England fans are strange

Note: I think this post is going to cost me some readers or at least will create some visceral reactions. Feel free to hit me with your best insults if you like. I can take it.

I have to admit, as a German, I do not understand English football fans. Or English sports fans in general for that matter. Every time the FIFA World Cup or the UEFA European Championships come along, the English pretend that their team is one of the favourites to win the title. Nobody else in the entire world thinks that England has anything more than a slightly above-average team, but England fans are convinced they are going to win it this time – only to be devastated when their team crashes out of the tournament in the group stages or at the latest in the quarter-finals. 

And don’t get me started about the last World Cup in 2018 where England reached the semi-finals. They managed to get to the semi-finals by beating the football power houses of Tunisia and Panama in the group stage (while losing against Belgium) and then Colombia and Sweden in the knockout stages. Even Germany managed to beat Sweden at the last World Cup, even though Germany had its worst tournament ever. Heck, England lost its semi-final against Croatia!

As I write this, the Rugby World Cup is on in Japan and tomorrow the team is playing against Australia in the quarter-finals. Everywhere I go, England fans pretend that their team is one of the favourites to win the title at the Rugby World Cup this year. I am no expert on rugby, but I suspect, there might be some optimism involved here that may not be 100% justified.

As a German, my approach to supporting my team is far more cautious. At every World Cup we expect our team to crash and burn and at best make it into the quarter-finals. And then they win the bloody thing. And again. And again. And again. In total four times by now. And how many does England have? But I digress…

The advantage of my approach is that I am far less disappointed when Germany actually does crash and burn as they did in the last World Cup. It is a form of emotional hedging or diversification. By mentally betting on Germany to lose, I dampen my disappointment when Germany actually does lose and increase my pleasure when Germany wins, because I didn’t really expect that to happen (see also my argument why pessimists have it better).

But now I have come across a study by Lajos Kossuth and his colleagues that shows that England fans are incredibly reluctant to bet against their own team. What they did was to give people the chance to bet for or against England during the World Cup 2018. They then asked people to rate their happiness before and after the match. The chart below shows that if they bet on England and England won, they were, of course, happy, but only mildly happier than before the match. If on the other hand, they bet on England and England lost, their happiness dropped significantly. Compare this to my strategy of betting against the team I support. England fans who bet against their team still were slightly happier than before if England won, but if England lost, their happiness did not decline. Instead, their winnings compensated for the emotional loss and they remained happier after the game than before the game no matter the outcome. In other words, betting against your favourite team makes you happier.

Betting on England and happiness

Source: Kossuth et al. (2019)

Yet, only 15% of participants in the experiment were willing to bet against England in the group stages while 40% wanted to bet for England. In the knock-out stages it was even more extreme. 18% of participants were willing to bet against England but 59% bet for England to win. Presumably, it gets harder and harder to win the longer a tournament lasts, but in the case of England fans they were more and more willing to bet for their team than against it. So much for the ability of football fans to think rationally.

In essence, what we observe here is a form of home bias. Just like investors are prone to invest too much in companies of their home country, so they invest too much in their favourite sports teams. The result of home bias is a portfolio that often suffers more losses than a well-diversified portfolio and in the case of fandom it is a life that becomes an emotional rollercoaster.

But England fans can rest assured that they are not alone in their inability to make sensible decisions with their passions and emotions. A study by Carey Morewedge and her colleagues asked fans of the Pittsburgh Steelers football team in the NFL if they would be willing to bet for the Steelers or rather the Philadelphia Eagles in an upcoming match between the two teams. The chart below shows that Steelers fans were far more likely to bet on their team rather than the Eagles, no matter what odds they were given.

Propensity of Steelers fans to bet for or against their team

Source: Morewedge et al. (2016).

I know there are some pretty avid Eagles fans amongst the readers of my blog so all I can say is that this shows that Steelers fans are stupid. Eagles fans would never be so biased in their decisions.

The bezzle

Note: This post has originally been published in the CFA Institute Enterprising Investor Blog on 12 September.

In his book The Great Crash of 1929, John Kenneth Galbraith writes about the bezzle, the total number of embezzlements that grow in a time of rising markets. He notes that when markets collapse, these schemes all blow up and cause large losses to investors. However, as Galbraith writes, there is a sweet spot when the bezzle has been committed but not yet discovered. Or in his own words:

Weeks, months, or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.)

I think the bezzle of the current bull market aren’t Ponzi schemes and frauds but the notion that risky assets have become practically riskless thanks to central bank policies. 

Ever since central banks have cut interest rates close to zero, investors have been told to stretch for yield and take on more risk in their portfolios. First, there was TINA (There Is No Alternative to stocks) then came the hunt for yield in bonds and the use of low volatility and high dividend stocks as a substitute for bonds. No wonder low volatility stocks have outperformed the global equity market over the last decade.

Performance of MSCI World vs. HFR Low Vol Risk Premium Index

Source: Bloomberg, HFR.

I even heard investment strategists quote Mark Zuckerberg:

The biggest risk is not taking any risk.

One of the stupidest things anyone ever said. The thing with risk is that taking risk is necessary, but taking risks means one can fail if the risk materializes. Thus, there are always risks that are not worth taking because they will eventually lead to catastrophe. That Mark Zuckerberg can get away with saying something this stupid is simply a reflection of survivorship bias. There have been plenty of entrepreneurs who took risks and failed. We just don’t hear from them afterwards.

Over the last decade, investors have felt like they were forced to take on risks. I remember a family office client of mine who asked me to optimise their portfolio. For historical reasons, their portfolio was one third invested in property, one third in a single stock (the company of the founder) and one third in liquid assets. Because the family office was based in Switzerland, it faced negative government bond yields for most government bonds. So, what do you do?

We couldn’t add property or stock market investments to the portfolio because of the highly concentrated positions they already had. In fact, the family office was forced to decide between taking on duration risk, credit risk or foreign exchange risk in fixed income investments or a combination of these factors. It wasn’t a nice situation, but in the end, the family office opted for a combination of credit and duration risk. This has worked out well so far but just because risks don’t materialise, it does not mean that they are not there.

It seems to me that the last couple of years we have been in this blissful state of increased psychic wealth as Galbraith would say. But if we face a recession, some of these risks will come back to bite investors and the bezzle will shrink. Central banks have provided ample liquidity since the financial crisis and as someone said:

Giving liquidity to a banker is like giving a barrel of beer to a drunk. You know exactly what is going to happen, but you don’t know which wall he is going to choose. 

And I think once we come closer to a recession in the US and in Europe, we are going to find out which wall we are going to hit. I have no idea which one it is going to be, but my guess is that credit risks and equity market risks will both come back to haunt us. But my guess is as good as anyone’s.

What we as investors have to do today is take a look at the risks that are buried in our portfolios. As I have said recently, we had a very calm first half of 2019 and this is usually the best time to prepare for a bumpy ride ahead. Now, it seems these volatile times are coming and if you haven’t done it, yet, check your portfolio and make sure you only take risks that you can live with.

If you don’t feel comfortable with some risks in your portfolio reduce them or hedge them. And this is where government bonds – even at negative yields – can be really helpful. Because they do provide a level of safety that is hard to come by in other asset classes. 

If you feel that it makes no sense to hold low yielding government bonds, cash or other safe assets in your portfolio at these yields, then I suggest you read tomorrow’s post on the fourth rule for the Virtuous Investor. In it, I will show you a technique, how you can look at your portfolio in a different way so that you understand why you hold safe assets and what role they play in your portfolio. Hopefully, this will enable you to better manage your risks and achieve your financial goals. Stay tuned…

The Virtuous Investor: Rule 10

Laugh in the face of danger – keep a slogan for your encouragement

This post is part of a series on The Virtuous Investor. For an overview of the series and links to the other parts, click here.

“It shall not profit meanly against all kind of temptation to have some certain sentences prepared and ready, specially those with which thou has felt thy mind to be moved and stirred vehemently.”

Erasmus of Rotterdam

The legendary value investor Ben Graham called the stock market a weighing machine that would take all the information about all the stocks in the world, and then weigh them through the interactions of investors in markets to determine a price for each stock. Unfortunately, stock markets and financial markets in general are not just weighing machines, they are also mood machines. As markets swing from bull to bear market and vice versa, the mood of investors swings in even bigger amplitudes from euphoria to despondency and back again. The chart below shows that often, these mood swings of investors can be more exaggerated than the actual swings in stock markets.

The stock market and mood swings of normal investors

The main problem with the stock market’s ability to impact the mood of investors is that we tend to become optimistic at the wrong point in time, namely after markets have gone up for a while. This is the time when trends have formed and matured, and investors want to jump onto a bandwagon that is already going at full speed. 

Of course, no bull market lasts forever (not even the current one), and prices will eventually start to decline. At first, the decline will look like a correction since the nature of bull markets is that they have many intermittent corrections. Nobody can predict when a correction turns into a fully-fledged bear market. That’s why no investor should ever listen to people who claim they can time the market or predict the next bear market. They can’t. Nobody can. One can only prepare oneself for a bear market – whenever that may happen. 

But most investors are woefully unprepared when a bear market strikes and as a result, they tend to panic – often at a very inopportune moment when prices have declined a lot. As a result of thee mood swings, normal investors tend to buy high and sell low and destroy performance by giving in to their emotions and trying to time the market.

Compare this behaviour to the mood swings of a value investor like Ben Graham or his student Warren Buffett. Value investors always insist on a margin of safety in their investments to ensure that even if their analysis of an asset is wrong or off the mark, they can still make money. Warren Buffett’s mood swings are almost a mirror image of the mood swings of a normal investor in a cycle. Because the margin of safety in investments is highest, when prices are low and low when prices are high, this focus on margin of safety means that value investors like Warren Buffett have a better chance than most investors of buying low and selling high. This does not mean that Warren Buffett tries to time the market. It just means that he only buys when there is significant upside to the price of an asset relative to its fair value.

Warren Buffett’s mood swings

The challenge with becoming a value investor is that it is going against our natural impulses as investors. Very few people have the necessary discipline to stick to a value investment strategy even if it underperforms for years (as it did since the last financial crisis). 

But besides the normal investor and value investor, there is a third class of investor: the investors postulated by finance theory. Traditional finance theory assumes that investors have no mood swings at all and don’t get carried away by the ups and downs of markets. They are, supposedly like Mr. Spock of Star Trek (or Data of Star Trek: The Next Generation if you are part of my generation). They find the ups and downs of market a mere curiosity. And because they are unaffected by the ups and downs of markets, they simply buy an asset and then hold it for as long as possible.

Mr. Spock’s mood swings

Clearly, both Warren Buffett and Mr. Spock are more successful investors than the normal investor. But how can normal people like you and me influence their moods to become more like them?

Erasmus of Rotterdam recommends having a slogan at your disposal that you can recite when you feel exuberant or despondent. I have been using the most famous of these phrases of all time for many years and I have to say, it has helped me to stay invested, when markets declined precipitously and remain cautious when markets rose. It is, of course, the phrase recommended by President Abraham Lincoln in a famous anecdote:

“It is said an Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: ‘And this, too, shall pass away.’ How much it expresses! How chastening in the hour of pride! How consoling in the depths of affliction!”

Abraham Lincoln. Address before the Wisconsin State Agricultural Society, 30 September 1859.

I have nothing to add, except to try it for yourself. If you look at your portfolio performance over the last ten years or so, it is likely to show significant gains. Now tell yourself, “this, too, shall pass away”. What does that trigger in you? Do you want to be more cautious going forward? If so, how can you reduce risks in your portfolio without limiting the ability to benefit from future upside too much?

Similarly, you might have some long-term investments in your portfolio that did not perform well at all and may even have incurred significant losses. Now recount to yourself, “this, too, shall pass away”. Do you still want to sell that asset? If so, why? Is there a fundamental case for the asset never to come back to where it once was? If not, then hang on in there and stay invested.

This little mantra has prevented me from making many an investment mistake in my life and if you constantly recite it to yourself while you look at your investment portfolio, I am pretty sure it can help you as well.

This is not how yield curve inversions work

Over the last couple of weeks, I have seen several bloggers make a fuzz about the fact that the Treasury yield curve is steepening and no longer inverted. The general thrust (either stated explicitly or heavily implied) of these articles is that since the yield curve is no longer inverted, there won’t be a recession.

I am sorry, but that is not how logic works.

It is one of the most common logical fallacies to conclude that the inverse of “If A then B” is “If not A then not B”“If the yield curve inverts, the US economy drops into recession” does not imply “If the yield curve does not invert, the US economy does not drop into recession”

The correct contraposition of “If A then B” is “If not B then not A”“If the yield curve inverts, the US economy drops into recession” implies “If the US economy does not drop into recession, then the yield curve does not invert”. Unfortunately, the last statement doesn’t make for a good story, so you never hear about that.

By the way, if you do not understand why “If A then B” implies “If not B then not A” then you need to brush up on your high school math (at least that’s where I learned that) or simply look up the explanation here. Unfortunately, the inability to do simple logic is widespread in the investment world and one of the reasons why so many pundits can safely be ignored.

Let’s look at past yield curve inversions in the US to see what’s what. The chart below shows the difference between the 10-year and 2-year Treasury yield (10Y2Y) going back to 1976. As I have explained here, the 10Y2Y spread is my preferred measure of yield curve inversions because it has very few if any false positives.

Spread between 10-year and 2-year Treasury yields and US recessions

Source: FRED St. Louis Fed.

The eagle-eyed observer will notice that before almost every recession, the yield curve inverted and then steepened again, sometimes several times before the actual onset of a recession. 

But for those of you like me who suffer from bad eyesight, I have summarised the data in the table below. For every recession since 1976, I have noted down the start date of the recession and the start and end date of the first yield curve inversion before the recession. I only counted yield curve inversions that happened at most two years before the onset of the recession. If a yield curve inversion ended before the onset of a recession, I checked if the yield curve dropped back into inversion before the recession. In order to avoid false counts simply because the yield spread was fluctuating around the zero mark, I only counted yield curve inversions as new inversions if they happened at least one month after the last inversion ended. As you can see, with the exception of the double-dip recession in the early 1980s, every recession of the last thirty years was preceded by yield curve inversions that were interrupted several times. A steepening yield curve and an interrupted inversion is rather the norm before a recession.

Interruptions of yield curve inversions before recessions

And how often did the yield curve invert and no recession followed within two years of the first inversion?


There has not been a single false positive since 1976. If you ask me, I wouldn’t get my hopes up that this time is different, and we don’t get a recession in the US in the next one to two years.

We only have a limited amount of morality

Last Monday, I wrote about my indignation with the campaign to abolish plastic straws. The reason for this indignation is rooted in what researchers call moral licencingCraig Mackenzie and Alan Lewis interviewed investors in the late 1990s about their concerns for the environment and other ethical issues and their investment habits. They found that while many of their interviewees were concerned about the environment, for example, they were unwilling to sacrifice financial return to create a more ethical investment portfolio. In reaction to this ethical dilemma, investors engaged in a core-satellite strategy, where they invested some of their money in ethical or sustainable funds and the rest in conventional funds. The allocation to ethical funds provided the investors with a licence to invest in unethical or conventional funds to achieve other goals. 

Over the last twenty years, many more studies on moral licencing have been done and their findings are pretty unanimous. It seems that we have only a limited reservoir of morality in us and the more we spend it in one area, the less we have available in other areas. Worse, people who behave morally, afterwards feel like they have the right to be act in an unsocial or even mean way to other people. 

Sonya Sachdeva, Rumen Illiev and Douglas Medin asked people to describe themselves in either a positive or a negative way. Afterwards, they were asked to donate to a charity. The people who described themselves in a positive way donated only about a fifth of what the people donated who described themselves in a negative way. The feeling of superiority that was created by an affirmative self-description made the participants less altruistic. 

Even worse, Nina Mazar and Chen-Bo Zhong from the University of Toronto showed that buying organic produce in a grocery store makes people more inclined to lie and cheat. They asked participants in their study to shop for groceries in a simulated store. Half of the participants purchased items in a store with predominantly organic produce while the other half purchased items in a store with predominantly conventional produce. Afterwards the participants were asked to participate in a visual experiment where pictures were shown to them with a random number of dots to the left and right of a dividing line. After they had looked at a series of these pictures, they were asked to report how many of these pictures had more dots on the right. The trick: The participants earned ten times more money when they indicated that there were more dots on the right than when they indicated that there were more dots on the left. On average, 40% of the pictures shown had more dots on the right and those participants who shopped for conventional groceries reported on average 42.5% of the pictures as having more dots on the right. Those who shopped in the organic store, on the other hand, identified 51.6% of the cases as having more dots on the right-hand side. They were lying in order to get more money…

Increased lying after moral behaviour

Source: Mazar and Zhong (2010).

Unfortunately, this moral licencing problem extends to our investment behaviour. A recent study by Ann-Christine Brunen from the University of Cologne followed consumers for a full year and recorded both their consumption and their investment behaviour. She found that moral behaviour, such as buying predominantly organic food, donating to charities or supporting small local businesses reduced their investments in socially responsible and ESG funds and stocks. People who purchased more than 50% of their groceries in organic food markets (i.e. the Whole Foods crowd) were 14% less likely to invest in ESG funds. Again, positive behaviour gave them the moral licence to act unsustainably in other domains. 

This is why I think movements like the ones to ban plastic straws are counterproductive. They deplete our reservoir of moral behaviour for actions that have very little if any meaningful impact on the environment or our society. We should rather focus on what matters most and where we can get the biggest bang for the buck, so to speak.

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