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Why calamity catches us by surprise.
And what to do about it.
Novice investors often suffer serious losses from economic calamities causing
sudden market reversals that catch them by surprise. Blame the Cassandra
Syndrome and Demon Extrapolation, two very basic psychological mechanisms we all
share to some extent. Learning to overcome these two very common pitfalls is
essential for anyone striving to avoid surprises and become a seasoned,
successful investor. Let me tell you about the Cassandra Syndrome first.
I define the Cassandra Syndrome as the refusal to contemplate bad news about the
future usually accompanied by rejection of the messengers who bring it. Remember
Cassandra? Recall the Iliad, in which Homer tells the story of the
beautiful young princess, Cassandra, to whom Apollo gave the gift of clairvoyant
prophesy and, when she rejected him, cursed with disbelief she could see the
future clearly, but no one would believe her predictions.
Greek myths, as you know, are all about human nature even the gods are human.
The Cassandra myth reveals how it is human nature to refuse to hear bad news
about the future and to reject, disparage and sometimes kill the messengers who
deliver it. Succumbing to the Cassandra Syndrome, we run the risk of ignoring
the most valuable information we can get, to our great regret. See how the
Cassandra myth makes the point.
When Cassandra’s brother Paris returned to Troy with Helen, Cassandra shrieked
with horror and despair, and railed against him because she foresaw Troy would
be attacked and plundered by Greek armies coming to rescue Helen. Cassandra’s
father, King Priam, did not want to believe that Troy’s peace and
prosperity would be shattered by Greek armies. It was much more comfortable to
believe Troy’s longstanding peaceful and prosperous independence would
continue forever, without hostile Greeks at the gate. So Priam locked Cassandra
in a palace room to keep her quiet. It wasn’t long before Troy was surprised
by Greeks pounding at the gate.
After about a decade of fruitless siege, when the Greeks had seemingly given up
and left, nobody believed Cassandra when she warned that the wooden horse the
Greeks left at Troy’s front gate was full of soldiers. No Trojan wanted to
believe the departed Greek armies would come back. It was more pleasant to
envision a future without hostile Greeks surrounding them. However, once again,
Cassandra was right. The Greek soldiers emerged from the horse at night,
surprised the Trojan guards and opened the gates to the returned Greek army,
which then sacked and burned Troy, brutally slaughtering most of its
inhabitants.
After the destruction of Troy, Cassandra was taken captive back to Greece by
king Agamemnon. Once there, Cassandra quickly sized up the situation and warned
Agamemnon that his wife, Clytemnestra, and her lover, Aegisthus, were plotting
to kill them. Agamemnon did not want to believe his wife was unfaithful
or murderous. It was more pleasant to envision a future without wifely deceit,
betrayal, and lethal motives. Agamemnon ignored Cassandra¹s prescient warning,
and so the king and Cassandra were killed, just as she had foreseen.
Imagine Cassandra’s excruciatingly bitter irony: she could clearly see
calamity coming, she could cry out the warning, but no one would believe her.
She was the original vox clamantis in deserto (my college motto, by the
way). As Cassandra cried out in the wilderness, her listeners, yearning for a
happy future, suffered the ultimately fatal consequences of refusing to hear bad
news simply because they did not want to believe it could happen.
Dismissed as a doomsayer, Cassandra was then condemned to
live the horrors she had foreseen, including her own imminent death. It is worth
noting, that each of Cassandra’s pessimistic prophesies provided the most
valuable information her audience could have heeded, and by the same token,
proved to be the most costly advice they would ever ignore.
Which brings us to the lesson of the Cassandra myth. It is one thing
to dismiss gloomy predictions after careful consideration, if they are clearly
flawed. However, if you find yourself dismissing bad news out of hand, because
like the Trojans, you don’t want to believe calamity is coming and
prefer the comfort of imagining a pleasant future, you suffer from the Cassandra
Syndrome. My advice to you is: Snap out of it! Major calamities are not
swayed by our desires; they will happen regardless of our wishes. The only
question is, will you succumb to the Cassandra Syndrome and refuse to
contemplate approaching calamity, and thereby suffer its consequences; or will
you heed cogent warnings of impending calamity and be prepared when it comes?
Seasoned, successful investors learn to examine their response to dire
predictions and resist the tendency to reject them out of hand in a fit of
wishful thinking. Instead they logically weigh the merits of the arguments
presented in support of each plausible calamity scenario, and if they are sound,
respond to them appropriately with profitable investment strategies, as
developments confirming the scenario begin to materialize. Moreover, seasoned
investors do not conclude that because a predicted event hasn’t happened, that
it won’t happen. This is a state of mind astute investors grow into, some by
hard experience, others by sudden insight. Hopefully I can save some of you the
hard experience by offering you the sudden insight.
In addition to the Cassandra Syndrome, most of us suffer from another
psychological mechanism that leaves us vulnerable to surprises: demon
extrapolation -- the human tendency to project our immediate past into the
indefinite future. It is a useful mechanism much of the time, since often the
future does resemble the past. However, demon extrapolation implies the future
will advance indefinitely in a straight line from the past. Yet history tells us
straight lines are rare in economics and finance, and never last.
Demon extrapolation is analogous to driving while looking into the rear view
mirror. Not surprisingly, therefore, demon extrapolation suffers from the
same fatal flaw as driving while looking backwards: you always miss the turns
ahead. There is nothing in the immediate past revealing changes in the
direction of the road ahead, so, if you expect “more of the same”
indefinitely, you invariably miss a turn, crash and burn. . . guaranteed.
Astute investors regard the immediate past only as a point of
departure from which inevitable turns are likely to originate. They study
the curves of the distant past as an indication of how curvy the future
is likely to be. They also notice conditions in the past that have signaled
imminent turns and use these signs as warnings of turns to come. As these
signals of impending turns multiply, seasoned investors re-deploy their assets
so as to prosper from the new conditions likely to prevail after the turn. Consequently,
they do not buy and hold, but rather buy and sell to make money.
So while there will be calamities in our future, the good news is, by
avoiding the Cassandra Syndrome and Demon Extrapolation, you are likely to see
calamity coming and not only avoid suffering adverse consequences from it, but
by monitoring its progress and adroitly redeploying your resources as it
develops, you will profit handsomely when calamity comes. Remember, for every
move, up or down, in any market, there is a profitable course of action. The
trick is in navigating the turns so that you are riding the horse in the
direction it’s going.
When the Chinese write "crisis," they combine the characters for
"danger" and "opportunity." Louis Pasteur, a man
intimately acquainted with the dangers and opportunities arising from crises,
once said "Chance favors the prepared mind." I urge you to learn the
lessons of the Cassandra Syndrome and Demon Extrapolation so that you may
prepare yourself to find the opportunities in the calamities ahead.
This might just be the most valuable information you will ever get, and the most
expensive advice you will ever ignore.
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