What Donald Trump and Bernie Sanders Can Teach Us About Investing Psychology
Or how to escape individual responsibility by joining a mass movement
April just wrapped up, which means two things: Game of Thrones is back, and I am having a greater than expected number of dinners where friends and relatives defend their newfound support for Bernie or Trump.
The frequency of the latter reminded me of a scene from the former where Lord Varys and Tyrion discuss the nature of power:
Lord Varys: Power is a curious thing, my lord. Are you fond of riddles?
Tyrion: Why? Am I about to hear one?
Lord Varys: Three great men sit in a room: a king, a priest, and a rich man. Between them stands a common sellsword. Each great man bids the sellsword kill the other two. Who lives, who dies?
Tyrion: Depends on the sellsword.
Lord Varys: Does it? He has neither crown, nor gold, nor favor with the gods.
Tyrion: He has a sword, the power of life and death.
Lord Varys: But if it’s swordsmen who rule, why do we pretend kings hold all the power? When Ned Stark lost his head, who was truly responsible? Joffrey? The executioner? Or something else?
Tyrion: I’ve decided I don’t like riddles.
Lord Varys: [pause] Power resides where men believe it resides. It’s a trick. A shadow on the wall.
How, in nine months, did Bernie and Trump move from ostracized pariahs on the edge of absurdity to actual potential presidential candidates dominating 2016’s political zeitgeist? The short answer is that it happened in much the same way Hemingway describes going bankrupt: slowly at first, then suddenly. The long answer is, well, longer. But it might have something to do with belief and mass movements. Or, more specifically, with the gratuitous amount of unbelief required to make belief in a mass movement possible.
To create a mass movement, use the following formula: find a disaffected group of people exhibiting widespread frustration with the present. Galvanize them around a mimetic doctrine that, when accepted unquestioningly, promises sudden and spectacular changes to their conditions in life. Preach a brand of around-the-corner hope. Demonstrate some evidence of your movement’s power (note: it can be totally unrelated to the task at hand — see the affect heuristic). Promote cohesion through ritual and ceremony. Foster and perpetuate a facility for united action and self-sacrifice. Organize your movement in opposition to some enemy (invent one if you have to). Demand blind faith from your followers. Use force on dissenters. Seed suspicion to promote uniformity and quell rebellion. Infuse patience by refocusing your followers on a distant hope — the grand dream and vision. Religionize your doctrine. Suppress the next mass movement.
Oh, and don’t overthink it.
In fact, for men to plunge headlong into an undertaking of vast change, “they must be wholly ignorant of the difficulties involved in their vast undertaking. Experience is a handicap.”
Or so says Eric Hoffer, author of The True Believer, a 1951 philosophical treatise on the nature of mass movements. His book deals mainly with upheavals in Europe in the first half of the 20th century, but if you replaced the words “communist” and “national socialist” with “disenfranchised working class” or “ISIS” then you’d be hard pressed to know the book wasn’t written this decade.
Hoffer’s core insight is that all truly mass movements spring from a collective sense of acute frustration. Not oppression or misery or hopelessness — but intense discontent simmering with rage.
In a recent essay, political commentator Andrew Sullivan outlines some of the reasons for today’s widespread rage. They include:
- Automation and outsourcing of the craftsmanship that used to give meaning to low paying working class jobs
- Degradation of social institutions — like the church or union hall — that used to provide a refuge from the barrenness of individual existence
- Pummeling of blue collar workers through globalization
- Renewed wealth and no consequences for those who helped create the last recession, with the working class facing declining options to make a decent living
- A progressive passion for racial and sexual equality that has created a more diverse mainstream culture and, in turn, alienated the white working class and made their subculture despised
This last point is worth expanding on, as it is the white working class that tends to fill the ranks of Trump’s mass movement. Sullivan writes, “the white working class, having had their morals roundly mocked, their religion deemed primitive, and their economic prospects decimated, now find their very gender and race, indeed the very way they talk about reality, described as a kind of problem for the nation to overcome.” Trump tags this as ever escalating “political correctness.” Though, Sullivan points out, it is perhaps better described as a rigid passion for specific equality rather than the lofty liberal aspiration of abstract equality that we’ve been talking about doing but not actually doing for some time now.
He goes on to describe how the newly energized left has come to demonize the white working class as bigoted, misogynistic, racist and homophobic thereby relegating a group at the bottom of the economic hierarchy to the bottom of the social and cultural hierarchy as well. “A struggling white man in the heartland is now told to “check his privilege” by students at Ivy League colleges,” says Sullivan. Even if everyone agrees that privilege exists, it’s hard not to empathize with this group’s boiling frustration.
Thus we have today the widespread discontent necessary for the emergence of mass movements. What’s surprising, however, is that the ascendance of Trump on the right is paralleled, to a lesser degree, by a rise of Bernie’s demagoguery on the left. Bernie was a nonentity at the start of the democratic primaries. Now it’s him versus Hilary. Hoffer, however, would argue that this shouldn’t surprise us at all: all mass movements are rooted in widespread frustration, draw their adherents from the same types of humanity, appeal to the same types of mind, and are, ultimately, interchangeable. For “when people are ripe for a mass movement, they are usually ripe for any effective movement, and not solely for one with a particular doctrine or program.” Pre-World War II, it was often a toss-up whether a restless youth would join the communists, fascists or socialists.
Bernie and Trump appear to be on total opposite ends of the spectrum. But their followers share a similar frustration with the present and a fury at the status quo. And so, Hoffer’s theory predicts that if/when Bernie drops out of the race, a significant portion of his frustrated supporters will shift over to Trump’s movement. Time, I guess, will tell.
A mass movement seeks to interpose a fact-proof screen between its followers and reality. It does this by creating a doctrine claiming absolute truth, whose validity is derived from authority rather than through experience or observation. It is not meant to provide meaning or be understood, but rather project certitude and be believed in. It encourages the movement’s believers to shut their eyes and ears to “facts that do not deserve to be either seen or heard.” You’d think the doctrine would need to be profound or intelligible. On the contrary, “the effectiveness of a doctrine should not be judged by its profundity, sublimity or the validity of the truths it embodies, but by how thoroughly it insulates the individual from his self and the world as it is.”
The mass movement’s doctrine is a psychological panopticon: a mental imprisonment so total that the follower does not realize he is locked up.
The out-group is incredulous when Trump suggests “Mexico will pay for the wall.” They can scarcely believe the audacity, not to mention the impracticality that borders on delusion. But the in-group cheers ever louder, chants the meme with increasing fervor. For a mass movement provides refuge from individual responsibility by “enfolding and absorbing them into a closely knit and exultant corporate whole.” The price of admission, argues Hoffer, is self-renunciation, a surrendering of some portion of one’s autonomy.
This price may seem egregiously high. Yet, ironically, a mass movement attracts and holds a following precisely because it demands this price. It appeals to the poignantly frustrated “by the refuge it offers from the anxieties, barrenness and meaninglessness of an individual existence.” It draws early adherents precisely because it satisfies a passion for self-renunciation, offers a “sense of liberation from having escaped the burdens, fears and hopelessness of an untenable individual existence.” The more extreme the movement, the greater the assimilation of the individual into a collective body and the harder it becomes to pay attention to the petty objections of “reality.” Smart people trumpet delusional ideology and we shouldn’t be surprised. In the words of 21st century philosopher DJ Khaled, “congrats, you played yourself.”
So we know mass movements harness powerful psychological forces to gain momentum slowly at first, then suddenly. Where else do we see evidence of mass movements gone cray?
Well, one place is in investor psychology.
Howard Marks has this great metaphor for investing psychology being a pendulum, swinging back and forth between optimism and pessimism, greed and fear, risk tolerance and risk aversion. If you asked a statistician where the pendulum is most likely to be, he would say “the middle.” But in reality the pendulum spends little time at this happy medium. Rather, herding behavior and psychological forces drive the pendulum to one extreme, where it inevitably reverses course and moves back toward the midpoint and then is driven to the other extreme. The investing herd, much like the mass movement, eschews the loneliness of autonomy and contrarian thought in favor of in-group warmth and the “wisdom of the crowd.”
Let’s look at a hypothetical-ish example of this in the technology markets:
- A few smart entrepreneurs realize the untapped potential of some trend or technology to transform X market and so they start companies in the space. They say they’ll focus on network growth before monetization.
- Most investors tell said entrepreneurs that the idea will never work, that failure to monetize caused the last bubble, the market is too small, they have seen a similar thing fail before, etc. Still more investors, unable to assess the risk on its own merit, look at their peers passing on the deal and they pass too. Nobody ever got fired for buying IBM.
- A small handful of contrarian (or lucky) investors back the entrepreneurs. The idea works, growth is explosive, the network is defensible, monetization blows away expectations, and everyone gets rich.
- The forces of capitalism do their thing and a bunch of new businesses enter the market to compete away the profits. We see ever narrower variations on a theme. Phrases like “Uber for X” or “Airbnb for Y” proliferate. New buzzwords originate. Companies generalize the lesson of “network growth over monetization” to “momentum over monetization.” User metrics and revenue go up.
- Venture capital floods the segment. The company metrics keep going up. Investor FOMO accelerates. Investors that passed at a $X million valuation six months ago experience frustration and self-doubt as the company now raises money at five times that price from a peer firm. So the investor leans in harder to the next variation of the theme that comes through the door. Prices start going up.
- Entrepreneurs notice it’s easier to raise money when growth of high-level metrics is explosive, and this incentive prioritizes their actions accordingly. Budgets reflect increasingly optimistic revenue or KPI growth and investors adjust prices upward based on these expectations. Deals get done at higher multiples and these higher multiples, in turn, get incorporated in the valuation comparable analysis for the next funding in the category. The good times seem like they will never end. No one pays attention to mundane metrics like profits. The phrase “winner takes all” gets said a lot.
- Prices keep going up. Getting rich in this segment looks easy! Nontraditional capital floods the ecosystem. This is the mass movement in full swing. Prices go still higher. Investors compete ferociously to get into the “best” deals. It’s painful watching their peer firms’ portfolios grow in value on paper. Companies learn to expect easy money in exchange for momentum so they hire quicker and spend marketing dollars faster.
- A butterfly flaps its wings in China and recently IPOed companies miss earnings. However, private investors retain equanimity, sometimes for long periods, rationalizing that private companies will “grow into their valuations” or are subject to different rules than short-term focused public companies. Private and public trading multiples diverge. Non-tech investors express their schadenfreude more vocally. In-group investors dig in their heels and tweet that out-group investors “don’t get it.” There is still an incremental dollar from a random oligarch to fund the deal at a higher price.
- Still more negatives mount. Private companies miss their revenue/user projections. Investors that paid 12x forward revenue multiples end up having paid 20x in hindsight. Company cash burn is higher than expected in the absence of a revenue cushion. The cost of capital starts going up. Many companies trade off higher prices against more egregious security structure (multiple liquidation preferences, senior preferred rights, full ratchets, etc.).
- Eventually the other shoe drops, perhaps the house of cards grows too high, and the mounting concerns can no longer be ignored. The prevailing wisdom of “momentum over profits” is derided as muppetry. Now it’s all about unit economics and profitability (the beginnings of a new mass movement?). Investors tighten their belts and it becomes harder to raise capital. Companies that have gotten ahead of their skis are forced to lay off employees to curtail cash burn, which impacts momentum, which makes it harder to raise additional capital. Down rounds and increasingly egregious securities structure become commonplace. Nontraditional capital withdraws from the sector in search of greener pastures. Multiples come crashing down. Business Insider publishes at least 10 headlines per day bemoaning the death of the sector or the explosion of a supposed bubble. Investors overreact and refuse to back any company that does not have a plausible path to profitability, momentum be damned. Fewer deals get done.
- Prices drop further, pessimism proliferates, new terms are invented for failing companies (Cockroaches? Unicorpses?). The pendulum accelerates toward despair, skepticism, and risk aversion, which causes risk to decrease and prospective returns to rise.
- Savvy investors think things will improve, even as the collective market tumbles to its nadir, and find a big opportunity that is undervalued due to the mass movement’s pessimism.
- The cycle repeats anew.
While not a perfect parallel, the investing herd shares many characteristics with the mass movement. Elements of frustration (FOMO, watching your friends getting rich, etc.) and hope of spectacular change (constant talk of unicorns and newly minted millionaires) are certainly present, as is self-denial when the tides reverse course.
Smart investors through the ages and across asset classes note the impossibility of consistently predicting the future. There are very few things of which we can be sure. Yet Marks’ pendulum and the model of mass movements illustrate the near certainty of cyclicality in investing markets. We can reliably predict that extreme investing behavior will reverse: the pendulum will not move in one direction forever or remain at one extreme forever. The basic reason for this cyclicality is human psychology.
The pendulum-like pattern in most markets is extremely dependable but we never know how far the pendulum will swing in its arc, what will cause the swing to stop and reverse, when this reversal will happen, and how far it will swing in the other direction. So we have two choices: totally ignore the cycles and take a buy-and-hold approach OR try and figure out where we stand in the cycle and what it implies for our actions. I prefer the latter. In the words of Marks, “We may never know where we’re going, but we’d better have a good idea of where we are. That is, even if we can’t predict the timing and extent of cyclical fluctuations, it’s essential that we strive to ascertain where we stand in cyclical terms and act accordingly.”
The mass movement formula and the pendulum metaphor are mental models that can be used to improve decision making and investing outcomes. The pendulum reminds us that human psychology makes markets cyclical so we should stay alert for occasions when a market has reached an extreme. The mass movement formula shows us when a herd is likely to gain unusual momentum. It’s also a tool for self-evaluation — for making sure we have not fallen into line with herd behavior.
So ask yourself: have you recently found yourself repeating impractical economic policy proposals that sound like demented fortune cookie scrolls? Do you defend your opinions by appealing to an authority figure? Are you content to base your beliefs on a doctrine held together as loosely as the plot of Batman vs. Superman? Have you been asked by a man in silk robes to imbibe a nondescript liquid out of a golden chalice? If you answered “yes” to any of the above, then you may be part of a rising mass movement.
Or work in the tech sector :)