“Dow futures soar as Britons decide whether to remain or leave” was a pretty typical financial headline the day of the EU referendum as markets convinced themselves the UK would choose the first option. And “It’s official – Brexit’s ‘Black Friday’ sell-off was the worst ever at $2 trillion” was an equally typical headline a few days later as the financial press came to terms with the opposite result.
Then, just a few more days after that, you could read headlines such as “Why US markets’ rock-star start may have further to go”. As it happens, all three examples of these extremes of emotion are taken from the same media outlet but they were by no means unusual – markets had swung from hope to despair and back to hope in the space of about a week and, each time, the move had been unexpected.
That did not stop the financial press trying to come up with a reason – any reason – why markets were behaving as they were. The reality, of course, is that reason was in fairly short supply in the weeks around the EU referendum but people like to know why something is happening and, as it turns out, even a rubbish reason tends to be seen as better than no reason at all.
Such an observation is not merely based on the headline-writing skills of financial journalists but has some significant academic foundations in a well-regarded experiment that has become known as ‘The Copy Machine Study’. Undertaken at Harvard University by psychologist Ellen Langer, it involved her trying to persuade people to let her use a photocopier ahead of them by asking one of three questions.
The first was simply: “Excuse me, I have five pages. May I use the Xerox machine?” The next offered a reasonable sort of explanation for her cutting in: “Excuse me, I have five pages. May I use the Xerox machine because I am in a rush?” And the last contained a rather more dubious excuse: “Excuse me, I have five pages. May I use the Xerox machine because I have to make copies?”
In the first instance, 60% of people allowed Langer to cut in, compared with 94% who acceded to the second version of her request. The really remarkable aspect of the whole study, however, was that, even though the third version of Langer’s request was essentially nonsense, 93% of people still allowed her to use the photocopier ahead of them.
The US psychologist Robert Cialdini mentions Langer’s study in his book Influence: Science and Practice, which we last came across in Under the influence. “When people ask us for a favour, we are more likely to comply if they give us a reason – even if we don’t understand the reason or it is wrong,” he writes.
“Often it isn’t the reason itself that is important, but the way the reason is phrased. Sometimes the word ‘because’, without a sensible reason, is all that matters. We want explanations and the word ‘because’ implies an explanation.” Cialdini sums up this human weakness, saying: “Our need for making sense makes us even believe in nonsense.”
In articles such as Tale of woe and The peacock’s tale, we have argued that people’s fondness for stories can lead them to make poor investment decisions and the same goes for the human desire to find reasons – even when none exists. The sort of unemotional appraisal of risk and reward that lies at the heart of value investing gives investors a much better chance of adding meaning to their portfolios.