Is the stock market just vibes?

0:00When France lost to Greece in Euro 2004, the stock market fell. When shoe company Allbirds rebranded as an AI company, its stock rose by 600%. And when British people play happy songs, the footsie improves. This might lead you to conclude that the stock market is just vibes. But is it? Well, find out on today's episode of Nudge.

0:32most businesses have an overwhelming amount of data it's typically scattered across the business in different tools with different teams but because it's scattered no one can use it that is where hubspot come in hubspot connects it all every interaction every support ticket every conversation and they connect it into one platform that every team can work from because when you know more, you grow more. Check out HubSpot.com, the agentic customer platform for growing businesses. Hello, you are listening to Nudge with me, Phil Agnew. I'm delighted to be joined again on the show by the award-winning author, Alex Edmonds.

1:14My name is Alex Edmonds. So my day job is a professor of finance at London Business School. So what that involves is teaching students and conducting scientific research. In addition to that teaching and research, Alex is a brilliant author. I interviewed him about his book May Contain Lies last year. I loved that book. It was a great book. Still is a great book. I would suggest you read it if you haven't already. But his most recent book, The Madness of Markets, covers how investors behave in strange and often irrational ways. Yeah, so it's called The Madness of Markets, Why Smart Investors Make Crazy Decisions and How to Exploit Them.

1:51It's a book about investing. Now, even though it is specifically about investing, it's more general about the mistakes that we make in terms of decisions, which appear in all walks of life. But let's give an example. So we often think the stock market is driven by fundamentals. So what determines the price of a stock is rational scientific factors, such as profits and dividends and sales growth. But what I show in the book is it's affected by emotion. One example is overreaction. For example, it could be there could be good news about a stock but we get overly excited and we think it's fantastic.

2:28For example, in the pandemic, Zoom rose up by 700%. Now, clearly the pandemic was good for Zoom and we noticed that we were doing more meetings online, but did it really justify going up by 700 %? Don't people know that the world will return to normal or some rivals such as Google and Microsoft Teams will catch up? And notice that's the idea of overreaction we see in everyday life as well. For example, when a football manager loses three games in a row, we might call for him to be fired, even if he's had some two great seasons. It may be that we are upset at our job because we were excluded from an email or a meeting and we think, should we quit?

3:08Or maybe we go on a date and then we get ghosted and then we think dating is pointless for me. So in many areas of life, we overreact to information. And I wanted to highlight this in the specific case of investing, but also more generally. Alex writes in his book that we are wired to overreact. Humans latch on to recent events and blow them out of proportion. Psychologists Daniel Kahneman and Amos Tversky repeatedly showed this in their lab work. In one of their most famous studies, a study that I've cited several times before on the show, they ask two groups of people to multiply eight numbers without a calculator and under time pressure.

3:49However, there is a twist, of course. They are split into two groups, and one group saw the numbers in ascending order. 1 times 2 times 3 times 4 times 5 times 6 times 7 times 8, while the other group saw the exact same numbers in reverse. 8 times 7 times 6 times 5 times 4 times 3 times 2 times 1. The answer for both groups is the same. It's 40 ,320. But the average guesses between the two groups were wildly different. Those starting with one times two estimated that the total was 512, while the descending group estimated the answer to be 2 ,250. People are anchored by those early values, the most visible attention-grabbing values and they overreact from there.

4:40I asked Alex for an example of this type of overreaction. Absolutely. So if you go back to April, then Allbirds, the trainer company, they announced a rebranding to Newbird AI. So once popular shoe company founded in San Francisco has announced it's ditching the apparel business and making a pivot to AI. Allbirds announced it will now become Newbird AI. And then stock prices soared on this news, jumping nearly 600 % today. And the stock price went up by 582%. And this was crazy because all they did was change their name. Was there any evidence that they would be able to execute this AI strategy?

5:19If you make trainers, that's a very different business from being an artificial intelligence. But the market just looks at the label, gets overly excited and buys it because it's got AI in its name. Allbirds are hardly the first company to attempt this. In 2017, a struggling drinks company called Long Island Ice Tea renamed itself to Long Blockchain. Alex writes in the book that the Ice Tea company had about as much to do with blockchain as Jenga Blocks. But despite that, its stocks leapt 380 % after the name change. And as you're saying, Phil, this is not something new. It's happened time and again.

5:58So in the dot-com bubble, if you added dot-com to your name or similar things like dot-net or internet, there is an average increase of 73%. Now, behind any irrational behavior, there is a grain of rationality behind it, which is why such behavior persists. And we think in investing, if you snooze, you lose. And so people might think, oh, when there's something new like AI, then we do want to applaud a company who is now changing its strategy. But what is the idea of overreaction? We're too driven by surface level things. What a company calls itself rather than whether it's actual strategy or operations have changed.

6:37But Alex first noticed overreaction not after seeing a name change to AI or watching a bubble burst. He noticed it after a football match.

6:50so i was working on the trading floor of morgan stanley in new york city and it was the european 2004 football championships and you might think well this shouldn't really have an effect in the u.s number one um the u.s cares much more about baseball and ice hockey and basketball rather than what we call football and number two this was the european championship so team usa they was not even playing. However, many people from the US, they may have European ancestry, as you can see from their last name. And there were huge swings in people's emotions on the trading floor, depending on what the results were.

7:30And when Greece knocked out France, the pre-tournament favourites, there was one trader who got so angry, he stormed off and then didn't return to the office for a few days. I thought, well, this is weird, but is this just a one-off thing or can markets be more systematically affected by emotions? And so when I went back to MIT, where I was doing my PhD in finance, I wanted to dig out the data and look at after a country's knocked out of the World Cup, does it feed through into the stock market? And what my co-authors and I found after studying 1 ,150 football games was the answer was yes. On average, when a country gets knocked out of the World Cup, the market goes down by about half a percent.

8:14And that's about 15 billion pounds when applied to the UK market. Stock markets consistently fall after a national team loses a match. It proved that even the most rational minds fall prey to emotion. Alex says that investors, for all their spreadsheets and sophistication, are human. And humans all over the world slip into the same expensive traps. Most people flounder in these traps, but Alex writes that a savvy few cash in on the chaos. And I think this is striking because many people will say, yes, my emotions are affected by football results because I really care about sports. But you might think when I go to work the next day, I'm going to put my game face on.

8:58I'm a professional. I'm going to focus on fundamentals and what really matters. And what the paper suggests is you can't do that. It's not because you're a bad person. It's just that you're a human. You're a whole person. If you're affected by emotions, they could come from football results. They could come from when your children being sick. They could come from you having an argument with your spouse earlier that morning. But all of these things do weigh in on you and may well distort your decisions. And this keeps affecting stock markets, even in the AI algorithmic world we live in today. Yeah.

9:31So when England got knocked out by Argentina in the most common World Cup, So the market opened about half a percent down the next morning, even though there was positive economic news. And Yahoo Finance, which should be rational and focus on the fundamentals, it attributed this partly to the England defeat. So something which might have seemed crazy 20 years ago, people now do realise that sentiment does feed through into the stock market. We overreact. We let our emotions take over. And this affects the stock market. But can you reverse engineer this? Can you look for cues about the nation's mood and use that to predict how the stock market might grow or decline?

10:10Well, this is something Alex has studied. This is another study that I did, which tries to link mood to the stock market. So in all of these studies, what you need is a clean measure of mood that doesn't affect economic fundamentals. So let's say national mood is down during a pandemic. if I show that the market goes down during a pandemic, you couldn't include this is due to people's mood being lower because they're locked down. It could be because of the economic effects of a lockdown that there's just less spending. So what you want is something that affects mood, but doesn't affect economic fundamentals.

10:47And so that was why I looked at football. And that's why in this later paper, I looked at music. Specifically, Alex used Spotify's most streamed songs in each country to create a daily global mood barometer that he and his team called Music Sentiment. So what is the idea of music? Why did my course and I choose this? Well, what we realized is that your mood may be affected by many things. So maybe the football result, maybe an argument with my spouse, maybe kids being sick, maybe there's a lot of work stress or I need to repair the leak in my basement. we don't have data on all of those other factors so what i wanted to look at was one encompassing measure which reflects the mood that you're in and so this is why i chose music listening chances so there is quite a bit of evidence in what's known as behavioral congruity that you listen to music that reflects your mood so if you're happy you might listen to walking on sunshine if you've broken up with a partner you might listen to nothing compares to you at a funeral you'll have more somber music.

11:52Whatever your underlying sentiment is, this might be reflected in your music listening choices. And luckily, we do have data on this at a national level. So you can look at Spotify's list of the most streamed songs. And we use an artificial intelligence program to measure what we call the valence of a song, which is how happy or upbeat towards. So the idea here is not that I listen to music, the music gets happy, I become happy, and then I start buying stocks. It's not causal in that way. It's more, what is my underlying mood? That underlying mood will cause me to listen to a particular type of music, and the same underlying mood will cause me to trade in a particular way.

12:36So if I'm bad-tempered, I might be more pessimistic about the stock market, and I'm also going to listen to more some of the mood. This was something that we studied not just in the UK, but dozens of countries around the world. We found that there was a significant effect. Not only do we find this in stocks, but people are more likely to go into mutual funds and people are more likely to go out of government bonds, which makes sense because if you're in a more positive mood, you're more likely to go into risk taking investments. So how should you use this information? Should you change how you invest based on the music people listen to or the football results?

13:14Yeah, so there's a couple of takeaways. So you wouldn't do the most literal takeaway of maybe selling stocks after a country has not been knocked out of the World Cup or trying to have an investment strategy based on listening choices. Instead, that's not the point. It's not to devise a trading strategy, but to make us aware of two main things. Number one, your own mood will affect your decisions. You might think, I should be able to shake it off and be a true professional. I can still go to work and maybe you're an investor or maybe you're doing something else. You're a manager within the company making resource allocation decisions.

13:49Be kind to yourself. The second takeaway is that if the market responds to something as irrelevant as sentiment or football results, then you recognize that this means that the market could be overreacting to many other things, such as a AI or dot-com rebranding, or such as, say, Zoom and Peloton soaring during the pandemic. And this is really interesting because this opens the door to one of the most tried and tested investment strategies in practice, which is known as contrary in investing. And it was first devised by Dick Thaler, who won the Nobel Prize. He found this in 1985. And what he did is he said, if you saw all stocks, let's say on the UK stock market over the last three years, the ones that did the worst, we call them the losers.

14:41The ones that did the best, we call them the winners. If we buy the losers and sell the winners, then over the next three years, we see a reversal. The losers become winners and the winners become losers. And why is this? Well, what is a winner? A winner is a stock that had moderately good news, but the market got carried away and the market just bought it too much. The future path is down. And similarly, what is a loser? That is a stock in which there was mildly bad news, but the market got too pessimistic and it's too cheap right now. Fahler looked at how stocks had performed over the past three years and split them into two groups.

15:18The high flyers, as Alex said, were called the winners and the laggards when labelled the losers. But then Fela measured what happened next. Over the next three years, the losers beat the market by 20%, bouncing back, while the winners underperformed by 5%. A staggering 25 % gap. Yeah, so this was initially found in US stocks. But since then, it's been extended to many other countries around the world from Austria to Australia. You could also play this at the country level. So rather than buying some stocks and selling others, you buy loser countries, which have underperformed over the past five years, and then sell winner countries.

16:00It's safe to conclude that in some ways, despite me hating the word, the stock market is just vibes. It changes, it shifts based on intangible, irrational things like the result of a football match, the name of a company or the music investors listen to. But what should investors do to counter this? What can you do to take advantage of all of this irrational behaviour? Is there some money you can make here? Well, that's what I ask Alex after the break. The Ross Simmons Show is brought to you by the HubSpot Podcast Network, the audio destination for business professionals. I've been following Ross for a while.

16:38His podcast is great. And an episode I'd highly recommend is called Mastering Time, Prioritisation Over Productivity. He gives some really well thought out tips on how to prioritise your time, including something I care a lot about, which is how a small percentage of your efforts can drive the majority of your results. So go and listen to The Ross Simmons Show wherever you get your podcasts. Hello and welcome back. You're listening to Nudge with me, Phil Agnew. So far, we've covered how the stock market moves in irrational ways, how investors overreact, and how that creates opportunities in the stock market for others to exploit.

17:15But how can you exploit these opportunities? Well, Alex advises you to look at areas that most people ignore. For example, the pay package that a company decides to give its staff. Yes, in March 2025, so Costco raised its minimum wage to$20 an hour. And that was three times the federal minimum wage of$7.25. and what this meant was the average pay for cashiers and warehouse staff and other hourly workers was now$31.90. That was almost double that of Walmart, its arch-wide. The price of just about everything is going up and competition for workers is fierce right now. So Costco is hoping to gain an edge with higher starting pay.

18:00And so to many people, this is crazy. This is inefficiency. Why are you paying twice as much as you can get away with in a low margin business like retail, this is a surefire road to ruin. But in fact, what my own research found was that this was not the case. So I wanted to look at the link between employee satisfaction and a company's long-term stock returns. And what I found was that over a 28-year period, companies that treat their work as well delivered stock returns that outperformed by 2.3 to 3.8 % per year. That's 89 to 184 % compounded. Just to recap that, Alex used the 100 Best Companies to Work for an America list.

18:46This is the list that was published in the Fortune magazine every year. And it is a pretty comprehensive measure that covers stuff like credibility, fairness, respect, pride and camaraderie. Alex writes that crucially, it is rooted in the views of the workers themselves, what it is actually like to spend five days a week working at said company. The list surveys every employee within those firms, and specifically it asks them 58 questions across these topics. And when Alex ran the data from 1984 to 2011, he found that these companies with highly motivated, highly satisfied staff beat their peers by 2.3 % to 3.8 % per year.

19:28And so why is this? So what is the market mistake, market madness here? It's actually the opposite of overreaction. It is underreaction. So how can we have both overreaction and underreaction at the same time? So we overreact to big, flashy things where there's not real substance behind them, such as a name change, adding.com, or maybe something with some substance like the effect of the pandemic, but we just overreact to this and bid up Zoom and Peloton too much. Underreaction is where there is something which is an important fundamental driver of a company, but because it's not so flashy, because it does not pop in a big news headline, we miss it.

20:07So corporate culture is not something where we have a quarterly earnings announcement, or there's an earnings call or press release saying, hey, our employees are happy. So it may well be that this gets ignored by the stock market. And even if it wasn't ignored, even if you knew that a company had really happy employees, what do you do with that information? If I know that my company's revenues were 10 % higher than people thought, I could increase every cell in my spreadsheet by 10%. But if I know that a company has happy employees, how do I change cell C23 in my spreadsheet? That is not clear.

20:43And so the market can underreact to something either because they don't know the information because it's not so salient, Or number two, because if it's qualitative, even if I know that information, I don't know how to put it into a quantitative model. And so this is why just the simple strategy of buying companies with high employee satisfaction outperformed over nearly three decades. The market didn't realise the value of employee satisfaction. So these companies were underpriced. They were too cheap. We underreact to intangible metrics like staff satisfaction. But is the same true for customer?

21:20satisfaction? Yeah, so there were actually two papers which looked at the American Customer Satisfaction Index, which is a measure of customer satisfaction, actually, which found that companies that did well on this list, they outperformed significantly. Interestingly, the study was done in 2006, and then it was replicated in 2016 and still found to be holding. And again, you might think, well, this is crazy, because isn't it obvious that customer satisfaction matters? but again even if you know a company has great customer satisfaction or poor customer satisfaction how do i change the cells in my valuation spreadsheet i will attach one caveat to this which is very recently after i'd finished the book i said i saw a pretty detailed critique of of these papers which suggested that the data may not be as robust as those papers claim even though they were published in top here with new journals and i've looked at the critique and i think it is something to be taken seriously.

22:19So I will attach that caveat because of new information which has come out about those measures of customer satisfaction. This doesn't mean that customer satisfaction does not matter. Just those specific measures were not found to be robust. Now, there's other things that people can look at, which is not linked exactly to customer satisfaction, but something close to it, which is the importance of brand. And those papers have withstood scrutiny. So how do we know how valuable a company's brand is? Well, you can look at two things. Number one, interbrand is a company which values brands. And not surprisingly, companies that had highly valued brands, they were outperforming significantly.

22:59Again, even though the market should have taken this to account, they failed to do so. Another thing that you can look at is the number of times a company mentions brand in its annual report. And you might think, well, this is a really simplistic measure. But it actually is quite informative because it highlights the significance and the weight with which management cares about its brand. And the ones that were mentioning brand more often, and therefore probably paid more attention to it than the competitors, also were outperforming the lot. The stock market isn't the reliable foolproof benchmark of true value that many of us believe it to be.

23:35It is to use the slang affected by an awful lot of vibes. the irrational biases that all humans have affect the market. We overreact to a bad football result and we underreact to happy staff. And it's a reminder to all of us that despite all of the AI and data-driven insights out there, we are humans and humans are often irrational.

24:00That is all for today's episode of Nudge. Folks, thank you so much for listening. I would like to give a massive, massive thank you to Alex for coming back on the show. we we met up in person this year at nudge stock we were both speaking at the event it was great to meet alex properly it was great to hear him speak as well he was one of my favorite speakers at nudge stock and i couldn't wait to get him back on the show i can't recommend his books highly enough they are brilliant if you liked this podcast if you like this episode you will love his writing and because i love alex's writing so much i have featured his work in my last two newsletters.

24:34Last Friday, I shared a story about how product placements in movies influence sales and includes a very interesting anecdote about Steven Spielberg's ET. And then the previous week, we covered how satellite photos of car parks are used by investors to gauge performance. I have left a link to my newsletter in the show notes of today's show. And if you use that link, you can read both of those newsletters for free without having to enter your email address. If you like today's show, I think you'll like the newsletters. So that is all for today. Thank you for listening. I'll be back next Monday with another episode of Nudge.

25:09Bye bye.