Mentalists such as Derren Brown use psychological suggestion to manipulate their subjects. Mr. Brown’s experiments demonstrate that individuals can be compelled to do insane things, such as robbing a bank (watch here) or pushing a stranger off a building. His shows build on the famous 1963 Milgram experiment which conditions its participants to highly disturbing acts, inspiring Peter Gabriel’s song ‘We do what we’re told’ in ‘So’, one of the best rock albums of the 80’s.
Cognitive biases can indeed be readily exploited to create a false reality, as in magic tricks. Take cold reading, or the ability to read people’s mind, for example – a Derren Brown speciality. This talent finds support in the Forer (or Barnum) effect aka ‘The Fallacy of Personal Validation’. As observed by Bertram Forer in a seminal paper in 1949, ’A person who receives superficial diagnostic information, especially when the social situation is prestige-laden, tends to accept such information. He is impressed by the obvious truths and may be oblivious to the discrepancies […] But he does more than this. He also validates the […] diagnostician.’ Since the input from a mentalist offers some aggrandizing angle on a subject’s life, why not embrace it and make it reality? For that same reason, horoscopes are foolproof.
A similar mental trap called ‘confirmation bias’ is also used by mentalist to manipulate individuals’ thinking. This bias can be defined as the natural tendency to seek out information which validates one’s belief. In one experiment called ‘Messiah’, Derren Brown convinces influential figures in fields including psychic powers, new age theories and alien abduction that he has powers deserving their public endorsement. The experts oblige after interviewing him, more than happy to see in Mr. Brown the perfect validation of their singular beliefs.
That same confirmation bias plays an important role in the valuation of equities. In a ‘How value–glamour investors use financial information’ (2014), the authors demonstrate that investors have higher than rationally justified expectations about the future performance of premium stocks. This is due to the fact that they tend to disregard and misprice bad news and fairly price, if not over-react to good news since confirming their positive bias towards the underlying asset. The same is true, but in reverse, for non-premium stocks. These dynamics which work in cycles have contributed to an increasing polarization of the equity market as discussed in ‘Shifting The Goalposts’ in July: The valuation premium of Growth over Value is at an extreme level, which is also true in Industrials.
An analogy with politics is warranted: It is fairly obvious that President Trump’s supporters are immune to his critics, and instead over-react to any news which is favorable to him. The same happens to their opponents, resulting in a schism in politics in the U.S. and in other democratic nations for similar reasons. In this example as in the others, perception ends up significantly diverging from reality, to the extent that facts become irrelevant in a world gliding towards a ‘post truth’ state. As they get more extreme, though, biases get harder and harder to confirm, and factual reality eventually catches on. The recalibration process is brutal, as the participants in Derren Brown’s experiments find out, often requiring some heavy psychological support after the show. Alas, there are reasons to fear that a broad category of investors enamored of Growth and many democracies are on the verge of an Almadòvaresque nervous breakdown.