Cognitive Dissonance on Wall Street

I have been writing about brown shoots for too long to recount - perhaps since the term green shoots was created by some bull with calls on the S+P - and I have been astounded by the number of analysts, pundits and whatever who bought the argument. Congress is expected to re-write the laws of math but no one else. So why were so many people surprised on Thursday with the unemployment data?

This Thursday's unemployment report should not have been a surprise. I will not waste your time recounting numbers you can see or have seen elsewhere. But the sharp selloff means a) a lot of traders got in on the wrong side of the trade and ran in a hurry and b) there is still a historically high amount of cognitive dissonance on Wall Street. Cognitive dissonance may, in fact, explain the entire rally and is, if you like behavioral psychology, is central to understanding the behavior of markets that fly in the face of economic reality.

To quote part of the Wikipedia definition, "Cognitive dissonance is an uncomfortable feeling caused by holding two contradictory ideas simultaneously. The "ideas" or "cognitions" in question may include attitudes and beliefs, and also the awareness of one's behavior. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance by changing their attitudes, beliefs, and behaviors, or by justifying or rationalizing their attitudes, beliefs, and behaviors."

Sounds like the Street to me.

Wall Street does one thing quite well - math, usually reserved for bonus calculations, commissions, fees but occasionally used for analyses - and it knows the consumer is dead and getting deader, suppressing business behavior and employment. But it wants to go long - it longs to go long - and this tension is cognitive dissonance. It removes the tension by reconciling these two ideas with what it really wants--for the market to go up. Otherwise intelligent people go on TV and tell people things are fine with green shoots everywhere - I am not talking about screaming anchors who have traded ideology for intelligence like Larry Kudlow, nor am I referring to corrupted reporters now always optimistic as if they had a patriotic duty to be so - perhaps it is ratings? I am talking about money managers who are mostly long and want to stay that way. They are now telling people to "invest in the second derivative" - a decline in the rate of decline - and their reasoning "green shoots." So if you are going to willfully deceive yourself and resolve cognitive dissonance, you might as well pull some sucker along for the ride.

This optimism extends to individual market segments and companies. In the good old days, pre Bear Stearns, when housing starts hit one million per year it was a "bottom" and time to buy the home builders. We are down to half of that rate with no rebound in sight but pundits are talking up the companies, most of them kept alive by billions in tax rebates that end this year. Not one investment bank, not to mention a major money center bank, has earnings power remotely approaching their capability five years ago but the stocks have risen sharply based on accounting metrics the Street knows are on paper, not the real world. Not to mention all of the money center banks cannot exist without Fed guarantees of their bonds. And within this group, look at Citigroup (C) - worthless balance sheet, some great businesses, but having no real shareholder value and if and when forced to properly (I don't mean legally, what they do with their books is legal) account for assets, they are wroth nothing. And how about GM (GMGMQ.PK) trading above a buck?

There is another variant to this optimism - honest optimism based on a mis-reading of data. My favorite TV analyst, Ron Insana, a brilliant and painfully honest man, not quite fully pulled back into all of CNBC's mantras about green shoots, thinks we have hit bottom in the market with the overwhelming reason being the amount of liquidity the Fed has injected into world markets. Yet, if you look at the circulation of "new money" - its velocity - how much it circulates - against what the Fed has metaphorically printed you can see the money supply may have actually declined in the past year. No kidding. And even if I am partially wrong, where is the liquidity? It is now showing up in margin accounts of hedge funds or trading desks - it is sitting in bank mattresses, ready to be used to balance out future losses.

So there is optimism from cognitive dissonance, know one thing, think another, reconcile this by sticking with a belief even if you know the belief is wrong. Or you are getting it wrong because you are using historical norms to analyze something far less than normal - today's economy and markets.

I am not complaining - well, I guess I am, sort of, since I live on fundamentals even though I only recommend options positions in my service, ChangeWave Shorts - but a day of at least partial reckoning is coming. Either a blow up or a slide that defeats even the hardiest if bulls. And even if I am wrong, based on the history I am trying hard not to use, the economy will inhibit corporate profits and at best keep the market going sideways for several to many years. Even Congress cannot change how the market value corporate profits - and the market is way overpriced based on the next 2-12 quarters of economic and profit growth.

The bottom line? Whatever trades you make, they need to be in the face of an economy that is not bottoming and when it does, facing a recovery that could take as much as a decade. And, seriously, take a look at Citi as a short - if it is forced to move its off balance sheet assets on its books, well, lots and lots of these. Check out page 21 of the town hall presentation the company had for employees last November. And if you are long Citi, have a drink before you get to that page, and that can be found here.

Comments

[Tim Singleton:]

Anyone's surprise at anything right now is a blue eyed miracle to me. You can sit an American down, force feed him facts, figures, historical data, and prove to him that certain things have to happen.
Best case result is that he cups his hands over his ears and yells, nana nana nana until you get tired and walk away; worst case scenario is he or she starts screaming at you about their rights as if that has anything to do with what the economy will do in response to their actions.
Looking at the government talk about green shoots to me is the same as watching asylum doctors make inmates feel better by drugging them into submission. Looking at consumers get excited about greenshoots is like watching those same inmates talk to each other about all the interesting things living under their beds after medicine call.

Jul 05 08:44 AM

[Ferdinand E...:]

Ínteresting and excellenty written. Reminds me of my work.

Of course I have never used the term cognitive dissonance, although I will make sure that I use it in the future. I will use it when discussing Nobel laureate and energy secretary Chu. You probably don't have a problem with CD if you are ignorant, but Dr Chu almost certainly recognizes the importance of energy, while at the same time being instructed to get more of it with sub-optimal means. .He'd better watch his step or he will be making the acquaintence of those folks in the white coats.

Jul 05 09:00 AM

[zyzzyva57:]

What helps this spread of Cognitive Dissonance?

I also see a real "meme-zation" of the world, the latest being with the Michael Jackson Death

It is frightening to think of what this means

America is well on her way to becoming the United States of Amnesia--We go ever faster from one Meme to the next

Already we have major politicians proud they are ignorant, e.g., "I don't have to read the bills I sign"

News readers are more and more variations to FOX's $ucce$$ of blonde Vagina looking lipped, short dressed, leg showing news readers around 30'ish who are clueless to what they read

We have a president who unabashed, reads and takes his cues from a teleprompters as the FOX ladies

(According to Wikipedia, a Meme is "A meme is a postulated unit or element of cultural ideas, symbols or practices, and is transmitted from one mind to another through speech, gestures, rituals, or other imitable phenomena)

Jul 05 09:34 AM

[Tony Daltorio:]

Great article! And remember that the cognitive dissonance affects not only the elite on Wall Street, CNBC, etc. but also your neighborhood financial advisor or planner.

I was in the business for 20 years and I still have lots of contacts in the industry. These people still haven't changed despite the enormous changes in the investment landscape - "Duh, holding S&P 500 index funds for the long-term is a smart investment......."

Jul 05 11:38 AM

[DaveW:]

I've been looking for a good word (which is not an expletive) that describes this market post-March bottom and 'cognitive disconnect' fit's that void perfectly. nice article.

If I might add, the process through psychological pain can take one of two paths, 1.) Avoidance, through addiction or denial and, 2.) Acceptance, by acknowledging and processing the pain. The former can last a very long time and always ends badly. Extending the metaphor to the current situation on Wall Street/Capital Hill, only an intervention at this point can direct us to the path of the latter: acceptance of the pain and coming to terms with the world as it really is at this time. But, who will intervene?

Jul 05 11:55 AM

[derryl:]

Great article. It's always nice to see someone who points out clear realities rather than blinding themselves with the audacity of hope.

Jul 05 12:19 PM

[Northstar10000:]

I saw Boggle Brain on TV. Even the CNBC jockey questioned him when he said buying the 500 and holding was the right course.
Look on the charts and every 30 years they wipe out the buy and holders with no chance to recover. It take about 30 years to grow a new crop of fools.

Jul 05 03:08 PM

[cfg3450:]

Green Shoots is about the same as Global Warming.

Jul 05 03:38 PM

[cfg3450:]

Green Shoots is about the same as Global Warming.

Jul 05 03:41 PM

[joes:]

The main cognitive dissonance that I see at the moment is pundits continued rants that the past predicts the future.

How this can be the case when almost every document that they sign or create in the deceptively named Financial Advisory business has a disclaimer removing the consideration of past performance when considering future results is beyond me.

That there is a structural change in motion is not in question, technology, most specifically at this point the IT/Internet, soon to be followed by nanotechnologies, are changing the game for many business models.

History provides no value at this time, just as it didn't in 1870, 1900, 1916, 1929, 1933, etc...

There are new markets and new companies that are going to make some investors very wealthy, while making our lives much cheaper and pleasant. Presidents come and go, congresses reshuffle and the beat goes on.

As the concepts of globalizations, reductions of hunger in disease and environmental considerations as we start to stress food chains and water systems, become the focus of groups like the G-20 there will be a very different looking world on the other side of this dislocation.

Jul 05 04:10 PM

[Ajit Kapoor:]

Very well articulated. Now this is what I would expect our leaders should be communicating and not a voodoo version of public relations. I want our president to have time to deliver but are his stimulus plans based or reality or just wishful thinking? We cannot as Americans live on the rest of the world pay for our standard of living. Mr. Biden just acknowledged that the economy is in worst shape than they (the financial team) envisioned. Huh! But how can the people fix the problem that help create it. Mr. Treasury secretary is the product of past financial excesses and may be cannot think out of the box. We need Mr. Obama to tell us as adults that things will get lot worse and will settle at a much lower standard for all Americans in a decade. Prepare our future generations with truth so as to learn to live with pain of reality rather than dream in the intoxication of false and fairy tale finance green shoot.

Jul 06 09:08 AM

[cgm205:]

Being a mathematician, I liked the way the author showed how a science supposed to be tamper proof like mathematics can be manipulated by those desiring a 'proof' of their theses just as easily as earnings in a 10-K can be manipulated

Jul 07 12:32 AM

[chaonet3:]

"Not one investment bank, not to mention a major money center bank, has earnings power remotely approaching their capability five years ago but the stocks have risen sharply based on accounting metrics the Street knows are on paper, not the real world."

Based on accounting metrics the Street knows are on paper, not the real world ... on paper!!! Has it not being like that, all the time or at least since debt used as colateral for money. The value of money, a perceived value.

Perceptions change, volatile. They are here now, they are gone tomorrow. They were there yesterday, they are now departing. The whole system crumples. Perceptions change daily. Perceptions ... drawn out and based upon, the attitudes displayed by people-consumers that is- as it is described in your article 'Forget Green Shoots: These Are the Brown Shoots Turning Black'.

Housing: Dead and believe it or not, getting deader.
Consumer Spending: Dead, deader, dying again
Banks: On the mend in the headlines, the big ones - Citi (C), Wells (WFC), BOA (BAC) - broke and getting broker ...
Credit Markets: What credit markets? They do not exist for all but a couple of investment banks and AAA rated companies.

What would the perceived value of money be now or be in the near future. Would the trillions and billions of dollars mentioned make any sense at all?

What will still stand there, are the buildings and the factories, the ones that were labeled toxic. It is a matter of perception. What house the people, that are still ... producing ... innovating ... creating.

Jul 12 09:32 AM