The Investment Scientist


240_F_119564777_rEkf9eOoPwdUrMeRlzSKmO6eKokHwbvd.jpgLet me start with my usual disclaimer that I can not predict the market. Like the similar article I wrote four weeks ago, this article is simply an exercise in which I think through possible scenarios for the market. 

When I wrote “Will The Stock Market Give Us a 30% Discount?” the market had already fallen 19%, and I was thinking through the scenarios under which it would fall through 30%. One of the scenarios unfortunately came true: some US states have lost control of the Coronavirus situation, and the market did drop all the way to 36% before recovering to 23% down as it stands now.

Now with Europe finally turning the corner and the rapid spread in the US beginning to decelerate, will the market discount disappear quickly or will there be more shoes to drop that could  cause the market to give us even deeper discounts? Could it hit 40% or more?

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envelopes.jpgAllow me to indulge in a bit of fancy. I would love to be remembered as the person who invented the oxymoron “Intelligent Ignorance.” By the end of this essay, I hope to convince you that intelligent ignorance can make you a better investor.

Like the other oxymorons “jumbo shrimp”, “pet peeve”, “bloody awesome” etc., this one needs a story as well. It all started with Nobel Prize winner Daniel Kahneman’s discovery that we humans experience joy when making money and pain when losing money – Duh!  Hold on, keep on reading, there’s more. The pain is usually twice as intense as the joy even if the amount of money lost or gained is the same. This means that if you pay too close attention to a volatile market, it could be a hell of bad experience. Bad experiences lead to bad judgments and before long you are making bad trades.

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28_base-rate-neglect.jpgAllow me to ask you a seemingly unrelated question: what do you think the most common hair color in Ireland is? If you answered red, you are like the majority of people, but you are also wrong. The most common hair color in Ireland is dark brown (80%.) 

As you answered that question, what went through your mind? What mechanism caused you to arrive at the wrong answer? How is it relevant to stock market investing? I will answer these questions one by one in the space below.

If you answered red, you were using a mental shortcut called the representative heuristic to answer the question. What is the representative heuristic, exactly? It essentially says we humans tend to erroneously equate what is representative to what is likely. Indeed, red hair is representative of Irish people. Just under 10% of the Irish are redheads, compared to 1% of the rest of Europe. So the typical Irish in your head is a redhead, probably wearing green clothes and holding a pint of Guinness. Since you can easily recall a redhead Irish in your mind, you think therefore that the Irish are more likely to be redheads.

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crowdsource.jpgYesterday I wrote about this little mental quirk called the “availability bias” that could cost you a lot. I gave you an example, based on my conversations with clients and their propensities that I had to suppress. If an investor sold his portfolio four days ago at the bottom of the market based on his experience the prior week, and bought back yesterday because he was inspired by the 3-day 20% rally, he would have owned 20% less productive assets.  This is even though the total dollar amount is the same, since what he bought was 20% more expensive than when he sold it.

But most likely, this person won’t sense any loss, since after all, he owns the same dollar amount of stocks. How cool is that? He loses 20% of his wealth, his future income will be 20% less, and yet he barely notices it. It turns out there is another mental quirk that is playing games with him. It is called the “saliency bias.”

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drawing-chart-going-up.jpgAfter three days of the stock market rallying, I have noticed a change of tune among my clients who have been calling me. Three days ago, a few of them were asking if they should get out of the market altogether and wait until things turned the corner. Three days and 20% higher in the Dow, they want to increase their investment in stocks. But why? Why are stocks so bad when they are 20% cheaper and so good now that they are 20% more expensive!?

There is a little mental quirk that has been playing games with us. This quirk was discovered by Nobel Prize winner Daniel Kahneman, together with his trusted collaborator Amos Tversky who died too young to share the Nobel Prize. This quirk is called “availability bias.” That is when we assess the probability of a future event, we try to recall that event from our memory. If the event can be easily recalled, we subjectively judge it to be more likely. Read the rest of this entry »


Now that the panic has abated a little, many financial advisors (FAs) are advising their clients to buy strong stocks on sale. None other than Jim Cramer made the same proclamation, he even mentioned ten stocks by name. (Just FYI, he did the same in 2008 – and I did a study afterward – 8 out of the 10 underperformed the S&P 500 index that year.)

So what are the strong stocks to own? Are they industrial titans like Boeing or GE? They were strong stocks but are they still? Are they Wall Street banks too big to fail like JP Morgan or Citibank? But how do we know they’re not just another Lehman Brothers? Is it a consumer tech giant like Apple? How can we be sure it won’t go the way of Sony, which was the previous consumer tech giant. How about Netflix? When we are stuck at home social distancing, you’ve got to watch Netflix right? But what if Amazon, Apple and the other big boys jumping in the streaming market eat its lunch?

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1.jpgPrior to the market’s open yesterday, the Fed announced unlimited asset purchases that also include corporate bonds, municipal bonds and securities backed by consumer loans.


There is a long-term downside of taking this measure. I am not going to write about it until the market calms down. Today I am going to write about the short-term upside for the economy, for the market and for investors like us.

Whether it is called QE (quantitative easing), asset purchases, or balance sheet expansion, it means the same thing: the Fed is creating new money. Just ten days ago, the Fed announced they would create $1.5T new money, but the market pretty much ignored that. Now the Fed is essentially saying that they will create as much money as possible to back-stop this financial crisis.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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