No More Easy Money?

Tyler Durden's picture

By Nick Colas of ConvergEx

(Brick) House Money Investing
Every gambler knows about the “House money effect” – betting more when you are up, since part of your pile of chips comes from winnings rather than initial capital.  Recent global stock market volatility means we are essentially in the middle of a huge behavioral finance experiment: how will investors consider their substantial gains over the past 5 years?  “House money” is an illusion, after all – a trick of the light.  Every dollar of gain or loss has the same value.  After 5+ years of outsized gains, however, will investors sit tight through increased volatility, reasoning that “House money” gives them a buffer to accept lower prices for a while?  Or will they prove truly rational and reduce equity exposure if we see further market churn?  The answer may well lie in the speed and magnitude of any further declines. August may not be the cruelest month, but it may well prove the toughest one of the year for long term investors. 
When I started on Wall Street in the 1980s, the Securities and Exchange Commission frowned upon comparing the stock market to gambling.  As an analyst writing a research report, your compliance supervisors would edit out any allusion - no matter how metaphorical - to “Rolling the dice”, “putting it all on black”, “doubling down” or any other reference to games of chance.  Investing was supposed to be a rational discipline, with positive expected returns over time.  Gambling, where the “House always wins”, was an unwelcomed comparison. 
What a difference a few decades can make to our understanding of capital markets, for now commentators, academics and even central bankers routinely use the language of gambling to interpret investor behavior.  The relatively new study of behavioral finance appreciates that human beings calculate risk and return through the lens of their personal histories and emotional biases. That’s as true at the gaming tables of Monaco or Macau as it is on the corner of Main and Wall Streets. And don’t think for a minute that the rise of quantitative investing has made capital markets more rational or dampened the effect of “Fight or flight” responses to volatility. Humans still write the code, and their DNA – emotions and all – intertwines with the mathematical precision of programmatic trading like one strand of a double helix.
Consider, for example, the concept of “House money”. If you’ve ever had the good fortune to be on the winning side of a few turns with Lady Luck, you know that your decision-making changes as the stack of chips in front of you grows. Wager $100 and win $100, and that second Benjamin feels different from the first. From that point, losing $50 doesn’t feel as bad as if you had lost $50 right off the bat. That makes no rational sense, of course. Both outcomes are negative, and both cost you $50. But the $50 that comes from your winnings is “House money”, and chances are you consider it less seriously than the cash you brought with you to the casino.
The Federal Reserve Bank of Atlanta published a very useful paper on the topic of capital markets and “House money” back in 2003 (see link at the end of this note).  The authors both summarized the concept and ran a simple experiment to show how it related to capital markets pricing.  Here is a brief summary of their paper:

  • The intellectual anchor for much of behavioral finance is something called “Prospect Theory”, an idea first developed be Amos Tversky and Daniel Kahneman. Contrary to classical financial models, they posited that humans do not evaluate gains and losses along the lines to expected returns. Rather, we consider losses as more psychologically painful than gains prove beneficial. 
    An easy example of Prospect Theory: would you rather have a certain $1 million or flip a coin for $5 million/nothing? You should choose the coin toss – the expected value is $2.5 million, well ahead of the $1 million. But the thought of losing out on the sure thing weighs heavily on your mind. What if you lose the toss? How much regret would you experience? So you chose the “Suboptimal” choice, grab the million and feel good about it. 
    Daniel Kahneman won the Nobel Prize for Prospect Theory in 2002. 
  • Prospect Theory opened the floodgates to reconsider other aspects of financial theory. In 1990 researchers Richard Thaler and Eric Johnson published a paper that outlined the “House money effect”. Their work showed that “Prior outcomes influence real monetary decisions”. Initial losses create risk aversion, while prior gains spur individuals to take greater risks.
  • Atlanta Fed researchers Ackert, Charupat, Church and Deaves looked at the effect in the context of price setting in capital markets. They ran experiments where subjects received varying amounts of cash and then bid on fictitious stocks in a market-based game. Sure enough, when the subjects were given more cash up front (the “House’s money”) they bid more aggressively. 

So how much “House money” are market participants playing with at the moment?  The answer, by pretty much any measure, is “A lot”.  We’ve had years of gains in U.S. stocks ever since the March 2009 lows for the S&P 500 of 666. Over the past five years the S&P is up by 95%, the NASDAQ by 120%, and the Russell 2000 by 99%. Until recently, those returns came with little in the way of volatility, meaning that investors did not need much fortitude to earn them. Not only are these returns “House money”, but “easy money” as well. 
With the price action last week, we seem to be entering a new phase for capital markets. The 4% GDP print, hawkish commentary from parts of the Federal Reserve, and worries over equity valuations all conspire to force a general re-think of appropriate equity allocations and sector weightings. Those considerations aren’t going away any time soon, and nor is the continued slow burn of geopolitical concerns from the Ukraine to the Fertile Crescent. Volatility may have well seen the lows for this capital markets/business cycle. The world likely only gets more complex from here – no more easy money, anyway. 
At least one key question is a simple one: “How will investors respond to the recent volatility?” If the concept of “House money” is valid, they may well sit tight for a while. Even after last week’s sell off, after all, the S&P 500 is still up 12.6% over the last year.  The star-crossed Russell 2000 is still 5.3% higher over the same period even though it is 4.1% lower in 2014. The five year numbers are, of course, still pretty fantastic, giving those investors with a long enough memory a lot of psychic “House money” in the memory bank. 
Unfortunately, there isn’t much work out there on exactly how much “House money” gamblers or investors are willing to lose before they know to walk away (or run). Fans of technical analysis know their Fibonacci retracement levels by heart – 24%, 38%, 50%, 62% and 100%. Those are the moves that signal the evaporation of house money confidence as investors sell into a declining market. There isn’t much statistical analysis that any of those percentage moves actually mean anything, but enough traders use these signposts that it makes them a useful construct nonetheless.
The only other guideposts I can think of relate to the magnitude of any near term market decline. One 5% down day is likely more damaging to investor confidence than a drip-drip-drip decline of 5% over a month or two. The old adage “Selling begets selling” feels true enough in markets with a lot of “House money” on the line. After all, you don’t want to have to walk home from the casino after arriving in a new Rolls-Royce. 

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zorba THE GREEK's picture

No more easy money = crash in auto sales

Save_America1st's picture

I picked up 10 troy ounces of easy money yesterday for a steal by trading worthless fiat paper.  Then I picked up 10 more ounces of easy money this morning for even cheaper by trading a little less worthless fiat paper.

The easy money is still available, "Folks". For now. 

Tick-tock, bitchez...

Keep stackin'...

y3maxx's picture

..."What difference does it make?"

USSA is totally screwed.

...PM's wont' buy food or water.

Save_America1st's picture

nobody stacks PM's thinking they will buy food or water with them.  Stackers also stack storable food and water purification devices, medical supplies, hunting, fishing, shooting, camping supplies, etc. etc. etc.  Enough to get by for a very long time. 

People who say stupid shit like, "You can't eat gold." and then scoff at everyone else who stacks PM's sound like total fucking retards. 

But anyone who only stacks PM's while neglecting to stack any other essential necessities will most likely be trading a lot of their phyzz for very little return value in food or water because they were a total dumbass to begin with.


Da Yooper's picture

I never qualified for "easy money "




I reallllllllllllllly Dont



Ness.'s picture

If you’ve ever had the good fortune to be on the winning side of a few turns with Lady Luck, you know that your decision-making changes as the stack of chips in front of you grows.


"Money won is twice as sweet as money earned." ~  Eddie Felson

theonewhowaskazu's picture

Except the moment the market crashes too much the fed will go back to ZIRP. Or maybe not ever leave it in the first place. So BTFD.

eeaton's picture

reminds me of a scene in the movie 29th Street where Danny Aiello's son heard he was up $2,000 in a card game and when he got home the son asked about the winnings and Danny said "I lost $200." The son is incredulous saying "I heard you were up $2,000!!" Danny says "yes I was but I lost it," the son says "so you lost $2,000!" Danny says "no, I lost the $200 I brought to the game," the son goes crazy saying "you lost $2,000!!" Danny says "it wasn't my money I lost, I lost their money." Classic scene.

Keltner Channel Surf's picture

Not sure about how easy it’ll be, but if a strong “Russia invades” headline hits over the next few days, the slide to the downside could be severe in the Russell, as recent action, along with a glance at the charts w/ volume, makes it clear the machines loaded up big time for a play back to the 20, 200 or even 50 DMA, and if their sell stops could be hit, it’ll be cordless bungee time –  splaaaat !

disabledvet's picture

Traders are just like fighter pilots. "Everyone here is gonna lose but me." Under Bernanke these folks got to trade the Fed's balance sheet itself...and obviously the proof in the pudding is in the eating. "Equities have more than doubled while General Electric still sucks wind." That's a healthy market folks!

Frothy? Name ANY bull market that isn't off the charts?

The problem remains the lack of recovery when I hear "the easy money has been made" I say NO WAY. Leaving aside the simple fact that you would have needed balls of steel to ride out Amazon, Netflix or Tesla when they were in their Swan Song phase...risk itself has been risky (blowout in both spreads and yields last year) cut the crap about any of this money being EASY.

STUPID maybe...but NOT easy.

So as a consequence I remain a super bull when it comes to treasuries...ironic because this is suppose to be the "riskless investment" but part of my thesis is that the greatest of all risk is being taken in this arena...and that's probably why no one talks about it but me.

Gold had a solid day today...but let's face it...Ebola, Israel, Ukraine, Fukushima...this is all about Government bizness. "The War" as it were.

That says one thing and one thing only to me...and that's the dollar as reserve currency...not just gold. That's Banks, basis trading and treasuries.

Trillion dollar deficits? Even better.

Inflation ILLUSION is more like it.

Space X just launched another satellite. "They're putting the big players under the gun." ORB is the real deal too though. These folks ain't making microwave ovens but "microwave engines"!

I Write Code's picture

I'm sure that Yellen's plan is one more 150 point move down to the Dow 200ma - or not even one more move.  Then she wants to catch the falling knife and trend it mildy upward again while curtailing QE.  That's her plan for the next six to twelve months, my ouija board insists.

All this Fibonacci numerology is no better than my ouija board, especially with the Fed printing faster than Fibonacci can count.  Will Yellen succeed?  Will the Penguin capture all of Gotham's gold?  Will the governor pay Catwoman's ransom for 400 school girls?  Is the Joker serious this time?  Stay tuned, bat girls and bat guys.

Temerity Trader's picture

Gotta laugh at the number of people I meet that are past their prime working years, yet heavily invested in the equities markets. When I ask them if they are ever worried, most all repeat two major themes, savings gets them 1/4% and the Fed and the government will not let the markets fall, especially with upcoming elections. The powers that be have truly conditioned the lemmings to believe all risk has been removed. Just blindly by into any mutual fund and be handsomely rewarded. No need to do any research, no work, and no risk. When they find out otherwise, there will be hell to pay. People don’t give a s*** about Gaza or Ukraine, but take away the punch bowl and no more “free” SUVs, BMWs and I-Toys and the mood of the masses will turn ugly real fast.

agstacks's picture

When I was 18 I remember going to my first casino. I played a dollar slot and won $200 within 15 minutes. I quit and watched my friends lose all the money they brought. I went home with the $200. I guess you could say I have a low tolarance of risks. (Especially when my odds suck)

TheSecondLaw's picture

What it says is that you're not a gambler. Casinos weren't built for people like you.

As far as I can see the big money - and I mean BIG money -  is made in one of two ways (or combination therefore):

1) Luck (for which you need high risk toelerance to stay in the game)

2) Cheating (insider trading, inheritance, stealing, connected friends, etc)


"Legendary investors" like Buffett are only labled "oracles, etc" thanks to hindsight bias.  Truth is they were lucky, or cheated, usually both.

luckylogger's picture

Good post Tyler !!!!!!!!
Thank you !!!!!!!!!!!!!

luckylogger's picture

Good post Tyler !!!!!!!!
Thank you !!!!!!!!!!!!!

jballz's picture


The only Fib levels are .618 and .382 and 1.618

The rest are tossed in because of fucking morons, bitches.

AdvancingTime's picture

I love the way a market top is always being kicked out a year or two and never going to happen tomorrow. It is as if we can't handle what is coming at us and need more time.

For a long time I have been trying to develop a scenario for a market "super crash" and a reasonable map that would arrive at such a situation. Below is an article looking at how it could happen sooner rather than later.