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Seeds of Thought

Better Decisions, Better Results

Cognitive Science Meets Investment Management

Issue 14-1
October 14, 2014

Pac-Man Cometh
In June, Raboud University in the Netherlands, discovered something
interesting about the human brain as it relates to visual information. It turns
out that we see not just with our eyes, but with the brain as well. In the
image to the right, no triangle exists, but it is implied by the placement of
the 3 Pac-Man shapes relative to each other. Prior to the recent findings, it
was believed that the brain simply filtered the information that came in
through the eyes, but now weve come to realize that it actually interprets
it. That was the big news, but it was the ancillary finding that I think is far
more fascinating, and relevant to our job of interpreting what we see in
It turns out that the group of 3 Pac-Man shapes triggers less brain activity than the one all by itself,
because triangles and circles are far more prevalent in the world than Pac-Man shapes. The single PacMan shape is unexpected and therefore requires more processing by our brain. In other words, if
something is easy to explain, less brain activity is needed to process that information, compared to when
something is unexpected or difficult to account for.
Our brains are efficiency experts (read: lazy), and as a result, we will attempt to create order as quickly
as possible, using whatever shortcuts are readily available. What is odd is that it can easily produce two
simultaneously held beliefs that are in direct opposition to each other. So long as each belief is
confronted separately, the mental stress that comes with cognitive dissonance can be avoided, even for
an entire lifetime.
So why do I bring this up now? The S&P 500 has dropped 7.3% from its highs. Oil is off 27% from its
2014 highs. UK inflation surprised the markets today by printing its lowest level since 09, and
European harmonized inflation hit 0.4%. These three Pac-Man shapes form what appears to be a triangle
of sluggish growth, and confirm the consensus view in favor of a lower EUR and GBP versus the USD.
Or does it?
While todays data does in fact support the call for a more dovish Europe, all of the price action should
also dampen the expectations for a more hawkish Fed. Although the USD rallied after the inflation print,
the ratio of returns on 2y swaps in the US vs EU, one of my favorite indicators for predicting EUR/USD
direction, had a fairly significant move in the other direction over the past week. In fact, US treasuries
across the board have seen a significant lurch lower in yield since the last Fed meeting. What Im getting
at is, just because the three Pac-Man shapes exist and to look at them independently would require more
brain activity, doesnt mean a triangle actually exists.
Copyright 2014 by Bija Advisors LLC.;
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 14-1

In the summer of 2012, I began writing about and positioning for a return to long run equilibrium in
commodities, particularly in ags and energy. The call had absolutely nothing to do with growth rates or
cyclicality, and everything to do with the historic urbanization / industrialization project orchestrated by
the Chinese, having turned the corner. I cant emphasize enough, just how big this is, especially when
you consider how little attention it is garnering and the impact it is having.
I feel a little odd suggesting that the steady decline in commodity prices that weve seen so far (which I
believe will continue) should not be used as evidence of a slowing global economy. Truth is, I do believe
growth in the global economy, including the US, will continue to be sluggish. However, lower
commodity prices should not be seen as evidence of that. Quite the opposite actually. If the economy has
any hope for a real shot in the arm, it will be the sudden availability of disposable income afforded by
lower food and gas prices.
That brings me to Pac-Man #2. Inflation will continue to be limited because its drivers are non-existent.
Lower commodity prices push down, but so to does very poor employment growth, yes even in the US,
which continues to keep wage pressure in check.
How about Pac-Man #3, the equity sell-off? While it may fit the pattern that creates the triangle, I
believe its merely coincidental. The equity rally has, and will continue to be, a function of excess
liquidity sloshing around the system, in the hands of a very few, who refuse to invest it in the real
economy. Heres the caveat: what Ive just described is, fundamentally, a bubble. That doesnt mean its
overvalued. What I do mean is that the investment in equities is not necessarily based on the expectation
of higher growth or greater earnings, but merely serving as a destination for wealth that has no place else
to go. (A similar case could be made for real estate.)
What does it all mean? For those who are hoping for some radical move in markets and a sustained shift
higher in volatility, stop reading. What Im suggesting is that what we have been experiencing for the
past 4 years, will continue for many more to come. Commodities lower, rates low, volatility low (except
for the occasional, limited spike), and equities continuing to ratchet higher. Which of those am I least
confident in? The equity call, because equities arent a true macro asset class. Price action is a function
of herd activity. According to Bloomberg, the current P/E ratio for the S&P 500 is 17.2. Is that high, low
or just right? The reality is, its impossible to answer. If it goes to 12.91 like it was at year end 2011, the
index would be at 1408, or 25% lower than todays close. If it were to trade at a P/E of 26.6, like it did at
the end of 2001, the index would be 55% higher than todays close. Thats a wide range for it to trade
within, without any serious outlier change in macro fundamentals, but so long as that excess liquidity is
sloshing around, I wouldnt bet against equities.

About the Author

For nearly three decades, Stephen Duneier has applied cognitive science to investment and business
management. The result has been 20.3% average annualized returns with near zero correlation to any
major index, the development of a billion dollar hedge fund, the turnaround of numerous institutional
trading businesses and career best returns for experienced portfolio managers who have adopted his
Mr. Duneier teaches Decision Analysis in the College of Engineering at the University of California
Santa Barbara.
Through Bija Advisors' publications and consulting practice, he helps portfolio managers and business
leaders improve performance by applying proven decision-making skills to their own processes.
Copyright 2015 by Bija Advisors LLC.;
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 14-1

As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world
for more than 20 years on topics including global macro economic themes, how cognitive science can
improve performance and the keys to living a more deliberate life. Each is delivered via highly
entertaining stories that inevitably lead to further conversation, and ultimately, better results.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America and
Managing Director of Emerging Markets at AIG International. His artwork has been featured in
international publications and on television programs around the world, and is represented by the world
renowned gallery, Sullivan Goss. He received his master's degree in finance and economics from New
York University's Stern School of Business.
Bija Advisors LLC
Twitter: @BijaSeeds
Podcast RSS: BijaSeeds
LinkedIn: Duneier
Phone: 805.452.9429

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Copyright 2015 by Bija Advisors LLC.;

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document