This special guest commentary was written by our friend Richard Peterson M.D., MarketPsych
"To achieve their mating goals, male elephants will sometimes play games of chicken, with one individual essentially giving the impression that he is crazy and has become an irrational player in a game premised on shared rationality and predictability."
–Professor David Barash, Op-Ed in the NYTimes, 2011
Happy Chinese New Year 2017, year of the Rooster!
Fittingly, this Year of the Rooster corresponds with a surge in a cock-inspired game in international negotiations: playing chicken.
As a young man I occasionally stood on the bridges across the Rio Grande, practicing Spanish and watching Mexicans commute to work in the United States. They bagged their clothes, paid a peso or two to a man with an inner tube, and were gently pulled across the river under the eye of inert border patrol agents. U.S. customs wasn't apparently concerned enough to intervene.
I myself climbed under the fence or waded the river a few times out of convenience or curiosity. Even the Laredo, Texas INS chief's nanny was well-known to commute to work that way. In subsequent years the border has obviously tightened. And now we're hearing about The Wall, whose conception has badly punished the Mexican Peso and local stocks.
As active investors it is our job to predict trends and reactions in global economies and markets. Donald Trump's spontaneity has introduced a degree of unpredictability to our work. His negotiations around trade agreements, immigration policy, tax policy, military arrangements (NATO), and budgetary allocations are all going to be significant to the markets over the next year. Whether one agrees with Trump's proposals or not, it's important to know how he will pursue them, when he will go full force, and when he might back down.
Trump's tactics are familiar - and perhaps predictable - to students of game theory. Today's newsletter looks at this important topic - one we have addressed previously - the psychology of negotiation and playing chicken. Later we look at a turn in U.S. Dollar sentiment around the U.S. election and its aftermath.
Game Theory in the Real World
John Nash is the subject of the Academy Award-winning movie "A Beautiful Mind" and the father of Game Theory involving multiple equilibria in non-cooperative games - exactly what we need to understand the psychology of playing chicken.
In this past newsletter on the Iranian pursuit of nuclear weapons, we discussed how Professor David P. Barash explained the game theory of young male elephants as akin to playing chicken. When a player in a game is in a weaker position, the only way to get additional power is to fake crazy like an elephant in "musth".
Donald Trump may be in a position of "low power" (from a legal perspective) as he begins to renegotiate U.S. trade agreements. Yet there is a businessman's logic to his negotiation tactics.
Trump's Negotiation Style (or Playing Crazy)
In order to predict the future, we need to understand Trump's style, regardless of whether we agree with his policies.
To quote at length from the op-ed in the New York Times that opened this newsletter:
"It's a tactic that works surprisingly well, because male elephants can in fact become temporarily 'crazy'. One of the most terrifying sights in the animal world is an elephant in a state of must: Huge bulls, oozing a weird, foul-smelling, greenish glop from glands near their eyes, behave with violent abandon, taking risks and defying the basic rules of pachyderm propriety (and also giving rise to the term "rogue elephant"). Facing an elephant in must, other elephants — not to mention people — are well advised to get out of the way."
Dr. Barash explains that by playing chicken - as Donald Trump may be inclined to do as he renegotiates terms of existing trade agreements - low-power players can extract additional concessions due to their hardliner stance. As he puts it, "The trick to winning is for one player to convince the other that under no circumstance will he or she veer off course." Dr. Barash continues, "Another tactic, favored by the strategist Herman Kahn, is to "throw out the steering wheel," to demonstrate that you are locked into a certain path and can't swerve."
When playing chicken it is best to convince your opponent that either:
- You have no alternative course of action and so CANNOT compromise ("my constituents won't let me back down"), or
- You are stone-cold crazy and could care less about the consequences to yourself ("I will take you down with me if that's how it has to be!").
Both of these strategies increase the negotiating power of a lesser player, but they also presume a rational analysis of the situation by that player. Sometimes your opponent truly is crazy, and you will always lose when playing chicken with such an opponent (as will they, but they won't care). If Trumps keeps his competitors guessing what type of crazy he is, then he has already won.
Per Prof. Barash: "In either case, whether you're confronting a rogue elephant or a rogue nuclear state, the advice is the same: stop playing the game. Avoid the elephant or shoot it; politically isolate the rogue state or use military force to disarm it." But Trump won't let his opponents stop playing the game. They are locked in, and in his early negotiations, he has the advantage of unpredictability.
Trump's negotiation style works well when the bottom line of every negotiation is money. (Who cares about pride in business if there is money to be made?) But in international negotiations, national pride can be wounded (Mexico this week and perhaps China later this year). When pride is wounded, national dignity often trumps (-sorry-) economic self-interest.
In terms of sheer political survival, it is rational for a government to appease its own public opinion about being bullied by playing chicken until the collision. Trump himself has staked such a stance in his blocking of free trade agreements such as the Trans-Pacific Partnership (TPP), perhaps to his negotiating advantage.
But the real question remains unanswered - is Trump actually crazy or just playing crazy like an elephant in musth? As a psychiatrist I can't ethically answer that question. From this past week it appears that he will be consistent with his campaign promises. And in that sense there will be less unpredictability than his twitchy Twitter finger would suggest.
U.S. Dollar Sentiment
The election of Donald Trump prefaced surge in positive sentiment about U.S. stocks and the U.S. Dollar. A sentiment view of the U.S. Dollar is below.
Note that the U.S. Dollar has stabilized at a level well-above it's low of the pre-election period, so it's not as if the market doesn't trust Trump. But the original enthusiasm has faded as we settle into the messy business of negotiating and governing.
The month of February may set the sentiment tone for the year as we come to understand whether Trump has a method to his perceived madness, or whether conflict and turmoil will be a baseline state for the next four years.
Houskeeping and Closing
Just as Wall Street climbs a "Wall of Worry," we are at all-time highs in the equity markets. A bit of stress and a shake-up of the system may be just what the U.S. needs. And unless some clear method is discerned in the madness, it's likely that the perception of madness IS the preferred method of the next four years under Trump.
As Trump himself noted in his 1987 book, “The Art of the Deal,” and paraphrased from the WSJ his style is to “aim very high,” and then to keep “pushing and pushing to get what I’m after.” “Sometimes I settle for less than I sought,” he continued, “but in most cases I still end up with what I want.”
And always remember: Playing crazy isn't the same as being crazy. In fact, it can be quite the opposite if it gets you what you want.
We love to chat with our readers about their experience with psychology in the markets. Please send us feedback on what you'd like to hear more about in this area. Read more about individual psychology in our books "Inside the Investor's Brain" (Wiley, 2007) and "MarketPsych" (Wiley, 2010). Market psychology and sentiment-driven market patterns are examined in our newest book "Trading on Sentiment: The Power of Minds Over Markets" (Wiley, 2016).
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Happy Year of the Rooster!
Richard Peterson M.D. 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.