Wiser Daily

Human Nature #12: Sensemaking

Posted on September 6, 2016 by David Shahrestani, CFA

In 2003, when Saddam Hussein was captured, Bloomberg News released the following headline:
TREASURIES RISE; HUSSEIN CAPTURE MAY NOT CURB TERRORISM. About 30 minutes later,
they released another: TREASURIES FALL; HUSSEIN CAPTURE BOOSTS ALLURE OF RISKY
ASSETS.

This contradiction was made famous by Nassim Taleb in his book The Black Swan
(http://amzn.to/2bRejWv). Obviously, two opposite consequences can’t be explained by the same thing
but that doesn’t stop a good story. As such, many similar paradoxical headlines are littered across the
financial news landscape. In The Black Swan, Taleb argues:

The narrative fallacy addresses our limited ability to look at sequences of facts without weaving
an explanation into them, or, equivalently, forcing a logical link, an arrow of relationship upon
them. Explanations bind facts together. They make them all the more easily remembered; they
help them make more sense. Where this propensity can go wrong is when it increases our
impression of understanding

In the left hemisphere of our brains, there is a module called the interpreter
(https://en.wikipedia.org/wiki/Left_brain_interpreter) whose job is to close cause and effect loops. If
we act good, something good will happen. If treasuries rise, something must have caused them to
rise. For the interpreter, luck and randomness are never the answer. This can cause problems.

Narrative bias

The following is a TED talk given by Tyler Cowen on the subject of stories:
 Be suspicious of stories | Tyler Cowen | TEDx…
TEDx…

Cowen argues (through story) that stories are similar to candy – we can’t get enough of them. We are
biologically programmed to respond to and remember a good story. For example, we all remember
that George Washington cut down that cherry tree and couldn’t tell a lie. The fact that it probably
never happened isn’t important.

Stories are everywhere. If you’re republican, you might tell the story of good conservative values
versus evil liberal debauchery. If you’re democrat, you might tell the same story but reversed.
Obviously both stories can’t be true, but that doesn’t stop people.

Conspiracy theories take this idea to the extreme. It’s a lot simpler to apply causation to a bunch of
evil people plotting towards some nefarious goal, than it is to the complex unintended consequences
of human action. The better the story, the more skeptical we should be.

Cowen closes his talk with the following thought:

To think in terms of stories is fundamentally human. We use memory and stories to make sense of
what we’ve done, to give meaning to our lives, to establish connections with other people. None
of this will go away, should go away, or can go away. But again, as an economist, I’m thinking
about life on the margin. The extra decision. Should we think more in terms of stories or less in
terms of stories. When we hear stories, should we be more suspicious? And what types of stories
should we be suspicious of? It’s the stories very often that you like the most.

Hindsight bias

All of us have a natural understanding that the future is uncertain. Maybe the stock market will crash
tomorrow. Maybe a war will break out somewhere in the world. Any number of possible things can
happen tomorrow. But when we look back at yesterday, all we see is certainty. We see the events that
happened and assume that they were the only events that could have happened. We just have to
construct the most plausible explanation that fits. In hindsight, everything seems obvious.
An event could have been completely random and we will still find a reason for it. Once we have
constructed that reason, we tend to ignore any evidence to the contrary. This tendency – to find
patterns where none exist – is ingrained in our nature. If that swaying grass turned out to be a lion,
and our ancestors didn’t run, it would have been game over. Today, we’ve expanded that mechanism
of prediction with undue confidence. The roulette wheel landed on red 5 times in a row, black is
guaranteed. The price of oil keeps dropping, it is due to go up. Pattern X will lead to outcome Y since
it has in the past.

In reality, the uncertainty that exists forward also exists backward. More things can always happen
than will.

As it relates to investing

Investing is about having an accurate view of the world. Thus, the best investors aren’t married to
one way of thinking. Their favorite long position can be a short position at the drop of a hat. When
the facts change, they change.

Being actively open-minded isn’t easy. We tend to fall in love with stories and simple explanations.
To avoid this, it helps to have systematic way of updating our beliefs.

Conclusion

In his book Seeking Wisdom (http://amzn.to/2bRu4Nh), Peter Bevelin explains how:

We refuse to accept the unknown. We don’t like unpredictability and meaninglessness. We

therefor seek explanations for why things happen.

In an HBR interview (https://hbr.org/2011/09/embracing-complexity), Michael Mauboussin put it this

way:

When you see something occur in a complex adaptive system, your mind is going to create a
narrative to explain what happened—even though cause and effect are not comprehensible in that
kind of system. I think that’s the biggest single bias.

Stories and sensemaking allow us to function as humans – they get us up in the morning. However,
when we underestimate the role chance plays in our lives, we are prone to overconfidence and flawed
reasoning.

References:
https://en.wikipedia.org/wiki/Hindsight_bias (https://en.wikipedia.org/wiki/Hindsight_bias)
https://www.bloomberg.com/view/articles/2015-08-24/zen-explains-why-stocks-have-to-rise-and-fall
(https://www.bloomberg.com/view/articles/2015-08-24/zen-explains-why-stocks-have-to-rise-and-
fall)
http://www.bloomberg.com/news/audio/2016-08-12/interview-with-michael-mauboussin-masters-in-
business-audio (http://www.bloomberg.com/news/audio/2016-08-12/interview-with-michael-
mauboussin-masters-in-business-audio)
http://www.bloomberg.com/news/audio/2016-08-04/interview-with-daniel-kahneman-masters-in-
business-audio (http://www.bloomberg.com/news/audio/2016-08-04/interview-with-daniel-
kahneman-masters-in-business-audio)

 
Posted in Human NatureTagged Cognitive biases, Hindsight Bias, Human Nature, Michael Mauboussin,
Narrative Fallacy, Psychology of Misjudgement, Seeking Wisdom, Sensemaking, The Black Swan, Value
Investing

Published by David Shahrestani, CFA

"I have the strength of a bear, that has the strength of TWO bears."
https://www.amazon.com/Navigating-Street-Better-Approach-Investing/dp/1098356403 View all posts
by David Shahrestani, CFA

1 thought on “Human Nature #12: Sensemaking”

1. makingsenseofcomplications September 6, 2016 Reply

Great post! Well considered and absolutely correct from my point of view. While we should trust
what we sense about the world, we should also mistrust it as it is just our minds telling us stuff
from our perspective. Kind regards, MSOC

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