I picked this off another board - since it addresses what seems to have become the topic de jour lately, I thought it was kind of interesting. I'm posting it here for two reasons - first of all it's quite lengthy and secondly, RB appears to have been attacked by the gremlins again tonight:
THE EMOTIONAL IMPACT OF SHORT SELLERS ON INVESTORS
Richard Geist
In early September Barron's was kind enough to quote my market comment saying that, "From an historical perspective we are approaching the
two worst performing months in the market. Therefore, we suggest that you invest cautiously during the next eight weeks"
With a 10% correction in the S&P 500 already achieved and the likelihood of another interest rate hike looming larger, I'm still advising caution.
But in the midst of these volatile market retreats, there is a little discussed topic than can be important to small cap investors. During these
volatile periods, professional short sellers seem to emerge from their bearish lairs as regularly as ghosts and goblins meander through haunted
houses on Halloween.
These fury pessimists do serve a useful and legitimate purpose. They correct excesses in the stock market and often call attention to some of the
shenanigans that plague our free market system. In fact, specialists could not function without the capacity to short stocks. Shorting is an
emotionally manipulative device-where short sellers not only bet against the success of a company, but through rumor and innuendo, do their
best to discredit management and others associated with a company. It is a process subtly carried out by a small minority of investors with the
conscious intent of influencing stock prices through manipulating our emotions. Internet chat boards are a prime place for such manipulation.
Because the process is thus far largely ignored by all regulatory bodies (e.g. longs are required to file a 13D if they own more than 5% of a
company, but no such requirement exists for shorts), it is important for us all to understand the emotional impact of such actions. For these short
sellers often pick on small companies who have yet to produce significant revenues and earnings. It is up to us to recognize the psychological
forces at work, and this is very difficult to accomplish when we're nervous about a down market.
The Normal Investment Stance
All of our investments are motivated by hope--the hope that our stock selection will provide 1) the means to achieve some of our most cherished
ambitions and ideals, or 2) provide the ability to correct experiences which have been missing or insufficient in our lives. Whether our goals
involve accumulating money, power, self-esteem, independence, or other idiosyncratic phenomena, hope of success underlies all investment
philosophies. At the same time, most of us fear that any stock selection will repeat previous disappointments or traumatic experiences (losses)
from childhood. Each of these two dimensions has unique meaning for every investor, and the understanding of such meaning can illuminate the
psychological factors that determine both our rational and irrational behavior. So in this context, let's take a look at how the shorts wittingly or
unwittingly impact the dread of repeating earlier feelings of vulnerability.
The Creation of Misunderstanding
One of the primary principles that motivates us all is the organizing and ordering of experience--in other words, making meaning out of our
perceptions. Most of us who enjoy investing in development stage companies have done considerable due diligence before committing monies.
It is our understanding of the company's products, services and management that leads to a sense of confidence in the face of risk. It is this
"understanding" which strengthens our sense of self and allows us to remain invested long term in an early stage company. At the same time
there is always a fear that we might be misconstruing or misinterpreting a situation. This is why it is so important for management of development
stage companies to continually make themselves available to investors. For as long as we feel knowledgeable and confident, it is possible to
tolerate a wide variety of emotions as early stage companies attempt to achieve success against major odds. Without this confidence and
understanding, we can't tolerate glitches in the company's progress, and we tend to sell out at just the wrong time.
One of the first ploys of those attempting to manipulate our emotions is to create misunderstanding. For example, reports are published
employing emotionally tinged language with highly pejorative connotations--e.g. "It's been reported that highly questionable relationships exist
with the apparently unknown investment bankers..." Reported by whom? What questionable relationships? Who says they are questionable?
Investment bankers apparently unknown by whom? Why does it matter if they are unknown? These are all reasonable queries in the face of such
a statement. But the herd rarely challenges such distortions. Instead we buy into the demeaning and inflammatory connotations that are
designed to create confusion and misunderstanding in a contextual absence of any accurate facts to support a particular author's pejorative
biases.
When we feel we've misjudged a stock pick, a number of interesting psychological phenomena take place. The containment of strong emotion
becomes impossible (thus the normal self doubt characterizing such investments is no longer tolerated); psychological defenses such as
paranoia are mobilized, and the confidence in our decisions begins to break down. In a word, the successful creation of misunderstanding leads
to significant self-doubt, which is increasingly difficult to tolerate, and eventuates in exiting an important position at exactly the wrong time.
Adhominem Arguments
An Adhominem argument is defined as one that is directed at destroying the validity of a proposition, product, technology or service by
attacking a person's character rather than addressing the rational flaws in the company's product or technology. For example, a CEO might be
attacked because one of his or her shareholders had been involved in an unrelated shady deal ten years ago; thus, by implication, the reader
takes away the idea that the CEO might be dishonest also. Or the Chief Financial Officer may have worked for a company that went into
bankruptcy in the past, thus implying that the CFO had a direct responsibility for the bankruptcy and will repeat his or her mistakes in the present
situation.
Many of us remain with a small company through difficult times because we admire and respect its management. One of the requirements for
maintaining our investment confidence is our connection with available others who can be admired, looked up to and felt to be a source of
strength and empowerment. (This is one reason, why we become so frustrated and angry when management lets us down, and it is this rage,
which fuels many frivolous shareholder lawsuits). By calculating ways to destroy the credibility of such admired others, the enemies of a
company attempt to weaken investors' connections to their admired management. Psychologically, this disruption tends to temporarily
short-circuit our self-assurance, leading to a drop in self-esteem and vitality--and thus our investment staying power. For it is our imagined (or
real) connection with a competent management that safeguards against mistrust and second-guessing ourselves.
Contagious Emotions
It is a fact of life that emotions can be contagious. Whenever our sense of self weakens, a psychological regression takes place in which
cognitive functioning no longer remains at a logical rational, level. In other words, rather than maintaining our usual cognitive sophistication
when making reasoned judgements, we begin to associate words and concepts with their emotional connotations. For example, the word red no
longer denotes a color along a spectrum; it connotes danger. When the media wittingly or unwittingly relies on short sellers for their headlines
"du jour" (those sound-bytes that sell newspapers or attract viewers) the media choose emotionally laden topics designed to appeal to investor
emotion, usually suspicion and paranoia. For example, if a struggling company resorts to a Reg.-S stock offering, company detractors can point
to the numerous underhanded stock deals that have occurred in what is actuality a legal and legitimate mode of financing. Such comments rarely
include an analysis of the specific deal under discussion to determine its merits, or the fact that the financing may have been, for example,
obtained at market rates rather than at the usual discount. The seeming intent of such inflammatory language is to evoke in investors an internal
response, which has some affinity to the author's pejorative analogy by relying on the fact that emotions are contagious. Such subtly biased
(positive or negative) writing has been referred to in the literature as "journalism of illusion," and more recently by Robert Samuelson as "junk
journalism."
The World as Attacker
Whenever we feel threatened by anxiety, misunderstanding, or blatant attacks on our judgements, capacities or character, we become emotionally
vulnerable. At his point our sensitivities become heightened. Sights, sounds, smells, off hand comments, or rumors that are typically ignored
become very disturbing to us. Such vulnerability includes a readiness to experience the world as an attacker because the stimuli to which we
have become so sensitive become organized in a paranoid way in order to be mastered. This is the reason why those who use emotionally
manipulative devices can so easily disrupt financing arrangements. The investment bankers who are potentially open to funding development
stage companies become just as caught up in the generated paranoia as the average investor. Furthermore, these investment bankers succumb to
herd mentality, saying to themselves, if Merrill Lynch or Smith Barney hasn't jumped to secure the company's business, why should we?
The Negative Use of the Obvious
Many concepts in the investment world are taken for granted, but these notions are easily manipulated to appear anomalous. For example, a
common ploy when discussing development stage companies is to point out that the company has never reported any meaningful sales or
earnings. One could argue that such comments either reflects very little experience investing in development stage companies, or that someone is
attempting to turn the obvious into frightening revelations. It contributes to the na‹ve impression that one should not invest in companies, which
have shown no profits. As a specialist in development stage companies, it seems fair to say I have never seen a development stage company that
has produced revenues and earnings. But the negative use of the obvious creates a psychological feeling of estrangement in us--e.g. how could I
be so stupid as to invest in a company with no earnings or revenues"? The distortion of common sense facts fosters a sense of enfeeblement in
one's sense of self, as we feel exposed to such an "obvious" mistake.
The Illusion of Objectivity
Those attempting to manipulate investor emotion set themselves up to become the admired, omnipotent, and reliable purveyor of objective
information to others. Playing on the notion that companies sometimes exaggerate the benefits of their products or services, these individuals
display an unshakable self-confidence in their statements and express their "knowledge" with absolute certainty. Usually they'll back it up by
erroneous or out of context statements from ostensibly reputable studies which are not made available to investors. These characteristics are
especially designed to sway those of us whose self-esteem has been temporarily damaged during periods of market upheaval. For it is during
such periods that we are seeking hard facts and certainty. Much like cult leaders, the "experts" surface at this point to "objectively" point out the
moral flaws in other's personalities and behavior.
It is only by recognizing these subtle, manipulative devices that we can avoid acting irrationally -especially in the face of volatile market retreats.
(c) 1999 Richard Geist
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