Opinion: America’s poisonous “us towards them” insurance policies are actually spilling over into the inventory market, polarizing buyers

Why do columns criticizing meme stocks that invest in names like GameStop GME, + 0.26%, and AMC Entertainment Holdings AMC, + 1.58%, attract a lot of comments that mock the author personally without dealing with business studies to deal with? Why are we seeing new funds that invest exclusively in companies that oppose progressive policies as opposed to funds that advocate social impact investing?

Polarization used to be confined to politics, but it’s making its way into the investing community. In his new book “The Constitution of Knowledge”, author Jonathan Rauch examines how political divisions in many contexts expand into polarizing, vicious struggles between factions. The discussion draws on the psychology of groups, which also helps explain some of today’s nasty discussions about investment topics, from meme stocks to “values” investing.

Most issues in life do not get upset because being wrong and changing your minds does not have a huge psychological cost. For example, when people learn something new about setting a uniform international global tax rate, they correct their views at no personal cost.

But passions increase when views are part of one’s identity. This is what happens when the views define membership in a group. Political affiliation is a classic example of group identity, and the crowd that creates meme stocks is a modern one. Changing attitudes creates significant psychological costs as it is separated from group identity.

The cost of changing identity-based views leads to people sticking to them even when there is evidence that the views are wrong, from meme stocks that really lack business rationality to investments with social impact that actually hurt those who supposedly help. One reason for group convergence is individual fear of being ridiculed or rejected. In theory, members could play the devil’s advocate to bend the creed when new evidence emerges. But members tend to prefer existing beliefs and look for evidence. You reject conflicting information.

Views are hardened by today’s technical channels that form echo chambers and confirmation loops, particularly internet chat rooms, social media, group blogs, and email newsletters. Tribal creeds are gaining ground, such as that markets are deliberately manipulated for institutions against individuals, that capitalism is inexorably oppressive, or that American corporations “wake up”.

Rauch calls the result “epistemic tribalism,” which means that groups explain what is true, whether nuanced or realistic, such as that all short sellers are bad or that high stock prices confirm those who pay them. The group is a team whose players unite around the identifying beliefs, even when short selling increases pricing accuracy or the story is littered with bursting bubbles.

It can be rational for group members to support confirmation loops and market bubbles when they are wrong. This is ensured by strong incentives such as staying in the group, maintaining friendships and feeling the power of membership. Making mistakes by denying the information, including selling a stock or shorting it, is self-excommunication, a real personal price to pay.

But what is rational to members can be devastating to society as a whole if the influence of the group spreads significantly. This is the old “tragedy of the commons,” referring to the classic notion that sometimes what is good for an individual becomes tragically bad for society.

Meme stock traders seem to be having fun and some made money, but is that good for attracting investment in the economy? Some political progressives seem willing to sacrifice returns for virtue, while some conservatives now choose stocks based on a company’s ideological signals. It makes both seem happier. But is that good for the economy?

Rauch complains that the “cults” he is discussing are “on a collision course with reality”, the inevitable end of which is self-destruction. In this case, expect these social and political investment approaches to be disentangled and the venerable approach to be confirmed based on business and economic fundamentals.

Lawrence A. Cunningham is Professor at George Washington University, founder of the Quality Shareholders Group and, since 1997, editor of The Essays of Warren Buffett: Lessons for Corporate America. Register here for the latest information on Cunningham’s research on Quality Shareholders.

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