The latest piece by market commentator James Montier looks at confirmatory bias. In the report, Montier discusses how confirmation bias pops up everywhere, giving examples from job interviews, the field of medicine, and criminal investigations. He provides a nice quote on the topic:

The human understanding when it has once adopted an opinion (either as being the received opinion or as being agreeable to itself) draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects and despises, or else by some distinction sets aside and rejects; in order that by this great and pernicious predetermination the authority of its former conclusions may remain inviolate.. . . And such is the way of all superstitions, whether in astrology, dreams, omens, divine judgments, or the like; wherein men, having a delight in such vanities, mark the events where they are fulfilled, but where they fail, although this happened much oftener, neglect and pass them by. — Francis Bacon (1620)

And there I was, thinking it was a relatively new insight to the human condition (I'm currently reading The Black Swan which deals with these themes and others).

Montier concludes with advice on how to fight confirmation bias:

The most obvious way of avoiding plunging headlong into confirmatory bias is, of course, to look for the disconfirming evidence. When you meet companies seek to ask them the complete opposite of what you actually believe. Root out all the information that would show you that you are wrong. So if you expect margins to continue to grow, say, then spend your time probing for evidence that margins are under pressure.

This is easy to say, but actually hard to practice. It doesn't come naturally to us at all. For instance, when I read a bearish piece of research I often find myself nodding in agreement. However, when I read bullish research I find myself, tutting and circling all the points I disagree with, often ending up with large amounts of ink across the page before I throw the note away, dismissing it as typical of the bullish junk produced by our industry. I'm not an unbiased evaluator of evidence (and the chances are that you aren't either).

You should also pay attention to the absence of evidence as well as its presence. This is reminiscent of the Sherlock Holmes story in which the vital clue was that the dog did not bark in the night. One's attention tends to focus on what is reported rather than what is not reported. It requires a conscious effort to think about what is missing but should be present if a given hypothesis were true.

I fear my life is an exercise in confirmation bias!

Russell Sears comments:

Well I would agree that it is hard to do, but I would say Mr. Montier is still asking the wrong question.  With the markets it's not all about you. It is not about what you think you know, it's about everybody and what everybody else is thinking. So the right question is to ask the company to prove what everybody else is saying about it. After all if you don't think that the consensus opinion could be wrong you should be in the index. But the hard part of the investment game is asking the right question, the one where the consensus is wrong. You could start by considering where are consensus opinions consistently wrong, and which companies are good at deception?   


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