Penetrating Insights On Why The Market Feels Like A Colonoscopy

Tyler Durden's picture

Amid the best start of the year for the S&P 500 since 1987, Nic Colas of ConvergEx offers some deep thoughts on how behavioral finance concepts can help us understand the dichotomy between last year's derisking and this year's rerisking in terms of market participant psychology. Between delving into whether a short-sharp or long-slow colonoscopy is 'preferable' Nic reflects (antithetically) on 10 bullish perspectives for the current rally and how the human mind (which still makes up maybe 50% of cross-asset class trading if less in stocks) processes discomfort in very different ways. Critically, while it sounds counter-intuitive to him (and us), focusing on the pain of recent volatility is actually more conducive to investors' ability to get back on the horse especially when the acute pain is ended so abruptly (intervention).

Nicholas Colas, ConvergEx. Hurts So Good


The best start to the year for the S&P 500 since 1987 makes the pain of last year’s volatility feel just a bit more distant.  But at the same time it sparks the question: just how much pain do individuals even remember?  Fortunately, there is a growing body of psychological work on the topic, with some illuminating lessons.  Long bouts of pain that end with little discomfort are far preferable to short sharp shocks.  That sounds a lot like a Greek sovereign debt default – long anticipated and likely soon upon us.  And hopefully well enough firewalled to prevent collateral damage. 


Or consider that subjects who actually focus on a painful experience while it is happening are more willing to immediately undergo further pain than those who performed some distracting task.   Which might go part of the way to explaining the market’s ability to bounce back from gut wrenching – and closely examined - volatility.  None of this assures a positive outcome for the rest of the year, to be sure.  But it does explain why investors can plow right back into a market that has been so tough for so long.

I enjoy assessing the capital markets through the lens of behavioral finance, but I have learned from reading scores of academic studies that you do not want to be a subject in any experiment related to the discipline.  Ever.  Here’s just two examples:

In a widely quoted experiment by Nobel Prize winner Daniel Kahneman (with others, published in 2003) over 600 subjects undergoing colonoscopies were given different versions of the same procedure.  One set got essentially a short version, where the pain of the process peaked out near the end of the exam.  The other group got a longer version, with the last few moments in relatively little discomfort.  The second group reported much less pain when asked about the experience than the first.


In another experiment, researchers from the Leeds University Business School (Read and Loewenstein, published in 1999) took groups of subjects and paid them to place their hands in very cold water with the intent of inflicting moderate but prolonged pain.  One set of subjects were given a distracting task, while the other group was told to focus on the discomfort of the moment.  Immediately after the process, the group that had nothing to distract them was actually more willing to undergo the whole thing all over again.  But a week later, the distracted group was the more amenable to repeating the experiment.

There are other works in the corpus of literature on the psychology of pain, but these two suffice to show that the human mind processes discomfort in unpredictable ways.  The first shows that how experiences end is far more relevant to the memory of it than the pain involved at the time, even if the overall time spent in discomfort is greater.  The second shows (according to the researchers, anyway) that the mind actually needs to focus on pain in order to get over it quickly.  The ancient Buddhist advice about living in the moment turns out to be true even when the moment is painful.

I thought of these experiments in pain as I watched the U.S. equity tape yesterday, marveling at what has become the strongest opening gambit for a January since 1987.  Not that there’s any shortage of bear arguments (more on that in a minute), but because it was actually easy to sketch out a healthy list of near term positives for U.S. stocks.  In about 4 minutes I jotted this “Top 10” list:


1)      U.S. financial stocks have bounced back nicely from year-end tax loss selling, making it look (for the moment, at least) like investor confidence has returned to this beleaguered sector.


2)      After a flush of excess enthusiasm for Q4 2011 earnings in the middle of last year, analysts have reduced their expectations enough for companies to meet them as we go through earnings season.


3)      A lack of deadly European headlines, such as a failed auction or +8% Italian bond rates.


4)      No hard landing headlines from China.


5)      A Euro that seems to be standing on all four feet, even if genus and species of the animal are as yet undetermined.


6)      Reasonable valuations for U.S. stocks, at least against the much-mentioned $100/share for S&P 500 earnings.  And frankly even if they are $80/share.


7)      A gaggle of decent news from the U.S. labor markets and consumer confidence.


8)      Oil prices that have not materially lifted above $100 despite a hot civil war in Syria and a ruthless cold war, replete with unabashed assassinations, between U.S./Israel and Iran.


9)      The expectations for inbound money flows into U.S. equity mutual funds in January from new tax year 401(k) contributions.


10)   A rally that actually started in early October, did a pretty textbook reverse head-and-shoulders in November and December, and broke out about a week ago.


But what about the pain of the last three years, and the very clear prospect for more pain ahead?  It would be just as easy, after all, to sketch out the Top 10 reasons (or 20, or 30) about why this rally is doomed to failure.  And while I don’t want to anthropomorphize equity markets entirely – most estimates of daily volumes have carbon-based life forms responsible for less than 50% of daily activity – the pain studies I noted above can help put the S&P 500’s rally into context.  Two thoughts:

Kahneman’s colonoscopy is a tailor made, if coarse, analogy to the ongoing sovereign debt woes in Europe.  Both are unpleasant, and both have gone on for a long time.  But recall that how painful interludes end is critical to how patients, or investors, recall their experience.  If Greece’s seemingly inevitable default in March (and potentially subsequent ones elsewhere) can move smoothly, then the end of this particular chapter may resemble the procedure that Kahneman’s subjects found less painful.

While it still sounds counterintuitive to me, focusing on the pain of recent volatility is actually more conducive to investors’ ability to get back on the proverbial investment horse.  Granted, the money flows out of mutual funds last year shows that this phenomenon, if it is happening, is not centered on the retail investor.  But asset allocators such as those that manage pension funds are just as human, and it is likely this camp that is pushing money into equities the last few months.  And there is good reason for them to do so, with assumed rates of return for such funds still +7% and U.S. Treasuries yielding only 2%.

The bottom line is that pain, like beauty, is in the eye of the beholder.  And the way that eye views a painful experience is a critical variable in how its associated memory records it.  The markets have been to hell and back in the past 3 years.  But if (and a big “If” it is) policymakers and politicians can create some better outcomes in the coming months, then investors’ memories may not only focus on the pain but actually shift more permanently to the positive.


We agree that behavioral finance does indeed have plenty to teach market participants but our earlier discussion of the ever-slowing volumes in equity trading make us wonder if we are merely culling the universe of participants to the highest pain-threshold-capable (read TBTF funded) or shortest-time-frame-capable (HFT obviously) with the rest of the US investing public is in the middle having their net worth whittled away by the swings.

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ucsbcanuck's picture

Probably the best real indicator of how the markets will behave, as they are driven by human beings, well somewhat...

stocktivity's picture

More and more trading is done by program trading in milli-seconds. Colonoscopy my ass....oops.

vast-dom's picture

This market is like one big painful procedure that seems to have no end in sight. Utterly insane! 

JPM Hater001's picture

When I get my first colonoskopy I want it to this painless.  Just pretend it isnt there.

Of course it is and I wont sit comfortably for a month...

jeff montanye's picture

continuing with the metaphor, check out

if the totality of hedge fund investors had bought t bills they would have done twice as well (or is it four times if one adjusts for survivor bias?).

HungrySeagull's picture

Versed, Demerol and one other item will put you out as they ram a meters long tube up your heinie.

10 minutes that's all.

Oh, the day before you get to drink one or two gallons of solution and sit on the throne.


And there are 4 Nurses named, Hilda, Bertha, Wilma and Butch ready to arrange you and your back into a backwards V.

That is where it will hurt you for 6 months. The back right in the middle where they planted your head in the bed and your bum to sky.


Oh, one more thing.


Before the first drug is introduced into your system, you are made to understand that you may wake up post surgery in ICU if you do have cancer in your system. With a bag to shit into attached to your tummy.

Stack Trace's picture

WTF... Futures are red.

I am calling the POTUS requesting this be fixed.

Oh regional Indian's picture

Penetrating, Colonoscopy..... we got that Tylers. ;-)

Early morning read here in India. Market Psychology, it's almost as bad as economics, no?

There is a herd mentality, then there is a heard mentality, then there is the individual with-in the herd mentality, then there is the momentum and (high risk) and Holders (no risk) mentality....

All that in a test space of extreme volality, extreme manipulation, lies, deceit....

What des this psycho-logy try to capture?

Tok tok and NUMBers, they are not our friend in this environment.





BlackholeDivestment's picture



... well now I am reminded of one of the roots to the forbidden fruit, that'd be: Bush Dick and .... wait for it                                                                                                                      






Seasmoke's picture

Will not be long until you are told that you will have to wear a bag


And the Bernanke has done more than his fair share of anal probing. 

The Big Ching-aso's picture



Culonoscopy, hell.    This is like a rectal roto-rooter operated by Freddie Kruger on benzedrine.

ghostfaceinvestah's picture

psychobabble.  The ECB has exploded their balance sheet, and people wonder why stocks are up?

bob_dabolina's picture

This was a good article about that

However, the lab part chart was only for men not factoring in women. The follow on post I thought was a bit better

I found this on twitter when I was looking up inflation related articles trying to gauge inflation sentiment.

Stack Trace's picture

Thanks! Great article. Actually matches what I am seeing in the real world instead of the pretty green graphs on my monitors.

rosiescenario's picture

"If there was an increase in shipping goods, the price of shipping said good would go up."  This taken from the first article again goes to show that the Baltic Index is misunderstood by many.....if there is an increase of shipping space available that exceeds the increase in the goods to be shipped, then shipping rates decline as does the Index....


The BDI is a function of supply and demand....when many ships ordered back when things were better come on line, the rates go down as the owners hustle to fill the vessels.

bob_dabolina's picture

/fuckin dup

I hate it when that shit happens

Cabreado's picture

"But if (and a big “If” it is) policymakers and politicians can create some better outcomes in the coming months, then investors’ memories may not only focus on the pain but actually shift more permanently to the positive."

This is the antithesis of the thinking that the world needs.

"Yuck" comes to mind.

MsCreant's picture

Imagine when someone inherits Bernanke's job. Each Fed chairman probably has notes that only other Fed chairmen get to see (unless one breaks the chain and does not hand the notes down...). My point, the psychology research on market movements that would be contained in such a thing would be incredible. They know stuff like this, and more. This is the kind of conspiracy theory I am not uncomfortable to put out there at all. Why would you not hand on accumulated knowledge and experience? 

Hephasteus's picture

You mean like how each president gets access to what each previous president really did and for what reasons.

Which is why they can not ever give up the white house. If the white house were to be breached and made public It would literally rewrite history.

bob_dabolina's picture

Like a secret diary?

Dear Diary,

We had a liquidity issue with BAC one day. I called Warren Buffet, turns out he was taking a bath. We worked out some details and got him this great deal that basically could only make money, only he had to put some up to start. We worked it out.

Ben Bernanke

Stack Trace's picture

Do you mean conspiracies like not seeing the housing bubble?

EnglishMajor's picture

No, more like the minutes from Dick Cheney's Energy Task Force meetings...

Hephasteus's picture

You mean stuff like nixon tapes.

Can we bomb the damn and drown them? How many of them could we kill doing that 2 million?

Why don't we use nukes? Let's just nuke them.

We gotta think big.

That's talking about vietnam.

UP Forester's picture

"Up Poopy-Periscope!"


"Banker polyp 2 meters ahead!  Prep gerbil, set to chew!"

jomama's picture

i've never had a colonoscopy, so, um...

Manthong's picture

It's not so bad unless you start to come to before they pull it out.

I know.. and you can't even imagine..

but this market is worse.


MsCreant's picture

Ow, stop shoving that up me so fast please, oooowww, no really, please slow down, owwwwwwwwww, why can't you slow down? I don't say this hurts lightly, I expected some discomfort but, OOOOOOOWWWWWWWW, I'll kill you, you fucker...

Something like that.

Stack Trace's picture

Snorted coffee out the nose reading this. Ouch!

StychoKiller's picture

The worst part for me was drinking that nasty purgative (as much of a whole US gallon as you can stand!).  I was out of it the entire time of the actual test.

MsCreant's picture

I was throwing up really bad from that stuff, or so we thought. I drove to the test any way, doc said screw it lets get it done. Some one had to drive me home I was so messed up. Found my husband on the floor throwing up. Turns out we had both caught a bad 24 hour bug and didn't know it. Thought I was reacting to that, yes, nasty drink.

Good times...

Fastback's picture

May not only be Pain but, the average Americans ability to focus or concentrate is no longer than the length of their morning toilet dump.

Stack Trace's picture

I would rather the Tylers educated us on something like Endogeneity Bias. I have been studying Selection Bias and still can't get my head fully around this in a practical application if there is one for how a trader might go about selecting criteria for evaluating sovereign debt and default probabilities.

 This all started when I started to wonder: Does a country that is well governed have a lower likely-hood of defaulting on debt or is it because a country is perceived to be less likely to default on its debts that it is perceived as well governed?

bob_dabolina's picture

All governments eventually default, as all countries rely on debt to carry on services, and with all debts being the obligations managed by immoral men (politicians) the end result always end's up the same. 

...on a long enough timeline...

The U.S has defaulted several times in it's history, though in a more polite sense of the meaning. 

Stack Trace's picture

I agree with you for shizzle. Just having some wonky fun learning economics in my spare time. Not that I find any of it terribly "useful" but it sure is beginning to warp my perception of what I dubiously accept as reality. I start analyzing variables wondering if I am dealing with all knowns, some knowns, or no knowns. Where is Rumsfeld?

Spastica Rex's picture

You're on today, Bob. +++



Cult_of_Reason's picture

Past painful experiences are irrelevant when human greed (over-stimulated emotional and irrational primitive part of the brain -- amygdala) inhibits rational/logical frontal cortex outputs.

There is nothing more stimulative to the retail amygdales (emotional part of the brain believed to be responsible for human greed) than higher stock prices and green on the screen.

When a specialist or MM or a fund manager/broker needs to unload/reduce the supply sitting on his/her books, he/she spikes up and marks up a stock price first, or buys a large block of calls, or calls media buddy to start a rumor (in order to get retail investors excited – to stimulate their irrational primitive amygdales) then unloads the stock supply into retail buying euphoria /scared shorts covering frenzy (fear or "fight-or-flight response" also originates from an emotional primitive part of the brain).

onlooker's picture



Don’t get a Colonoscopy or high cholesterol meds or deal with gangster stock brokers. I have been stock free for 20 years. PM heavy and none of the above nonsense. My mom made 92, my dad 85 and me 72 without this.

Stack Trace's picture

Are you saying holding heavy metals is good for your longevity? ;-)

Cult_of_Reason's picture

Simply because you got lucky so far, do not give a stupid advice to others.

The evidence is indisputable, annual colonoscopies after 50 y.o. (or even 40 if you are a high risk with positive colon cancer family history) save lives (early stages of colon cancer can be cured -- examples, Herman Cain and Ronald Reagan).

MsCreant's picture

I had no idea those two were irradiated. Cain could still grow back. Ron not so much.

Caviar Emptor's picture

This is the market. This is the market on Biflation. Any questions? 

Biflation: the real victim is you and me. The real economy. But the cronies will live to party another day. That's the object. Living standards crumble as the buying power of currency declines. 

Stocks are pricing in inflation. Today they were talking about another $1 Trillion for the IMF alone. And other bazookas being re-loaded too (and a fresh record US debt ceiling breach). Bonds are prcing in deflation. Today we got a negative read for PPI, the BDI has plunged to near record lows, China's GDP is in 2009 territory, and Europe is going into recession. With $100+ WTI too. 

So no easy ride for any one or any one asset class ahead. Only serial colonoscopies


disabledvet's picture

the "cronies" AREN'T living. That's the problem. Forget colonoscopy...more like the enema used to "clear out the system." There's no way to unclog the "debt plug" that's backing up Wall Street's financial pipes. Think of it this way: post securitization Wall Street is now nothing more than cesspool of paper. Normal "mother nature" would simply allow the pool to naturally drain. Unfortunately when winter comes the ground freezes and "the lake of shit" get's turned upside down (hard part on top, warm and liquid on the bottom). Now the financial system starts to back up. the financial..."flusher"...doesn't work. cause the "shit finance" to back up into the bank the created the...what did Carl Levin call it?..."shitty" paper. Needless to say..."you're gonna need more than Joe the Plumber" on this one. Indeed the best that can be hoped is that..."nature takes her course" and the economy starts growing so that NEW loans can be made...and..."that's a good thing" in the sense that..."this time these loans are money good."

gwar5's picture

Real Lab Experiment..... Subjects told you are testing to see how long they can stand the "isolation". Who lasts longer, group #1 or #2?


Group #1: Authoritative looking PhD figures in white lab coats put subjects in plain room, with cot, and then lock the door. Inside room is a red "Panic Button"

Group #2: Same PhDs, but dressed casually, put subjects into same room, with cot, but door is not locked and there is no panic button. Subject is told to just come on out when done.


Group #2: Lasted a lot longer.

Group #1: Authoritative PhDs, locked door, and panic button created more anxiety. Investors are just hitting the panic button to GTFO, too. 




Goldilocks's picture

Caddyshack - Chevy Chase
"See your future, be your future. May, make--make it. Make your future Danny..." (0:13 audio)