s warning dream before the Ides of March in Julius Caesar. A few pages later, when a comet shoots over Bill’s castle in Ouzilly, a guest wonders what it could foreshadow. Later on, we use the crash of the space-shuttle to describe the collapse of a hedge fund, and the explosion of the Hindenburg as an omen of the Second World War.

What meaning you want to read into all that is entirely up to you, of course, but the images form a subtext sometimes unconscious, sometimes deliberate — to our discussions of ‘chance’ and ‘randomness.’ So our arguments might fly off in many directions, but they’re held together by the narrative texture.

We agree with David Hume’s premise on the Black Swan. (The same idea was captured beautifully in a book by V. S. Ramachandran and Sandra Blakeslee The Phantoms in the Brain). What has that got to do with the gravitational pull (or the centripetal force) of arguments in your book?

Hume’s bird illustrates the limitations of naive empiricism. Any number of observations of white swans is itself not enough to rule out the existence of black swans. But observing just one black swan is sufficient to prove the opposite.

What that amounts to is that humans consistently overrate their rationality. We may assume we are naive scientists dissecting the world with the finesse of brain surgeons, but there’s more butcher than brain surgeon in most of us. We’re far more beholden to biology than we think. And to language; to rusty concepts and clumsy logic that drag us along from demented premises to disastrous conclusions.

A lot of logic, in fact, is no more than bad theory, and a lot of empirical observation simply wishful thinking smothered with emotion.

I do have strong interests in mind-body research of the sort pursued by neuroscientists like Ramachandran. But raw observation alone will tell you something similar.

Investors who are long a certain stock may think they are impartially observing the fluctuations in its price, but they’re usually far more hopeful of its prospects than they would be if they didn’t hold it.

The existence of black swans also means we need to give more significance to risks that might seem remote statistically. In fact, I’d say that using mathematical assessments of risk to get a handle on it in the real world is probably about as smart as practising on a rocking-horse for a rodeo.

The universe isn’t plodding along in a narrow rut waiting for you to saddle up and ride it. It’s a far more intractable thing. Its complex patterns may appear chaotic to the naive eye, but they follow laws of their own that are liable to kick you in the shin if you ignore them.

“Events that experts rate as impossible or near impossible happen as often as 15 percent of the time, and certainties or near-certainties fail to happen 27 per cent of the time,” you write, citing Philip Tetlock’s Expert Political Judgment. Does that imply you are suggesting the Golden Mean?

No. That would be too clumsy a model. The things that are rated impossible and the things that are rated certainties are specific kinds of things that can’t be directly compared, let alone averaged, most of the time.

It’s one of our central arguments in the chapter called “The Number Game” that we need to pay more attention to the specificity of different things.

The colour and texture of our world has been washed out because we rely far too much on generalising and abstracting from spurious statistical data, data that the governments in most countries, including the US, heavily massage.

It makes no sense, most of the time, to talk about an average man. He’s a statistical fiction. We have to account for the real actions of real human beings.

Type 2 error is stated to be when a guilty person is let free (Jan Kmenta, Econometrics). What is the import of this to markets?

In Mobs we suggest that inaction is often as underrated a course of action in politics as it is in connubial relations. We even offer - tongue in cheek - a Hippocratic oath for social engineers and regulators: first, do no harm.

Our argument is that for any action to be worthwhile the costs imposed by crimes and errors would have to be more than the costs of detecting, rectifying, and punishing them. How often would that be the case? And how would you guarantee that the regulators themselves wouldn’t add to the crimes and errors? History shows that regulators often end up colluding with the people they’re meant to regulate.

There’s another angle to this. For example, the US Food and Drug Administration (FDA) can let something bad happen (by approving a harmful product), and they can also prevent something good from happening (by not approving a helpful product). The public suffers both times, but the regulators only get attacked by the media and public in the first case, since the second is a non-event. Then the attacks lead to more defensive regulation that holds up even more useful products.

This is a shibboleth of anti-regulatory rhetoric, but our book suggests that things aren’t so simple. If there is asymmetry between public responses to Type I and Type II errors, there is also asymmetry between what it takes to prove that something might have use and what it takes to prove it might do harm.

And who is doing the testing? The same companies who profit from selling the product and who often influence the regulators. There is simply too much complexity involved to take sweeping positions about the effects of regulation in all cases.

Take the Glass-Steagall Act, which kept apart the commercial and investment banks in the US. That probably prevented the development of some complex financial strategies that might have done some good to some sectors of the economy. But was repealing the Act in 1999 a good idea? Banking consolidation simply accelerated the financialising of the economy with the fallout on the credit market that is now shaking the US economy.

That said, a few simple, well-understood laws that are strictly enforced across-the-board are probably more effective than a swarm of “gotcha” rules that no one follows and that only serve to increase lawlessness. Problems of culture can’t be addressed simply by regulation.

What next? Your current research…

My next book deals with consumerism and its impact on the middle class in America in the last two decades. It will include my most recent investigative work on the banks’ culpability for the credit crisis. I also look at what used to be called the republican (small R) virtues - self-reliance, honesty, foresight, industry, and thrift as essential components of the free markets. I don’t like to say any more than that for now.

Bio: “I grew up in South India and completed my education there. Although I live primarily in the Washington DC area now, I still spend several months every other year visiting my family in India,” says Rajiva. “Over the last decade, I’ve had a chance to observe the huge changes there first-hand and have commented on subjects as far apart as water and waste problems in Chennai and investment in the transportation sector. From next year on, I will be based nearer, somewhere in South Asia.”

Rajiva holds an MA in English (Bangalore University) and an MA in politics (Johns Hopkins University) and has contributed over a hundred articles to web magazines (such as Dissident Voice, Counterpunch and Lew Rockwell), print publications like Himal South Asian and Forbes, and academic journals. She is the author of “The Language of Empire,” (Monthly Review Press, 2005), a ground-breaking study of public opinion in the Abu Ghraib prison scandal. She has worked as a musician, college lecturer, and journalist.



(This article was published in the Business Line print edition dated November 23, 2007)
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