“Baseball is 90% mental, the other half is physical.” Yogi Berra
I love that quote primarily because it so comfortably morphs into an analog saying about investing: it is 90% hard-nosed analysis, and the other half is intuition. The difference to baseball, of course, is that there is no sporting ability required. It’s 100% mental.
The “Placebo effect” shows how powerful the brain can be. Even if you are aware of the basics – that a sugar pill can be as effective as actual medicine in some cases – you may not know just how much the placebo is a challenge to modern medicine. For example:
- This is a long-standing problem. The makers of Prozac, which launched in the 1980s, had to run 5 different trials versus a placebo to get 2 positive results. The makers of Paxil and Zoloft required even more. While these drugs have clearly helped millions of people, the trial process also showed how complex depression is to treat.
- US drug trials are actually showing increasing rates of placebo effect where Asian and European trials are not. One research paper published in 2015 hypothesized that this due both to longer trials (which tend to amplify the placebo effect) and the presence of direct-to-consumer advertising (not allowed in most countries, and may inspire public confidence in the pharma industry).
- There’s not a lot of academic work on the placebo effect, but Harvard’s medical school has done some promising research. Their key finding thus far: genetic differences between patients may play a role in a placebo’s “efficacy”.
One thing most researchers agree on: the process of being in a trial may well explain the largest part of the placebo effect. Patients here get plenty of attention and see health care practitioners very regularly. They often go through batteries of unusual tests and keep diaries of any side effects, which the trial staff actually read and follow up on. All this attention - the thought that real medical professionals are deeply interested in their health - is what makes the placebo such a powerful “Drug” in the mind of those who take one in a trial setting.
You can guess where this is going: what are some examples of the Placebo Effect in capital markets? A few thoughts:
- A “Fed Put” – the common market belief that the US central bank cares deeply about asset prices and will lower interest rates quickly in the event of a major market dislocation. Now, the Fed clearly does this, but it is far from proven that it lowers market volatility or reduces drawdowns. Witness 2007-2008. But like a placebo, advocates of the Fed Put take comfort in their belief that the Fed, like a drug trial MD, is paying attention them.
- A “Fed mistake”. We’ll label this one a “Poison placebo” – something markets think is deleterious but has no historically proven ability to harm. Backers of this concern state that recessions/bear markets always come when the central bank raises rates too quickly and cite 1991, 2000 and 2007 as examples. They never seem to mention the Iraqi invasion of Kuwait/Gulf War I, the terror attacks of 9-11/Gulf War II or the Financial Crisis as the real root causes of recession in these cases, which seems a glaring oversight.
- A “Trump Trade Put”. We’ve written about this one a few times recently: the idea that President Trump cares a lot about US stock prices and will pull back on the tariff issue if it starts to hurt equity values. While we find this assumption intuitively appealing we also recognize it as “Placebo thinking”; that attention from powerful people is the same thing as therapeutically proven medicine.
Summing up: clearly, human nature is wired to believe in placebos. That much is clear. But just as a placebo cannot fix a broken leg or cure brain cancer, that belief is a systematic flaw in investor psychology as well.