Two weeks ago, someone sent me a motivational presentation that had reference to Dr Norman Cousins whom I had not heard of before. Apparently, when told by the doctors that he had a serious heart disease, he checked himself into a hotel, armed with vitamin C and comedy films. He laughed his way back to health. He lived up to 75 years of age and served as an adjunct faculty of medical humanities at the University of Californian, Los Angeles. Of course, all these details are available in public domain.
A transcript (www.bobrosenbaum.com/transcripts/nctalks.pdf) of his radio interview in 1983 linking positive emotions and health is available. Most of us are aware of the link between the two, but we hardly appreciate its enormous significance on a day-to-day basis. It is a must-read for our television network anchors and famous hosts for whom fanning panic—whether it is over Pakistan or China or swine flu—is now first nature.
His talk would help us to understand the damage that is being caused by most members of the mass media on the nation’s and society’s psyche. Former president A.P.J. Abdul Kalam used to refer to the importance of boosting the nation’s confidence often in his speeches.
At a philosophical level, most of the anxieties are traced to our attachment to our family, our wealth and ourselves. Of course, it is also due to our belief that we are in control of our destinies all the time. When external threats such as viruses or unforeseen natural calamities strike, this aura is shed and our defencelessness and vulnerability are exposed, leaving us feeling lonely, unarmed and fearful. But at a more mundane level, information bombardment accentuates or mutes the previously mentioned anxieties or self-confidence.
If that is the case, a legitimate question is why there ought to be objection, particularly from Bare Talk, for the power of positive thinking being applied in asset markets and lifting asset prices. After all, positive sentiment can boost asset prices. In turn, it can give confidence to households to boost spending that raises the economic growth rate, corporate earnings and, post-facto, justifies the rise in asset prices. Well, there are many problems with this line of thinking.
One, we have seen this movie before. It did not have a happy ending no matter where it was screened globally. So there is empirical evidence against extending the microlevel logic to the markets. It is due to the innate tendency of human minds to exaggerate both fear and confidence. In other words, human minds have the enormous capacity to convert the power of positive thinking into the bane of wishful thinking. When applied to investing, it meets with calamitous effects, eventually.
Second, just recently, two professors from the Chicago Booth School of Business—Atif Mian and Amir Sufi—published a paper, Household Leverage-Driven Recession of 2007 to 2009. In their summary (www.npr.org/blogs/money/2009/09/lessons_from_the_fall_househol.html) published at NPR.org, they write, “the pattern of boom-bust cycle in household leverage suggests that people borrow for reasons other than their long-term economic well-being. For instance, they may have self-control problems. As credit becomes easier to get, these problems entice them to borrow more heavily, which leads to future regret. The dynamic is even more severe if sophisticated creditors structure financial products to capitalize on their lack of self-control”.
If this were not convincing enough, the rise in correlations in returns across all the risky assets (stocks, commodities, emerging market stocks, bonds and currencies, to name a few) is suggestive of lack of self-control or, more formally, of underpricing of risk. Investors are failing to calculate their returns on a risk-adjusted basis yet again and so soon after the last boom that peaked October 2007.
Let us take the example of the New Zealand dollar (NZD). In New Zealand, the central bank bemoans the strength of the currency almost on a daily basis. New Zealand’s export prices were down 9% in the second quarter. Yet, investors are pushing NZD higher against most currencies relentlessly. Investors point to 2.5% interest rate on the NZD and 3% in Australian dollar. Intraday exchange rate fluctuations could easily wipe out the interest rate advantage enjoyed by the currencies down under.
The third reason is that money is a claim against real assets as asset prices are claims on future earnings. Without those earnings, the asset prices cannot rise indefinitely. Only up to a point can liquidity and sentiment substitute for real fundamental drivers of asset prices. That is why wishful thinking is not the same as positive thinking and that is why when it comes to investing, one has to celebrate the power or the potential of negative thinking for sustainable returns. Dr Atul Gawande reminded us of its usefulness in a different context (see The New York Times, 1 May 2007). When that happens, Bare Talk promises to become more positive on the outlook for financial markets.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com