"Don't trade angry. Seriously. If you're considering an investing decision and you find yourself feeling angry, stop, walk away, and go do something less destructive, like headbutt your bathroom wall or drop a cast iron skillet on your foot."
The popular TV show "Billions" follows the conflict between powerful U.S. attorney Chuck Rhoades and hedge fund manager Bobby Axelrod. Chuck's wife Wendy Rhoades is a psychiatrist and the performance coach for Axelrod's hedge fund, Axe Capital. In the premiere of season 3, Axelrod's professional and personal lives are threatened by rage-fueled misjudgments. During a coaching session, Rhoades performs an exercise to help him transform his anger.
Axelrod (A) notes that the seeds of his anger were planted when he - a poor kid - was bullied by rich kids:
- A: "That rage grew in me. Worked like jet fuel for years." ...
- R: "It was useful."
- A: "Yeah it was, got me here."
- R: "We can agree your rage worked for a time. I think your brain, instincts, market feel, all that had more to do with it. But for the moment let's agree that the rage worked for a time. But let's look for a moment when it was the wrong tool, and it cost you more than it made you. And about how when you allow your anger to make you blind to consequences it shuts off those more crucial skills." [my bold]
As Dr. Rhoades alluded, anger distorts judgment. Anger is a unique emotion in that it increases both risk aversion and confidence. Irate investors are less willing to invest in a socially scorned company, they feel more certain that their decision to avoid them is sound, and they hold on to these risk averse feelings even after the company has taken action to remedy the situation. As the Buddha noted, "We are not punished for our anger. We are punished by our anger." Sometimes the anger is projected onto a target, like a company, and we miss opportunities due to our anger-distorted judgment.
In today's newsletter we demonstrate powerful evidence that the stocks of companies described with anger in the media outperform their peers substantially over the following year. When a company runs afoul of the social consensus - BP due to the Gulf of Mexico oil spill, Facebook due to privacy concerns, VW due to falsifying pollution tests - investors have an opportunity.
THE ANGER ADVANTAGE
The media demonstrates a frequently shifting spotlight of moral outrage. The phenomenon was captured in this Slate article detailing the daily social and media outrage explosions of 2014. Such social scorn often lands on publicly traded companies, hitting their stock prices. Because of the cognitive distortions associated with anger, causing investors to become risk averse, these media pile-ons provide a historically consistent and significant opportunity.
The below equity curve is one of our new quant results from our new Thomson Reuters MarketPsych Indices version 3.0 data set in the talented hands of our Head of Research CJ Liu and Alice Fu.
The equity curve was derived using the following analysis. Each year the top 100 stocks by media buzz in the U.S. are ranked by their average past year sentiment. The quintile (20 stocks) with the highest average media anger are bought and held for one year. The process is repeated each month with 1/12 of the portfolio. The model assumes no transaction costs. Blue line is the equity curve representing the growth of $1 (23x return since 1999). Dotted green line is the S&P 500 stock index performance (2.2x return since 1999). Media anger is high for companies that pollute (e.g. BP), that lie (e.g. VW), have invasive products (e.g. Facebook), incompetent management (e.g. Valeant), or other causes.
The year-by-year statistics are below. You can see the sizable improvement in the portfolio Sharpe ratio (bottom row, right) derived when the market undervalues companies people are angry at:
This anger-outperformance result is true globally, in companies based in every nation we've analyzed (except one). A few examples below:
And in other regions as well.
But it doesn't work well in Brazil - not sure why. I'll let cultural psychologists figure that one out.
I'm typically asked, what companies are associated with anger right now? Here is a short ranking of the past 360 days average anger for U.S. companies. It's a fairly diverse list, and is a screen shot from our Research website:
"Holding on to anger is like grasping a hot coal with the intent of throwing it at someone else; you are the one who gets burned."
Sometimes anger creates positive social change. For example, on a personal level Bobby Axelrod harnessed it to power the growth of his hedge fund. At a social level, anger drove protests that compelled pension funds to divest from apartheid-era South Africa, creating economic pressure for political change.
Other times anger is destructive. We left Bobby Axelrod contemplating his future - in jail - as a result of anger-fueled insider trading. At a social level, anger may be stoked for political purposes. One example is the manipulation of Americans' frustration and social protests by Russia-linked Facebook accounts before the 2016 U.S. elections.
Whatever the merits (and risks) of anger, it motivates some of what we do, and it drives us to push for social change. And in financial markets, when companies emerge from underneath the angry mob, their stock performance is the better for it.
Given the power of the outrage cycle to capture attention in the age of Facebook (itself facing down investor ire), there seems little risk of the anger price pattern we've identified disappearing in the near future. However, humans have a tendency to learn about and overcome impediments to progress, and we're optimistic that releasing this finding can itself contribute to a more thoughtful - and perhaps less reactive - world.
"People who fly into a rage always have a bad landing."
HOUSEKEEPING AND CLOSING
"Hatred does not cease by hatred, but only by love; this is the eternal rule."
The above research is derived using our Thomson Reuters MarketPsych Indices (TRMI). The TRMI are deployed globally to monitor the human side of financial markets. The TRMI measure and deliver real-time market psychology and macroeconomic trends from thousands of news and social media sites. If you're an academic interested in data for research, please reach out for access. If you represent an institution, please contact us. The commercial Thomson Reuters MarketPsych Indices dataset covers 45 currencies, 62 countries' fixed income products and stock indexes, 12,000+ companies and stocks, 36 commodities, 187 countries, and 150+ cryptocurrencies.
Our sentiment product for 150+ cryptocurrencies has launched (6 weeks early) and is now ready for testing and use.
Richard Peterson and the MarketPsych Team
This is a Hedgeye Guest Contributor piece written by Dr. Richard Peterson. Peterson is CEO of the MarketPsych group of companies where he leads MarketPsych's data and asset management division. He has trained thousands of professionals globally to leverage behavioral insights. He is a board-certified psychiatrist and author of Trading on Sentiment.This piece does not necessarily reflect the opinion of Hedgeye.