The Undoing Project by Michael Lewis

Michael Lewis’s writing has often explored the interesting crossroads between finance and psychology. With The Undoing Project, Lewis highlights the work of Daniel (Danny) Kahneman and Amos Tversky, two psychologists who spent their careers “undoing” what experts in many fields, including finance and economics, have taken as gospel in the past. However, this book is bigger than a detailed breakdown of their life’s work. In a sit-down interview with Malcolm Gladwell, Lewis jokingly compares the story presented to that of Adam and Eve. It is essentially a story of a profound human relationship, and through that lens, we find out how both men stumbled into helping create what we now call behavioral economics.

When Lewis wrote what was arguably his most popular book, Moneyball, there was one piece of criticism that he spoke of resonating with him deeply. The book was mostly about how baseball executives misjudged assets, but there was little explanation on why the experts were misjudging them. Following the sports theme of Moneyball, The Undoing Project opens with the story of Daryl Morey, a friend of Michael Lewis, who brought forth an analytical revolution to the professional basketball world in the same way that Billy Beane did to baseball in Moneyball (his approach was then aptly named “Moreyball”). Morey came into the Houston Rockets basketball organization aware of biases in sports, and admitted to still being a victim of its effects.

In the 2010 NBA draft, there was a player named Jeremy Lin that went undrafted. In Morey’s words, he “lit up” their model and the data suggested that the organization select him with their 15th pick. He had the “quickest first move of any player measured. He was explosive and was able to change direction far more quickly than most NBA players”. The Rockets, and every other team in the NBA in that regard, still decided not to draft him that year.

Lin became a free agent and bounced around several teams until he finally got a chance to start in an NBA game. The weeks that followed his first start turned into a moment in sports history dubbed “Linsanity”, a time where he did things no other undrafted player ever did in such a short span. He broke countless records and proved his doubters wrong. Morey commented on how this came to be: “the reality is that every person, including me, thought he was unathletic. And I can’t think of any reason for it other than he was Asian”. Racial bias is and always has been a hot topic due to its wide-ranging yet sometimes subtle effects. Morey learned from his mistake by implementing measures that would remove this bias from his team’s scouting. Namely, he made sure that every player comparison for somebody he was scouting was cross racial, in order to not fall into the trap of pigeonholing players for their skin color.

In essence, this is the biggest takeaway of the book: how to identity systematic biases and avoid them in order to make optimal decisions. The book examines confirmation bias, regression to the mean, the negative effects of heuristics (rules of thumb), recency bias and much more, while telling various stories on why people fall for these traps.

The subtitle of The Undoing Project is “A Friendship that Changed Our Minds”, and for good reason. The highly influential work would not have happened without Kahneman and Tversky’s unique and unlikely friendship. Interwoven within the examination of systematic biases is a captivating biography about these two army psychologists and their journeys navigating the newly formed Israel in the fifties and sixties. You get the sense that they truly had to start from nothing, which could have helped them think more like entrepreneurs. This open academic field in a new country enabled them to work outside the prevailing views of established Western psychology departments. Over the years of their collaboration, their contrasting personalities brought out the best in each other’s work. Kahneman was the more introspective and doubtful one, and Tversky the outspoken and sometimes overconfident counterpart.

In all, this is an excellent book for anyone who is even tangentially interested in behavioral economics. It tells a fascinating story and it is relevant now more than ever as we see analytical revolutions in a wide range of industries. For readers who have found Kahneman’s Thinking Fast and Slow (which we have reviewed previously) too dense, The Undoing Project is a perfect start to get the broad strokes on what made Kahneman and Tversky’s work revolutionary.

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For some reason, reading Good Economics for Hard Times feels like taking a vacation. One definition of “vacation” is leaving something one has previously occupied. Consider where we have been in the past three decades with our attempts to be informed. The pre-internet news model once delivered packages of stories to everyone based on an accepted formula: novelty, politics, celebrity, controversy and tragedy. With media concentration and specialization, news has given way to opinion (news with extra seasoning). At the same time, with media democratization, expertise has given way to “influence.” Each stage in this changing of the guard has represented a decline in the role of critical analysis. And the latest stage, made-up nonsense calculated to misinform, is the cynical outcome.

Good Economics for Hard Times is a refreshing trip in the opposite direction of this info trend. Banerjee and Duflo, a married couple from MIT who won the Nobel Prize in Economics in 2019, explore difficult subjects in a nuanced fashion. They cover migration, global trade, GDP growth, climate change and displacement of human employees by machines. They also look at wealth taxes and universal basic income. In sum, they write about what were considered the biggest economic issues prior to COVID-19.

As was the case with Duflo’s Nobel acceptance speech, the book begins by acknowledging the low level of trust people have in economists. In fact, according to a UK poll in 2017, economists were the second-least trusted professionals, only ahead of politicians. The authors offer a number of reasons for this lack of trust: economists are social scientists, so strong conclusions are hard to come by. In addition, economists in the media often attempt to forecast growth, which has a spotty record in terms of accuracy.

They counter this negative perception with humility. In their chapter “Make Economics Great Again,” they write that economists should not be compared with engineers. “Economists are more like plumbers; we solve problems with a combination of intuition grounded in science, some guesswork aided by experience, and a bunch of pure trial and error.”

Drs. Banerjee and Duflo use both natural and controlled experiments to inform their views throughout the book. For example, they look at the impact of migrants on the wages local workers in Denmark. From 1994 to 1998, Denmark had a unique policy of settling migrants according to areas in the country that had public housing available and administrative capacity. This created a random sample of areas that received migrants to compare with ones that had not. After 1998, new migrants generally settled where their co-ethnics were already living. Comparing the evolution of wages and employment of natives in cities that received more migration to those that received very little, there was no evidence of negative impacts.

One of the most interesting chapters for investor-readers is titled “The End of Growth.” The authors explore what makes GDP growth elusive in mature economies. They look at the balance between capital and labour in countries; investment in infrastructure; total factor productivity; and the drivers of innovation. They also look at developing economies, to try parse out the growth predictors.

In the end, the discussion is short on easy answers. Theories are presented and their limitations exposed. At the chapter’s close, Banerjee and Duflo warn readers to be wary of “any policy sold in the name of growth, because it is likely to be bogus.” Their chapter title, “The End of Growth” is a play on words, as they advocate for a broader approach to a society’s well-being beyond GDP growth. This warning about over-reliance on a single measure is reminiscent of the statistics lesson about a billionaire joining a party. Immediately, everyone at the party becomes, on average, a billionaire. However, the median hardly budges.

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In last month’s review, we discussed Robert Shiller’s timely book, Narrative Economics. In exploring societies’ narratives around spending, saving and investing, Shiller broadens the scope of economics. He incorporates psychology and history into the mix. And he graphs the use of key phrases over time, borrowing from epidemiology. Using case studies and quantitative analysis, he shows how viral narratives peak and decline over short periods, and even mutate and recur decades later.

One of the most apt studies for today’s markets is the chapter on Panic vs. Confidence. Shiller goes back more than a century, examining the stories people told around economic upheaval. In the nineteenth century, newspapers wrote about panics and depressions, but never mentioned consumer confidence. At the time, most working class people spent their entire incomes. They did not send their kids to college or save for retirement. Lifespans were short, and people expected to be cared for by relatives or charities in their old age. As a result, bank failures were widely viewed as problems of the wealthy.

The Panic of 1907 marked the start of the “confidence” narrative, where people assumed that slow economic activity wasn’t just about a particular financial crisis; it was also a general pessimism and unwillingness to hire. During that year, the New York Stock Exchange fell nearly 50% from its previous peak over a three-week period. Runs on banks were spreading. In the absence of a central bank, J.P. Morgan pledged his own money to backstop the banks and persuaded New York bankers to do likewise. Though the financial crises of the period were far from over, Morgan’s bold move likely saved the U.S. from a far more serious depression. This precursor to the Federal Reserve set the stage for the policy responses we are seeing today, more than a century later.

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A review of Narrative economics: How stories go viral & drive major economic events, by Robert Shiller (2019)

If you grew up in the quaint era of stagflation, Black Monday and Reaganomics (like your wealthiest clients did), you may find the current times a bit jarring. Pro-cyclical spending, trade wars and COVID-19 are today’s challenges.

Do you believe the above explanation of today’s challenges? You might connect with the second two:  trade wars and COVID-19. But the first point, pro-cyclical spending (i.e., increased fiscal spending during booms), is a red herring. It is rarely cited in the news, so it is not part of the “economic narrative.” It is, on the other hand, true: U.S. government spending as a percentage of GDP has risen steadily since 2016.

What makes trade wars and COVID-19 part of today’s narrative? They are emotionally salient. They stay in your mind: the U.S. is in a “trade war” with China; China is accused of “stealing” U.S. tech; the Diamond Princess cruise ship, docked in Japan, eventually counted 700 cases among its 3,000 passengers. Trade wars and epidemics also appear frequently in the news. By comparison, pro-cyclical fiscal spending, which sounds an alarm among those who remember introductory macroeconomics, barely elicits a yawn. It makes a poor headline and an awkward political insult: Compare “Crooked Hillary” to “Pro-cyclical Fiscal Spender Trump.” Not even close.

All of this brings us to the subject of Nobel laureate Robert Shiller’s latest book, Narrative Economics. A narrative is defined by the Oxford English Dictionary as “a story or representation used to give an explanatory or justificatory account of a society, period, etc.” Shiller expands on this to include things as wide-ranging as songs, jokes, theories, explanations or plans that have “emotional resonance and that can easily be conveyed in casual conversation.” 

Shiller contends that narratives are absent from economic analysis because they are hard to measure. At the same time, Google has provided a tool that allows some tracking. Google Ngram enables users to chart word frequencies from a large collection (corpus) of books published between 1500 and 2008. So, researchers can graph the appearances of words vs. the total number of words in the corpus over time. In addition, ProQuest News & Newspapers has both current and historical databases of news stories that allow similar tracking.

Shiller has used these tools to demonstrate viral narratives over the past century. He has discovered that a narrative indeed follows the pattern of a virus as it moves through a population, with a peak and eventual decline. Since an idea spreads by human transmission, this is not surprising. In fact, Shiller borrows from epidemiology as he examines narratives. One important insight is that there is more than one type of pattern. Some narratives build slowly and persist for decades, while others burn out quickly.

Also, like viruses, narratives that affect behaviours can recur and mutate over time. The stock market crash of 1929 was so dramatic that it was a “flashbulb” memory for people of the time. They remembered where they were when it happened. Today, it is hard to convince anyone that periodic stock market crashes aren’t inevitable. During the Great Depression, the crash of 1929 was viewed in moral terms: “a dividing line between the self-centered, self-deceiving 1920s and the intellectually and morally superior, albeit depressed, 1930s.” In another example of recurrence, the notion that a stock market crash is a kind of divine punishment remains with us today.

Shiller highlights one particular crash story that appears in various forms: the shoeshine boy narrative of the late 1920s. An important executive decides to sell stocks at the peak in 1929 after a shoeshine boy offers him stock tips. The executive takes this as a signal that the market is ready for a sell-off. There is no evidence of this story in the ProQuest database, though it was told in full by financier Bernard Baruch in his 1957 memoirs. Much later, it was re-told in Business Insider in 2017. These versions connect the story to a celebrity, Joseph Kennedy Sr. (JFK’s father). Kennedy not only got out of the market, he aggressively shorted it – “and got filthy rich.”

Vivid stories like these shape people’s impressions of markets and, even today, people search for “market top” stories that foretell the next crash. The odd thing about the Kennedy story is that it is a repeat of a 1915 article in the Minneapolis Morning Tribune, which stated, “we do not hear of the chamber maids and bootblacks who have cleaned up fortunes by lucky plays in the street. These romances typically mark the approach of the culmination of the advance.” The reason the 1915 version did not go viral is that it didn’t have a rich description or a connection to someone famous.

Similarly, Franklin D. Roosevelt’s famous words of encouragement from his inaugural address – “the only thing we have to fear is fear itself” (1933) – had at least two precedents. Yale professor Irving Fisher wrote, “My only fear is the fear of fear” in 1930, and Thomas Mullen, assistant to Mayor James Curley of Boston, made a similar statement in 1931. However, neither Mullen nor Fisher were celebrities, so Roosevelt went viral as the originator.

Another factor in “nothing to fear” (Roosevelt edition) going viral was patriotism. When FDR was delivering his address at the depth of the Great Depression, he tied optimism and courage to patriotism. The country had to come together and not panic – i.e., not empty out their bank accounts. In an example of recurrence, there are echoes of FDR in U.S. President George W. Bush’s talk to airline workers and the nation following 9-11: “…one of the great goals of this nation’s war is to restore public confidence in the airline industry. It’s to tell the traveling public: Get on board. Do your business around the country.”

Recurrence features in Shiller’s analysis of the Bitcoin phenomenon, which tapped into earlier anarchy narratives. He also explores the recurrence of themes such as anxiety over the replacement of human workers by machines, and “profiteering” by big business. These narratives influence our consumption decisions and economic policy.

Robert Shiller has gained a large following because he borrows from other disciplines to make economics more robust. As he analyzes stories that repeat over time, he reinforces one of the key insights of behavioural economics: remember to look at the way real human beings talk, tell stories and interact. Although these are hard things to quantify, it is important to try.

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Pulitzer Prize-winning historian Doris Kearns Goodwin has taken something she knows a great deal about – writing presidential biographies – and turned it into a unique hybrid: a business-book/presidential biography bestseller. Released in late 2018, Leadership in Turbulent Times draws compelling portraits of Abraham Lincoln, Theodore Roosevelt, Franklin D. Roosevelt and Lyndon B. Johnson. A simple explanation of this sampling is that Kearns Goodwin has already written bestselling biographies of the four presidents. So, if this were music, Leadership might be her “greatest hits” album, with one new track thrown in to satisfy fans.

This explanation, however, would be unfair, as the judicious selection, ordering and interpretation of the various stories makes it a unique work. Furthermore, as the title states, these “turbulent times” through which each president governed, represent four of the most challenging periods to the Republic. In addition, though slightly more than a century separated the first and last of these presidents’ terms, there are inevitable ties between their work.

Kearns Goodwin has organized Leadership in Turbulent Times into three parts. The first covers the upbringing and young adulthood of each man; the second, called “Adversity and Growth,” studies extreme setbacks each leader faced early in his political career; and the third, “The Leader and the Times: How They Led,” examines their time in the White House.

Each of the three parts is essential to the purpose of the book, which is to highlight what makes a leader, and what leadership looks like. “Part 1: Ambition and the Recognition of Leadership” illustrates that leaders are more “made” than born, and that there is no single path. Lincoln’s father thought that school kept his son away from real work, and even burned his books on one occasion. Lincoln had to defy his father to become educated outside of the school system, walking miles to borrow a single book. The two Roosevelts, on the other hand, benefitted from wealthy, connected parents who were committed to enriching their sons’ experiences. And Johnson, whose father, Sam Johnson, had served in the Texas state legislature for eight years, was fascinated with politics from a young age.

The second section, detailing each president’s personal crisis, illustrates the maturity and focus that can come from a setback. Franklin D. Roosevelt, for example, contracted polio at the age of 39, and lost the ability to walk. He withdrew from politics at this time and undertook various treatments, including swimming regularly to increase his arm strength. He also threw himself into helping others cope with this devastating disease. He bought the financially troubled Warm Springs resort in Georgia and transformed it into a rehabilitation centre for polio patients like himself. His personal struggle and his refocus on helping others during this period later proved crucial as he worked to guide the U.S. through the Great Depression as president.

The final section draws lessons from each president’s leadership. For example, in the chapter titled “Transformational Leadership,” we get a front-row seat to the political battles leading up to the Emancipation Proclamation. Lincoln assembled “the most unusual cabinet in American history, representing every faction of the new Republican Party – former Whigs, Free Soilers, and antislavery Democrats, a combination of conservatives, moderates, and radicals, of hard-liners and conciliators.” In other words, if you want to transform something, you don’t need like-minded adherents. Facing such a nation-changing moment, Lincoln chose to work with a team of rivals rather than a collection of yes-men.

There are several reasons to read business books: to learn specific methods that will increase business growth; to gain a deeper understanding of companies, geopolitics or economies, or; to draw inspiration from the success stories of others. Certainly, Leadership in Turbulent Times falls into the last category. Its value is in tying personal stories to leadership development, and in identifying specific leadership behaviours during crises. It also provides greater context for understanding the divisions that continue to shape the U.S.: race (Lincoln), labour vs. management (Teddy Roosevelt and the Coal strike of 1902), haves vs. have-nots (FDR’s New Deal), and race again (Johnson and civil rights).

There’s a lot of bad news in Talking to Strangers. It starts with an unnecessary traffic stop by a Texas police officer that escalated into a confrontation, with fatal consequences for the driver. It rolls through British Prime Minister Chamberlain’s misjudgment of Hitler, Madoff’s deception of investors, a Cuban spy inside U.S. intelligence, the abusive doctor to the U.S. gymnastics team, the suicide of Sylvia Plath and, for good measure, waterboarding. The theme tying these and other stories together is trust: how we default to trusting others, and the complicated business of protecting ourselves from untrustworthy actors.

Author Malcolm Gladwell continues his run as a first-rate storyteller. Even familiar stories have a twist, with social sciences research providing a deeper understanding. For example, for most of us, the Madoff case is well-worn ground. A respected asset manager runs a multi-billion-dollar Ponzi scheme. In spite of warning signals and U.S. Securities and Exchange Commission (SEC) investigations dating back to 1992, Madoff is able to keep the fraud going until 2008. Instead of focusing on the ineptitude of the investigators, Gladwell explores the challenges faced by Harry Markopolos, who tried, unsuccessfully, to warn the authorities. The independent forensic accountant couldn’t understand how Madoff’s returns could be so steady, in spite of being linked to the market. He used mathematical models to prove that the reported results were impossible, and it was probably a Ponzi scheme. He provided his data to the SEC in 2000.

Through a detailed description of Markopolos’s demeanor and actions, Gladwell shows that the very qualities that enable Markopolos to spot a fraud prevent other people from listening to him. He tells awkward jokes. He defaults to not trusting others, which is alienating. Gladwell writes that Markopolos is an example of the Russian folklore archetype: the Holy Fool. “The Holy Fool is a truth-teller because he is an outcast.”

Holy Fools are necessary, because they can see deception that others miss. At the same time, quoting researcher Tim Levine, lies are very rare, so the social advantage of defaulting to trust far outweighs the cost of being constantly suspicious. That is, we can’t all be Holy Fools, or trading systems like the stock market wouldn’t exist.

A favourite Gladwell theme is that things aren’t always what they seem. And Talking to Strangers doesn’t disappoint. Take, for example, “the myth of transparency.” It’s generally accepted that our facial expressions accurately portray our emotions. However, in cross-cultural studies, people commonly disagree on what expressions are supposed to mean. The “fear” expression identified by nearly 100% of Spaniards was only identified as such by about one-third of respondents from a chain of islands east of Papua New Guinea. By extension, we also assume that we can pick up clues about whether people are lying through stereotypical behaviours: not looking someone in the eye, shifting nervously, etc. The problems arise when we trust liars who have mastered the right-seeming behaviours, or wrongly suspect people who don’t conform to the “innocent” stereotypes.

While the case studies in Talking to Strangers are easy reading, the thematic strings take some effort to pull together. At some point, we have to make the leap from individual behaviours to the context in which bad things happen. In a section near the end of the book, Gladwell writes about “coupling,” where bad things have a much higher likelihood of happening in certain contexts (e.g., crime areas are extremely concentrated). Then we move from the individual and context to institutional tactics. How often should police officers pull people over? How should they act? What areas should they focus on? It would be satisfying to come away with a set of easily memorized rules, but perhaps the key insight of Talking to Strangers is that it’s not easy.

Useful info

The Chapter 8 case study, “The Fraternity Party,” is recommended reading for parents about to send their kids to post-secondary school.

Since its release in 2018, Dare to Lead has been at the top, or close to the top of the New York Times business bestseller list. Author Brené Brown has one of the top five most-viewed videos in the history of TED Talks. And yet, the title of her book sounds like nearly every other aspirational, “you-can-do-it” motivational book ever written. What has made this how-to book a phenomenon in management circles?

Dare to Lead is popular in part because it has an unconventional thesis: that success in the workplace starts with vulnerability. To people who work in competitive businesses (i.e., almost everyone), where winning not only counts, but is also much more fun than losing, the idea of showing vulnerability sounds whacky. Fortunately, that’s not what Brown is suggesting. Based on her social sciences research (20 years of interview data, plus new research with 150 global C-level leaders), she points out the following:

  1. People often come to work wearing a sort of emotional “armor,” that protects them from appearing weak or indecisive (i.e., vulnerable).
  2. To protect their own egos, they will often avoid engaging in difficult conversations and giving honest feedback.

Brown’s talent is in describing common business problems in ways that are original and immediate. Consider this passage, explaining why people avoid tough conversations in the workplace: “Some leaders attributed this to a lack of courage, others to a lack of skills, and, shockingly, more than half talked about a cultural norm of ‘nice and polite’ that’s leveraged as an excuse to avoid tough conversations… The consequence is diminishing trust and engagement and an increase in problematic behaviour, including passive-aggressive behaviour, talking behind people’s backs, pervasive back-channel communication (or ‘the meeting after the meeting’), gossip, and the ‘dirty yes’ (when I say yes to your face and then no behind your back).”

“The dirty yes” is a brilliant, memorable description that encapsulates a common work experience. And this pithiness is not limited to observation; it carries over to advice: “Healthy striving is self-focused: How can I improve? Perfectionism is other-focused: What will people think? Perfectionism is a hustle.”

The afternoon lull also affects analytical capabilities, including such diverse tasks as judges’ rulings (more favourable for prisoners first thing in the morning, plummeting as noon approaches) and math tests (student scores drop in the afternoon). At the same time, a bit of fatigue can be positive for “insight” tasks, where stepwise, limiting analysis actually gets in the way.

Throughout Dare to Lead, Brown attempts to outline the steps to working more productively with other people. Most of her descriptions are engaging, such as encouraging readers to “rumble with vulnerability,” meaning “having a real conversation, even if it’s tough.” At times, however, there are some eye-rollers, like, “I’m asking everyone to stay connected and lean into each other during this churn so we can rumble with what’s going on.” Because of the book’s many positives, after reading passages like this, it’s advisable to take five minutes to look at the sky, then keep reading.

A second warning about the book: beware of name-dropping. As a celebrity speaker in her own right, Brown now travels in the same circles as famous people. So, when she gives advice from luminaries like Melinda Gates, or quotes Beyoncé’s “first-person essay in the September 2018 issue of Vogue,” she starts to lose the common touch.

These are minor limitations, however, and the overall quality of the book is what matters. It is a coherent, engaging guide to building trust and engagement. Brown writes a very long section describing specific “daring leadership” behaviours and contrasting equally specific “armored leadership” examples. These passages are worth reading and re-reading. Brown also goes to great lengths to explain what vulnerability is not. For example, it is not oversharing. A leader doesn’t have to confess all their personal difficulties in order to build trust with teams; they just have to be willing to listen and discuss difficult things. The goal for Brown is to promote courageous organizations where people can bring their whole selves to work. For financial advisors, who find themselves fulfilling multiple leadership roles, Dare to Lead seems like a natural fit.

Consider these five cases:

  1. A teenager writes a standardized math test at 9:30 a.m.
  2. A judge denies an inmate bail at his 11:45 a.m. trial.
  3. At 2:00 p.m. the same day, a hospital employee changes a wound dressing without first washing his hands.
  4. At 4:00 p.m., a marketing manager thinks of an “outside the box” solution to a difficult problem.
  5. At 8:00 p.m., a mother decides to set up an RESP on her daughter’s first birthday.

After reading Daniel Pink’s 2018 book When, you might look more closely at the timing of these events, as you consider the biological drivers at play, the motivations and the outcomes. While timing isn’t everything, it is very influential. (At the end of this review, we will look at events 1-5 through a timing lens.)

When starts by dispensing with the idea that people are consistently energetic, good-humoured and productive over the course of a day. In fact, our typical workday is a convenient template stamped onto a predictable, but poorly fitting biological pattern. Real people, as opposed to homo economicus, have demonstrated that positive mood rises in the morning, dips in the afternoon and rises again in the evening. This has been borne out by language analyses of millions of Twitter posts across geographies, languages and religions; it has also been demonstrated in large studies using the Day Reconstruction Method. The pattern of rise, afternoon lull and late-day resurgence applies to reports of warmth towards others, happiness and enjoyment.

Pink describes the financial implications of this inconsistency. Three American universities analyzed more than 26,000 earnings calls from more than 2,100 publicly listed companies over a six-year period. Morning calls were consistently more upbeat than afternoon calls, leading to “temporary stock mispricing for firms hosting earnings calls later in the day.”

The afternoon lull also affects analytical capabilities, including such diverse tasks as judges’ rulings (more favourable for prisoners first thing in the morning, plummeting as noon approaches) and math tests (student scores drop in the afternoon). At the same time, a bit of fatigue can be positive for “insight” tasks, where stepwise, limiting analysis actually gets in the way.

How do we bridge the divide between the world of economic expectations and biologically driven actors? Daniel Pink proposes a compromise: one that includes both hard work and research-supported restorative breaks; and an awareness of timing when making important decisions.

When is a lively read, brought to life by good storytelling and bolstered by extensive notes. The author has also tried to impart practical lessons after exploring the research. Each research-laden section is followed by a “Time hacker’s handbook” that provides tips on putting the insights into practice. For example, after exploring the research about the positive effects of napping, he writes about his successful attempt to incorporate napping into his afternoons. A lifetime non-napper, Daniel Pink experimented on the ideal length and followed the research: under a half-hour is better, timed with his afternoon lull. He drinks a cup of coffee just before his nap (a “nappuccino”). Since caffeine takes time to enter the bloodstream, it doesn’t interfere with his ability to fall asleep. And, when it kicks in by waking time, it helps limit post-nap grogginess.

Reviewing the cases

  1. A teenager writes a standardized math test at 9:30 a.m.
    Teenagers, by some estimates, have a sleep midpoint of around 6:00 or 7:00 a.m., making many of them “owls.” Studies show better academic performance for teenagers when school starts after 8:30 a.m., and analytical tasks generally go better in the morning.
  2. A judge denies an inmate bail at his 11:45 a.m. trial.
    A 2011 study of Israeli judges’ parole rulings found that they ruled in favour of prisoners 65% of the time early in the day. By 11:45 a.m., a prisoner had virtually no chance at all of getting parole.
  3. At 2:00 p.m. the same day, a hospital employee changes a wound dressing without first washing his hands.
    During the afternoon trough, nurses and other caregivers are nearly 10 percent less likely to wash their hands before treating patients.
  4. At 4:00 p.m., a marketing manager thinks of an “outside the box” solution to a difficult problem.
    When you need a flash of inspiration, where the solution isn’t a stepwise, methodical examination, researchers found better performance at subjects’ non-optimal time of day. In other words, people who said they did their best thinking in the morning actually did better at insight tasks between 4:30 and 5:30 p.m.
  5. At 8:00 p.m., a mother decides to set up an RESP on her daughter’s first birthday.
    Temporal landmarks, such as a birthday, anniversary or start of a month, signal people to start things.

This is the second of our special two-part edition :30 Second Reviews with Emerging Markets Portfolio Manager Christine Tan. In July, we discussed the 1943 classic, The Little Prince, by Antoine de Saint-Exupéry. Here, we discuss a 2012 economic bestseller, Why Nations Fail.

Seven years ago, an M.I.T. economist and a University of Chicago political scientist published Why Nations Fail: The origins of power, prosperity, and poverty. Daron Acemoglu and James A. Robinson had an ambitious project: figuring out why some countries achieved solid economic growth and others seemed perennially stuck in neutral. Using numerous current and past examples, and testing various theories, they examined the conditions necessary for innovation, which drives productivity. They determined that innovation happens in places where there are incentives to be innovative, and this is often tied to political institutions. Countries that are “extractive” don’t innovate, since the fruits of innovation are taxed away or benefit only a few. A small, powerful leadership group tends to extract and distribute wealth to their family and personal connections, and are highly motivated to keep doing so. Or, a lack of central authority leads to disorder, and this inhibits investment. On the other hand, in inclusive economies, leaders are periodically voted out of power, so there are limits on self-dealing networks becoming entrenched. Innovators in such countries know that they can have an idea, take out a loan, start a business and make a profit.

Question: Your specialty is emerging markets. One of the exciting things about emerging economies is that institutional reforms can unleash a lot of untapped potential. And moving from low productivity to even middling productivity can be very lucrative for the country and investors. Keeping in mind the “inclusive” versus “extractive” classification of Why Nations Fail, have you seen improvements in emerging markets over the past 10 years, where institutional changes increase productivity?

Christine Tan: In the past, when people looked at countries that achieved economic success, the reasoning was often simple. For example, some believe that in Canada, we have a lot of oil, water and other resources, so that must be why we’ve done well. But Argentina, Venezuela and South Africa have more resources in the ground, and at one point Venezuela was one of the wealthier countries in the world. But today, all these countries are still emerging, and Venezuela is still fighting the cycle of hyperinflation, high interest rates and high debt levels. Contrast that with a little country like Norway, which also has a lot of oil, but with prudent inclusive policies has accrued the world’s largest sovereign wealth fund – at over U.S.$1-trillion, that represents around C$260,000 per citizen.

EM countries with inclusive policies are achieving better and more sustainable growth. One key development in recent years is that the democratic system is working in several EM countries to bring in reform oriented governments. This may be related to the powerful combination of younger demographics and technology. Through technology providing access to information, people have a better understanding of what they want. They see how their peers live in other countries, and they press for those structures. They vote for governments that are willing and able to enact those reforms. For example, if you look within the ASEAN region, the government of Thailand, Philippines and the Indonesia are opening up their economies, improving their education systems and are in the early stages of providing better health care coverage. Similarly, when you look at the corporate sector in those countries, companies are more focused on the incentive structure: employees are promoted, given wage increases and in some cases, getting stock options based on merit – simply put, these governments and companies are implementing inclusive policies.

On the other side of the coin, let’s consider two countries that have slowed. My birth country, Malaysia, was at one time one of the most developed of the ASEAN countries. We have often observed that having the same party in power for a long time can lead to stagnation. Malaysia had the same party for almost 45 years. That means they had slower policy reforms than other countries in the region and as a result, Malaysia has been falling behind. Recently, because of this, the younger generation in Malaysia voted a new party in the recent 2018 election.

South Africa has had the same ruling party since 1994, and there has been both corruption and a lack of reform and progress. In the recent May election, the ANC again won, under a different leader Ramaphosa – and even with this change in leadership, we have seen a change in sentiment. So, that’s how important government is in EM – even the expectation that a leader will make reforms and improve an emerging economy’s ability to tap into its young demographics, can drive investor interest. And the resulting increase in wealth creation can drive that virtuous cyrcle of greater domestic growth.

Q: In India, there has been a definite policy shift to make the economy more inclusive. The national identity program seemed to be following the authors’ advice, since the creation of a biometric identity database, which enabled wide adoption of electronic payments is an important structural improvement to include more of the population in the formal financial system. Can you comment on these types of structural moves in emerging economies? And as a related question, let’s talk about the EM category a bit in light of structural improvements. Canada and the U.S. still have home bias, but are you seeing any change in attitude?

CT: I’ll tackle the second part first. Ten years ago, the discussion was about “why emerging markets?” Today, advisors are asking about particular countries or sectors within emerging markets. Questions are more “Why India?” or “Why technology within EM?” So that is a sign that there is more comfort with EM, and that the conversation has progressed to differentiated positioning.

I’ve also noticed that with greater focus on ESG, advisors are more sensitive to these factors when they choose a manager for their EM exposure. So they are looking at the countries and companies that are following good practices.

One good example is Brazil. It’s a resource-intensive economy, with a lot of oil. And one of its most important companies is Petrobras – also a key employer. When oil prices were reaching peaks in 2008 and other commodities were expensive, Brazil had the capacity to implement very generous social policies. At that time, their pension was set so that a man who has worked for 35 years can retire at any time. So, someone who started work at 20 could retire at 55. And a woman can retire after 30 years of contribution. Today, oil prices are significantly down from the peak, and Brazil still has a lot of its fiscal budget going to pensions. As a result, even though Brazil is a relatively young country, relatively little spending is being allocated to education or health care, which are key “inclusive” policies for future growth. The government has been debating pension reform for two years, but now looks on track for final approval in October. It has been a very painful thing to negotiate, but the message was clear to the government that if they don’t act on this, the government could be bankrupt within a decade. In emerging markets, we have noticed that in Latin America, it often takes a lot more pain to compel change. In the ASEAN countries, the reform process has been more gradual.

Returning to your first question. Over the last 5 years, India had implemented tremendous reform that has created serious dislocation in the economy, and still, the government won a second significant majority in May 2019. Modi’s first majority, in 2014, was India’s first in over 30 years. Now with a stronger majority, with a bigger turnout of the electorate, that is positive. It’s not just that the change is happening; it is happening through democracy.

Q: Speaking of India and structural reform, India’s national biometric-based identity program has been linked to electronic payments. So there has been greater likelihood that benefit payments actually reach intended recipients.

CT: Exactly. It leads to a more inclusive economy, and more efficient distribution of government spending. Technology can provide information, but it can also enable governments to achieve meaningful reforms. And it can lead to leapfrogging of development. For example, in continental Africa, M-Pesa, a mobile payment system, was created by a telecom company – Vodafone, in 2007 – for the two largest mobile companies in Kenya and Tanzania. Mobile payments is really upending the concept of the financial company, because here we think of banks as financial companies. But, where the banking systems don’t have the same reach, the telecom system has that reach.

India’s biometric ID – Aadhaar, is the most extensive biometric program in the world – 1.1 billion people are registered. And one of the drivers of this change is that a portion of the population, for example among the elderly in rural areas, might not be literate. So now this does not limit their ability to access the financial system, they can just use their biometrics.

Q: Why Nations Fail co-author Dr. Daron Acemoglu contends that China is still an extractive economy, and that its growth will eventually top out, since innovation happens when new winners are able to emerge in economies. What is your view?

CT: Time will tell. Although China has a socialist republic structure with one party, the government has been successful in generating strong economic growth while improving the lives of its people because of its focus on inclusive policies. China publishes 5-year economic and policy plans, in part to inform, but also to involve its people. More importantly, these plans have evolved as the economy grew. The initial phase was focused on urbanization and infrastructure. Within that phase, there was a strong focus on affordable housing, access to schools and road/rail transportation.

Now that China has built out its infrastructure, the current phase is focused on shifting to value-added manufacturing and supporting growth of knowledge-based industries such as robotics, environmental protection and artificial intelligence. As these sectors grow, higher quality and higher wage jobs are naturally resulting in higher consumption, hence shifting the economy away from fixed asset investments to consumption, similar to developed economies such as the U.S. and Canada. An improving legal system, which includes more property rights and intellectual property rights, combined with the ability to finance at reasonable interest rates have also translated significant wealth creation within a generation for many Chinese. Today, reflecting this evolution, several of the world’s largest financial, technology and consumer companies are domiciled in China.

In this two-part edition, we have Emerging Markets Portfolio Manager Christine Tan with us to discuss two very different bestsellers: The Little Prince and Why Nations Fail. We will start this month with the former, and post our Q&A about Why Nations Fail in September.

Antoine de Saint-Exupéry’s The Little Prince was first published in 1943, in French. According to the New York Times, the 84-page novella has been translated into 250 languages and dialects, and sells approximately 2 million copies a year. It has a little prince, of course, and the very small planet he lives on. The setting is the Sahara, where a pilot (perhaps a version of the real-life pilot, Saint-Exupéry himself) has crashed his plane, and where he meets the traveling prince.

Question: This is an unusual book. When it was first released, people didn’t know what to make of it, and then its sales took off. Why do you think people find it important? Why did you choose this book for discussion?

Christine Tan: My English teacher (my all-time favourite high school teacher) gave me this book when she retired. She simply told me that it’s a book I should read from time to time over the years. And I have. Surprisingly, The Little Prince is very relevant to me as a portfolio manager, because one of its messages is to not make assumptions. Whether I’m meeting a CEO or assessing a new country, like investing in Vietnam – now that it’s becoming an emerging market as opposed to a frontier market – it’s important to approach it with a curious mind, and not let my previous assumptions bias me to quick conclusions.

The simple example in the book is that, as a child, the author draws a picture of a boa constrictor swallowing an elephant. And, in his child’s mind, that’s what his drawing represented. But, when he shows it to adults, they all tell him that it looks like a hat. That is a message I try to keep in mind. The more great companies you meet, the more you form an idea of what the key success factors are and what you should be looking for. While the knowledge gained from analyzing strong companies is valuable, it’s also important to be open and curious. By trying to prevent myself from jumping to conclusions too quickly, I will ask myself, for example, is there something different about the dairy industry in Vietnam compared to the dairy industry in Canada?

In that light, the book is using the observations of a child – the prince – to look critically at how adults behave and think. The child is outside of the day-to-day adult world, so he asks a lot of “why” questions. The prince visits six different, tiny planets and meets six different characters – adults, as he calls them. But each adult is a caricature of a different trait. There is an arrogant king who has no subjects, but he still believes he rules everything he sees. Most of the things he says are issued as orders. Another character is the businessman who is always busy counting the stars so that he can own them. These caricatures remind me to be aware of certain “adult” personality traits that, taken to the extreme, could become flaws. For example, am I really are too busy for my hobbies or to see friends, or am I behaving like the businessman, constantly counting stars that never change.

Another unique aspect of The Little Prince is that although the prince is a child, he goes through a lot of introspection – thinking about his relationship with the rose, and his home planet. So I find it’s a book that can be read at many ages. For example, I read it to my young godson and he loves the simple story of the little child prince who travels to various tiny planets. And he isn’t even aware of the life-and-death ending of the story. For me, each time I’ve re-read this simple book over the years, a different aspect impacts me….and it is a timely reminder to never stop being curious.

1. Behavioural economics: Cognitive ease as a force for good

The description of cognitive ease comes early in Daniel Kahneman’s book, Thinking, Fast and Slow. It refers to the fact that we like it when our assessments are made easier. For example, a sentence printed in a clear font is easier to understand than one in an ornate font. A side effect is that, other things being equal, we are more likely to believe a sentence in a clear font.

If you were to put together a chain of connections, it might look like the following:

Clear font – easier to read – more relaxed – more receptive – more likely to believe.

Here are a few more factors associated with cognitive ease:

Simpler writing – easier to understand

Primed idea* – familiar feeling

Repeated experience – familiar feeling

Good mood – feels good

*Priming refers to the unconscious effect of the context in which something is presented. Here is an experiment described in Thinking, Fast and Slow that illustrates its surprising influence: Young adults were asked to write a paragraph using words associated with old age (e.g., “Florida, wrinkle”). After the exercise, they were asked to perform another task in a room down the hall. Compared to matched participants who hadn’t had the “old age” priming, they walked significantly slower to the next exercise. “Old” words made them act older. Interestingly, using money as a primer tends to encourage selfish behaviour.

Why cognitive ease is a key concept

Kahneman uses cognitive ease to show how System 1 – our uncontrolled, effortless, associative, unconscious judgments – can be influenced by certain techniques. Recall that Kahneman’s key observation is that System 1 has mixed results in terms of accuracy, but it is powerful. In fact, it often overshadows our more analytical System 2 work, because the latter takes significant effort. Sometimes, System 2 gets co-opted into devising complex explanations to back up our initial System 1 snap judgments. Refer to every political discussion in the last 2,000 years as evidence.

Cognitive ease as a force for good

Consider this statement, which few advisors would disagree with:

“I want my Clients to do things that increase their chances of reaching their financial goals, such as

  1. Being aware of their timelines;
  2. Saving early, consistently and enough;
  3. Living within their means; and
  4. Taking a holistic view of family finances.”

If there is a Client-success behaviour you are hoping to encourage, how might you use repetition, simplicity and clarity to get there?

2. Behavioural economics: Buying, selling and the endowment effect

The CBOE Volatility Index had two spikes above 36 in 2018, one in February and one in late December –roughly double the long-term average. Canadian investors had positive flows into money market funds, a departure from previous years.

Money market fund flows in Canada, 2018: $2.44 billion1

Average annual money market fund flows, 2015-2017: -$381 million2

We have a sense that loss aversion is important in many areas of life, especially investing. This is the tendency to overweight losses, psychologically. As documented by Nobel laureate Daniel Kahneman in his 2011 bestseller, Thinking, Fast and Slow, in experiments, subjects experienced around twice as much emotional pain from loss as they experienced joy from an equivalent gain.

Here are some questions that tie to loss aversion, which are more thought-starters than prescriptions:
  • How might loss aversion affect investor behaviour during and after periods of market volatility, and what is the role of the advisor?
  • Is loss aversion necessarily a negative thing?
  • Are there investment strategies that seek to minimize the sting of loss aversion but leave room for potential growth? What is the role of guaranteed products? Asset class diversification? Low-volatility strategies?
  • How might Clients react to a service they had previously enjoyed being removed?

Fellow Nobel laureate Richard Thaler related loss aversion to the endowment effect, where people often “demand much more to give up an object than they would be willing to pay to acquire it.3” The basic interpretation of the endowment effect is that once we own something, we have a hard time parting with it. In Thinking, Fast and Slow, Kahneman points out cases where the endowment effect isn’t universal. For example, compare these two situations:

  • A professor purchased several bottles of wine for $10 that had risen in value to $100. She was unwilling to sell one of her bottles for $100, yet she would not consider buying more bottles for herself for $100.
  • A shoe store owner had no problem selling his last pair of a popular line of shoes.

The difference between the two situations is that the professor owned goods that were held for use, while the shopkeeper had goods that were held for exchange. This is an important difference, and has implications in various transactional settings. Here are some thought-starters related to the endowment effect:

  • The same financial holdings can be seen differently, depending on the person’s vantage point. For example, an employee participating in ABCD Company’s share purchase plan may be reluctant to sell any of their company shares, even though diversifying proceeds into other investments may improve their risk-adjusted returns. A second investor who has experience buying and selling shares also holds ABCD. They have no qualms about selling. Is it possible to reframe the first situation so the share purchase plan member thinks like a trader?
  • A house owner recently purchased a condominium. Their house is up for sale but they “can’t sell” because offers are coming in below the house’s peak value of a year ago. How is the endowment effect making it difficult to sell, even though they need the money?

When interviewed, Kahneman is humble about the success rate in applying behavioural research insights to produce actual behavioural change. There have been wins, but they often come from building guardrails around predictable errors rather than eliminating them through logic or willpower. Advisors who go back to Kahneman’s bestseller today will be in a better position to understand Clients’ varied, human responses to financial situations.

1 Strategic Insights, Investor Economics, January 2019, p. 19.

2 Ibid.

3 Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias by Daniel Kahneman, Jack L. Knetsch, Richard H. Thaler The Journal of Economic Perspectives, 5(1), pp. 193-206, Winter 1991.

3. Behavioural economics: Interesting, but what do you do with it?

Behavioural economics has inspired several good books over the past two decades, and people keep buying them. Thinking, Fast and Slow, Blink, Predictably Irrational, Nudge, The Undoing Project, The Power of Habit, Freakonomics and Outliers are all bestsellers. So, the secret is out: research shows that we often stray from the model of homo economicus, which assumes we make rational assessments to maximize utility. The question is, what are we doing with that knowledge?

System 1 and System 2

The old saying, “You can’t judge a book by its cover,” needs a postscript: “But you will anyway.”

Psychologist and Nobel laureate Daniel Kahneman, author of Thinking, Fast and Slow, spent five decades studying the way we interpret events and make decisions. His conclusion: people can be trained to make more thoughtful decisions but, ultimately, we are biased to making quick, intuitive judgments. Our more reflective processes, in many cases, align to support these judgments.

Through measurements of brain activity, researchers have evidence of fundamentally different processes at work, which Kahneman calls System 1 and System 2. System 1 is uncontrolled, effortless, associative, unconscious and skilled. It comes into play when we respond automatically to a photo of an angry person’s face. Similarly, tasks that have been practiced over and over can become a System 1 response. System 2, by contrast, is controlled, effortful, deductive and slow. It goes to work when people are asked, “What is 17 times 14?”

System 1 responses are powerful. From an evolutionary perspective, this makes sense. Snap judgments help us keep out of harm’s way and they conserve energy. Unfortunately, System 1 responses are also error-prone. This combination, of making errors but being powerful, means we have cognitive biases.

One of the most common patterns is that we substitute an easy question for a hard one. When asked what we think of a politician, we substitute the question “Does he look like a leader?” System 1 comes up with a quick answer: “He’s too young/old!” System 2 would entail time-consuming analysis to provide a more accurate answer: “What are his policies? How do they compare to the other candidate’s?” Since System 2 consumes energy, System 1 substitution takes place, and then System 2’s supporting points are brought in after the fact.

Practical tidbit: Have you ever walked out of a client meeting and thought, “Wow, we didn’t even get to (name the important issue)!” The “halo effect” in meetings is one example of System 1 taking over: issues that are introduced first and most forcefully tend to dominate the entire proceedings. One way to lessen this effect is to have meeting participants write down their ideas before anyone speaks.

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