The Psychology Behind Why Smart People Make Terrible Decisions | Alex Edmans – EP 823

In episode 823 of Passion Struck, Alex Edmans, professor of finance at London Business School and a globally recognized expert on behavioral finance, responsible business, and misinformation, explains why cognitive biases, emotions, and herd behavior can lead even smart, informed people to make terrible decisions.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01John R. Miles?

  Hey friends, what if your biggest problem isn't that you're not doing enough, but that you've spent too long proving that you are enough? You can be successful, needed, and surrounded by people and still feel completely unseen. That's the problem I explore in my new book, The Mattering Effect. I show you how we become hyper-visible for what we produce, while quietly becoming invisible to ourselves, and introduce the matter framework to help you reclaim meaning, autonomy, trust, time, energy, and reciprocity. Stop auditioning for your worth, start living from it. The Mattering Effect is available for preorder now at matteringeffect.com. What if the information that matters most is the information nobody is paying attention to?

• 0:44John R. Miles?

  We tend to react to what's visible, measurable, and impossible to miss. But what if that's exactly where everyone else is looking? My guest today, Alex Edman, argues that flashy, quantitative information can trigger overreaction, while quieter qualitative information can be overlooked by everyone at once. And that raises a much bigger question. What are we missing simply because we're not looking in the right place? Take a listen.

• 1:18Speaker 01

  So something which is front page and flashy and more quantitative, it might get a stronger reaction. Something which might lead to underreaction is off the front page. So if something tends to be more qualitative, it might be more hidden. And it's not just hidden to me, it's hidden to you, it's hidden to other investors, because naturally we like to plump for something which is flashy and visible.

• 1:42John R. Miles?

  Hey, it's your friend John, and welcome to Passion Struck. I'm so glad you're here. Whether you're a longtime listener or someone who just discovered the show, thank you for pressing play today. Maybe you've built the life you were supposed to want, but you've quietly wondered why it still doesn't feel like enough. If that's you, you're in the right place. Every week, I sit down with the world's top scientists, researchers, and thinkers to uncover what it actually takes to build an intentional life that matters. Thanks for joining me. Let's get into it.

• 2:22John R. Miles?

  Welcome back to Passion Struck, episode 823. In our current series, we've been exploring what it means to be an adaptive human, how we change, how we grow, and how we navigate a world that is constantly changing around us. Angela Duckworth started us off and showed us how much our environment shaped who we become. Marty Seligman reminded us that we still have agency, the ability to believe our actions can make a difference. David Epstein explored how a broad range of experiences can help us adapt, while also teaching us when constraints and focus matter. Cole Brower showed us what adaptations look like when there's nowhere to hide,

• 3:05John R. Miles?

  alone at sea thousands of miles from home, making decisions in real time. And Marissa Franco brought that journey inward, asking how we adapt without losing ourselves in the process. Today, we turn our attention to something that shapes nearly every decision we make: the way we think. Because here's the uncomfortable truth: being intelligent doesn't make us rational. And having more information doesn't necessarily make our decisions better. In fact, when millions of people bring the same biases, emotions, stories, and blind spots into the same system, those individual mistakes don't always cancel each other out. Sometimes, they compound.

• 3:50John R. Miles?

  That's where my conversation with Professor Alex Edman takes us. Alex is a professor of finance at London Business School and a fellow of the British Academy. You may remember him from our previous discussion in episode 463. Today, we're going to be talking about his new book, The Madness of Markets: Why Smart Investors Make Crazy Decisions and How to Exploit Them. This conversation picks up the thread of our last one, where we talked about misinformation, bias, identity, and the stories we believe, and takes it somewhere much bigger. What happens when millions of minds collide inside a system that we assume is rational?

• 4:33John R. Miles?

  We talk about why investors overreact to information that's flashy and visible, while overlooking information that's quieter and harder to quantify. We explore herd behavior, confirmation bias, anchoring, the danger of following compelling stories, and why even extraordinarily intelligent people can fall victim to the same psychological traps. We also get into something I found particularly fascinating: the things markets struggle to measure: culture, employee satisfaction, human capital, reputation, and innovation. These things can be enormously important to a company's long-term value, yet they're much harder to plug into a spreadsheet than an earnings number.

• 5:18John R. Miles?

  And then we take the conversation into the future. What happens to human judgment when AI becomes increasingly capable of making decisions for us? Alex argues that AI may make markets more efficient, but it won't make human beings immune to bias. Instead, some of these biases may simply migrate into the qualitative decisions that machines struggle to capture. And ultimately, Alex gives us a principle that extends far beyond investing: to see the other side. Before you commit to a decision, look for the argument against your own position. Find the person who disagrees with you. Ask what you're missing. Because adaptation isn't just about changing what we do.

• 6:03John R. Miles?

  Sometimes, it's changing what we're capable to see. Here's my conversation with Alex Edman. Thank you for choosing Passion Struck and choosing me to be your host and guide on your journey to creating an intentional life that matters. Now, let that journey begin.

• 6:24John R. Miles?

  I am absolutely thrilled to welcome back Alex Edman to Passion Struck. Welcome, Alex. It's so great to see you again.

• 6:32Speaker 01

  Thanks so much, John. It's really great to be back. Thanks for inviting me.

• 6:35John R. Miles?

  Alex, the last time you were on Passion Struck, it's hard to believe, it was episode 463, and we explored your previous book, and we went into why people believe misinformation. We discussed things like confirmation bias, identity, the stories we tell ourselves. But reading your new book, which is about ready to come out, The Madness of Markets, which I loved, it almost felt like a sequel. It seemed like the first book explored how individuals become irrational, but this one kind of explores what happens when millions of irrational decisions collide. Was that evolution intentional?

• 7:14Speaker 01

  It was, yeah. So how does it relate to my last book? As you mentioned, John, that is on biases and how we might fall for misinformation. But you might think in financial markets, that could be an arena in which misinformation should not have an influence. Why? You might think, well, there's two reasons. Number one is that in financial markets, the stakes are so high that if you keep trading on misinformation, you'll exit the market, and so it's only the smart people who will survive. And number two, what affects the market are the trades of millions of investors. And so even if we have biases, those biases could cancel out. For example, let's say I'm really bullish on Tesla because I'm an Elon Musk fanboy, and you're really bearish because you can't stand his politics.

• 7:59Speaker 01

  Well, I will buy too much and you'll sell too much, and overall prices will be correct. But what I explore in the book is that these are not canceling each other out. In fact, we might both overreact or underreact in the same direction, and therefore prices will depart quite a long way from fundamentals. So even in something as rational and supposedly disfashioned as the stock market, we do find these biases really playing out in the same way that we looked in my prior book in many other contexts.

• 8:27John R. Miles?

  When I think of financial markets, I don't really think naturally of human psychology. But in the point, you make this observation that markets don't just reflect information, they do reflect human psychology. If someone watches a financial market long enough, what would they ultimately learn about human nature?

• 8:50Speaker 01

  They would find that human nature is affected by biases and emotions, even in something where there is a lot at stake. And this even affects professional people who you might think should be able to act rationally and disfashionably. And so how can that be? How can people who are paid millions of dollars a year still be prone to biases? It's because these biases are so deeply set and deeply rooted in us. And this is because these biases exist in all our human behavior. So let's take one bias: overreaction. We just saw this in the World Cup. So the England manager loses one game, and then people say, oh, this guy should be immediately fired, even though he leads England to the best finish in a men's World Cup since 1966.

• 9:35Speaker 01

  And then if you apply that to the stock market, people respond to small bits of information. So let's say Allbirds, a sneaker company, rebrands itself as New Bird AI. The stock market goes up by 582%. Why people will think, well, this is a revolution, it's now embracing the future, this struggling shoe company now has a way of surviving. They don't evaluate, does it actually have the knowledge and expertise to become an AI company? And that itself is not new, because in the dot-com bubble, if a company added just dot-com to its name, then the stock price went up by an average of 73%. So as an investor, as a professional, you think, I'm paid a lot of money,

• 10:17Speaker 01

  I should be responding to information, I shouldn't just be sitting on my laurels. And all of those incentives might cause you to overrespond to small bits of information which are not as meaningful as you think.

• 10:31John R. Miles?

  I feel for that manager, because imagine he puts in the players that he did to play defense since they were up, and they actually win. He would have been lauded as the greatest manager of all time. The fact that he put them in, and now people are saying that he put them in too early, you're right, it's like we penalize people based on the observation of one thing when we don't look at the totality of how far they get us. And I think it's the same thing sometimes with markets and how we look at them. I did want to go one step further with this. Like, how do things like hope, fear, pride, envy, regret get underestimated when we look at markets?

• 11:14Speaker 01

  Again, I think it's because people think that the financial intents are so large that these fluffy emotional things, people should be able to put them aside and just focus on what maximizes financial returns. But I think this is really difficult because often people think that they're using those biases to make better decisions rather than thinking they're sacrificing returns. So let's give a concrete example. So one bias is the status quo bias or sunk cost fallacy. This manifests in many forms. In financial markets, it manifests in the disposition effect, which is the idea that we will not take a loss. So if I bought a stock at $100, it's now 95.

• 11:56Speaker 01

  Even though I think it could be going down towards 80, I will not sell this. Why? Because it's just really bad for me to take a loss. And I justify this to myself and I don't say, well, I'm doing this because I'm emotional, but because I'm rational, because shouldn't investing be about patience and the courage of your convictions and taking long-term decisions rather than responding to short-term fundamentals? And so I can rationalize what is an emotional decision based on seemingly scientific and sensible justifications. And so I then stick with a losing stock by telling myself I should be patient and have the courage of my convictions and the stock goes down to 80 or even worse.

• 12:40John R. Miles?

  Since we were just talking about football, let's go into your introduction to your book, which also talks about football. In fact, a match between France and Greece during the 2004 European Championships. What does that story have to do with markets? And how you fundamentally think about markets and how it changed your thinking about markets?

• 13:00Speaker 01

  So let's put 2004 into context. I started my PhD at MIT in 2003. And MIT being MIT teaches you that markets are driven by quantitative stuff. So profits, fundamentals, dividends. It gave the impression that to become a better investor, you need to be a better mathematician. You need to be able to do or solve equations better. Indeed, the Black Scholes model had roots in MIT. And this is a great Nobel Prize winning formula to value options. But then in the summer of 2004, I was doing a summer associate position at Morgan Stanley in New York City, 1585 Broadway. This was the European Championships. So two things.

• 13:43Speaker 01

  Number one, it was soccer, which is not one of the big American sports. And it's the European Championships. It was not even the US participating. And despite that, there were cheers or sighs or curses, depending on who won or lost. And all these are people who trade for a living, move billions of dollars, and yet they are affected a lot by emotions. There was one guy who, after France got knocked out by Greece, he left the office and didn't come back for a few days. And so when I went back to MIT, I thought, well, is this just one anecdote? Or is there something systematically there in the data? And so then I decided to write a paper with a question that sounded bizarre. Could the markets be responding to soccer results?

• 14:26Speaker 01

  And I didn't dare tell my MIT professors what I was working on because they might kick me out or just urge me into a different direction. But when I ran the data, the actual data was pretty clear. The evidence stared back at me and it said, well, when a country gets knocked out of the World Cup, the market goes down a lot the next day, even after controlling for world market movements and other determinants of stock returns. At one time I had to face the music. So I had to present it to a student seminar, which normally students come to. But then I saw some faculty sneaking in and thinking, well, are they here to look at a train wreck? This crazy student who's now writing about soccer. And then to their credit, they listened with an open mind and they told me afterward,

• 15:10Speaker 01

  no, I was skeptical, but you've done this well and carefully. And it ended up being published in the Journal of Finance, one of the profession's top journals. So what this highlighted was that even though you could be doing a PhD in the home of efficient markets, if you are willing to be curious and look into the data, people are open to the idea of psychology affecting financial markets. And so that 22 years ago was the genesis of the book that I've written now.

• 15:37John R. Miles?

  Well, let's also talk about events that are going on right now. I've been a bit surprised that with two major conflicts going on, all kinds of ups and downs in the energy markets, that most of the financial markets have continued to rise exponentially under the Trump administration. I would have expected at this point to see some major downtrends. What do you think is happening?

• 16:06Speaker 01

  I think there's a couple of things which might be going on. So number one is that economic fundamentals that you think might be negative, they might end up being reversed. For example, we saw this with tariffs, which I thought to be quite disastrous for not only the US but the world economy. And that, and then the negative reaction led even somebody like Trump, you might think won't listen to anybody. He did listen to the markets and reverse course. So here with energy prices, the market may be thinking, well, actually, if it gets so out of hand that it really affects production, there will be some intervention here. And even if there's no intervention, I think what history has shown is that companies are remarkably resilient. They might be able to find other ways of doing things.

• 16:50Speaker 01

  So in the COVID pandemic, which we thought is going to be absolutely devastating, people can't go to work. People found alternatives of being able to work from home. And therefore, while there was a substantial market correction, things recovered much faster than at least I feared that they would take. And similarly here, it may well be then in response to high energy prices, it might be that there's ways of producing it in a different way or saving energy. So businesses are quite adaptable.

• 17:16John R. Miles?

  Recently, as I was telling you before we came on, had the Nobel laureate Al Roth on the show to discuss his latest book. And one of the things he and I spoke about has really stayed with me. He said that markets aren't fundamentally about money. They're systems that determine who gets what. Do you have a similar view when you think about markets?

• 17:38Speaker 01

  So can I just ask, what did he mean by who gets what? Does he mean the division of a pie that winners and losers? Just that I understand what he was saying.

• 17:46John R. Miles?

  We were talking a lot about, you know, repugnant markets. And we were talking about when this came up, organ donors.

• 17:55Speaker 01

  Oh, yes, I know, I'm working on that.

• 17:56John R. Miles?

  Yeah. Well, he was specifically talking about how in some markets make it very easy to get organs. And in the United States, for instance, we have to put on our driver's license that we are open to it, which is the opposite. So in the States, I think less people are prone to get organs because of that than in other countries who make it automatic. So that's what we were referring to when he made the statement.

• 18:25Speaker 01

  Great, thanks for that context, which really helps. Okay, so he makes a comment about markets in general and I absolutely agree with him. So what are markets? They are ways of allocating scarce resources among different people. And if markets work well, then those scarce resources should be allocated to the people who value them the most, such as organs when they are scarce. And then how does this apply to financial markets? I believe it does apply to financial markets in the same way. In that what is the price? The price is a rationing mechanism to mean that the people with the greatest willingness to pay will be ending up with the resource. And so this is particularly applicable if you think that there's a bubble. So when non-fungible tokens were all the rage,

• 19:10Speaker 01

  there might be crazy people willing to pay thousands of dollars for a NFT of a tweet. And then what does this mean for us as a savvy investor? Is to make sure that we think about financial markets like we would do other markets. So in normal product markets, if prices go up, we might buy less. So this is econ 101, prices should be a rationing mechanism. But for some reason, in financial markets, if the price goes up, we buy more. And that's the opposite of econ 101. So Jason Zweig of the Wall Street Journal once wrote an article saying, the biggest problem with stocks is the letter T. Why? Because if it was socks, the more expensive socks are, we would buy less.

• 19:54Speaker 01

  Whereas with stocks, we actually do something which is irrational. We tend to over extrapolate and this leads to the bubbles and the herd behavior that I mentioned earlier. So I think there to view actually financial markets in the same way as regular markets. Then think about the price as a rationing device. If the price of something has gone up a lot, is it really something that I should be investing in or should I be going for something which is more affordable for the fundamentals that it's giving me?

• 20:23John R. Miles?

  Before we get back to my conversation with Alex, I want to tell you about my new book, The Mattering Effect, coming October 6. One of the questions I explore is what happens when the environments around us, our workplaces, relationships and institutions begin to communicate that we are replaceable rather than significant? Alex is helping us understand how the systems around us can distort the way we think. The Mattering Effect asks a different but connected question. What happens when the systems around us distort the way we see ourselves? If that idea resonates with you, you can learn more about The Mattering Effect at matteringeffect.com. Now, a quick break for our sponsors. Thank you for supporting those who support the show.

• 21:15John R. Miles?

  You're listening to Passion Struck right here on the Passion Struck Network. Now, back to my conversation with Alex Edmonds. I wanted to do this walkthrough to open this up because the book organizes itself, and you've already talked about one, around three distortions that fundamentally shape markets. You have overreaction, underreaction, and misreaction. And I wanted to ask, through that lens, once emotions become contagious inside a market, what determines which one of those distortions happens and then allows that either to be collective intelligence or destructive collective panic inside the market?

• 22:01Speaker 01

  Yeah, so this is a really good question because many defenders of efficient markets argue that, yes, there are lots of biases, but those biases will cancel out. So if I overreact and you underreact, then on average, we're going to get to the correct reaction. But what psychology suggests is that when somebody overreacts, everybody overreacts in the same direction. And then when people underreact, they might all underreact in the same direction. So your question then is, what are the types of things that people as a whole overreact to? And what are the things that people as a whole underreact to? And one thing I think which determines this is the salience of the information.

• 22:40Speaker 01

  So something which is front page and flashy and more quantitative, it might get a stronger reaction. For example, a rebrand from Allbirds to Newbird AI, that's something which makes big news. Adding .com to your name also makes big news. Those are things which might lead to a lot of hype, people just buying stocks too much. Something which might lead to underreaction is off the front page. So some of my other work looks at the importance of employee satisfaction. So it makes sense that corporate culture and happy employees matter for a company's long-term value. However, it's very difficult to announce in a press release, "Our employees are happy." I've not seen any press releases like that.

• 23:25Speaker 01

  And while there are measures of employee satisfaction, such as Glassdoor reviews or the list of the 100 best companies to work for in America, they don't get released with as much fanfare as you would have a rebrand. They're not as salient to investors as an earnings number, which you can plug directly into a spreadsheet. So if something tends to be more qualitative, it might be more hidden. And it's not just hidden to me, it's hidden to you, it's hidden to other investors because naturally, we like to plump for something which is flashy and visible. So then the message of the book is to say, to identify things that are more salient and more likely to be overreacted to, and therefore to educate the reader, don't trade

• 24:07Speaker 01

  on those things because they would have already been priced into the market. And then highlight the quieter stuff, which might be the hidden treasure. And those are the things that you should be using if you want to try to beat the market.

• 24:21John R. Miles?

  Alex, I'm going to do an ad lib. I wasn't planning to ask this question, but something you just said triggered it. Earlier today, as I was doing research, I watched your TED Talk and you were talking about pie in it and how companies look at the pie and often gravitate, if I'm summarizing correctly, to extracting value from customers for the benefit of the company itself. And you were talking about Vodafone in it. But one thing that connected with what you just said is, you were talking in this TED Talk about those companies that have the best policies around how they treat their employees. And so something I have really been trying to look at in my own work is, companies are

• 25:06John R. Miles?

  talking more and more about disengagement, but to the point you just made, they're not really looking at a return on mattering. So if you really make your employees feel like they matter, like they're seen, valued in the company, how does that impact performance? Is that something you're studying at all or doing more research towards as you think about how this impacts companies and their success?

• 25:32Speaker 01

  Absolutely. This is something that I started about, again, 20 years ago during my PhD, but it is something I'm working on an ongoing basis. Again, during the PhD, I wanted to look at what drives long-term returns. And while colleagues would be looking at the tangible stuff, I had been at Morgan Stanley and seen that human capital really matters. And it matters even in an industry where it should not. Because in investment banking, rational economic incentives should be enough, right? When you join at 21 years old, you're given significant bonuses for somebody that young and the prospect of promotion to associate and vice president and executive director. So really feeling it shouldn't matter.

• 26:13Speaker 01

  Even if my boss doesn't invite me to a meeting or mistreats me, I should just work hard because I'm so obsessed with getting promoted. But that's not true. And this is not true for me and not true for the people I interact with. They're all humans. And so we rack it a lot to whether the boss went to the meeting and bothered to spend five minutes debriefing you and thanking you for all the work you did, even though you couldn't go to the meeting yourself. And so when I was trying to study what drives financial performance during my time at MIT, I wanted to look at the human factor. And what I found, long story short, is that companies that treat their workers really well, as measured by their inclusion in the best companies to work for, they beat their

• 26:54Speaker 01

  peers by 2.3 to 3.8% per year for a 28-year period. And further tests suggest it's more likely that employee satisfaction causes financial performance, rather than financial performance causing employee satisfaction. So that was something I did. I started there 20 years ago, published in 2011. Then I did a follow-up study extending it from the US to around the world. And now in some current work, I'm looking at what specific dimensions of employee satisfaction matter. In particular, I'm focusing on equity and inclusion. Why? DEI is something which is quite topical nowadays, and topical and controversial in that people say, well, DEI is always going to be improving performance.

• 27:39Speaker 01

  And then you have the anti DEI people saying, this is just crazy, it's discriminatory and unmeritocratic. But all of that debate surrounds the D, which is often viewed as demographic diversity. And then I can see if you focus DEI on just demographic diversity, how sometimes it could be undemocratic. If you were to say, well, the US men's national team has to have X percent of Asians on the team, well, that I don't think would be meritocratic because you're not selecting the best players. But then if I focus on the E and the I, the equity and inclusion, that should be less polarizing. This is about making workplaces ones in which employees can thrive and express themselves

• 28:22Speaker 01

  and challenge their seniors without fear of repercussions. And so what my core design find is that measure of equity and inclusion is much more linked to financial performance than purely demographic diversity. So again, this goes within the theme of what we just talked about, is if you look at the more qualitative and tangible measures, those are things which are often under the radar screen. Whereas people who focus on DEI, they will only look at, say, the headline percentages of women or ethnic minorities in the workforce, not these broader inclusion issues.

• 28:54John R. Miles?

  Yeah, thank you for sharing that. From my experience from working inside these Fortune 50 companies is that I think the companies that do not practice where I think you're getting at is diversity of thought, end up creating these bubbles where everyone has group think. And I always thought the companies I was in that allowed for diversity of thought and other people's opinions on where the company should be going really had better outcomes. And it's probably why, when you look at the Fortune 500 from 20 years ago, 50% to 60% of those companies don't even exist anymore because I think they have too much group think and they don't keep along with the times and anticipate the future because they

• 29:37John R. Miles?

  become too tied to what's already worked and not what's going to work in the future.

• 29:42Speaker 01

  Absolutely. And when you link it to our earlier discussion, because we have these biases, we want to have people who are going to counteract those biases, not amplify them. So it could be that I'm male and my colleague is a female, but if we both went to the same university and think the same way, we're going to be amplifying. Actually, to have somebody of the same demographic background as me, but from a different educational background, he's going to be more likely to see my blind spots.

• 30:10John R. Miles?

  Well, let's talk about how things become terrible investments once expectations become unrealistic. And I want to go back in time for this one because one of the best stories I thought you had in the book was about even the man who discovered gravity couldn't escape financial gravity. So can you share with us why you decided to pick Isaac Newton to focus on in the book?

• 30:35Speaker 01

  Absolutely, because Isaac Newton was obviously an extremely smart person. And what I wanted to highlight is these human biases are human. So they will affect any human, even one of the smartest humans of all time. And so what did Isaac Newton do? He invested in the South Sea Bubble. So this was when there was the promises of untold riches by the UK trading with other countries. And so this caused the stock market to rise. He made some money and sold out, but then he decided to come back in for one last fling and bought it at the very top. And then he lost several million pounds in today's money. So even though he should have walked away, the idea of, oh, I don't want to miss out.

• 31:20Speaker 01

  I won once and I could be winning again. That is something which is very alluring and it's alluring for just anybody. So you could have made money on the stock market once. You think you're a genius about this. You go in even deeper and they end up losing even more than you won the last time.

• 31:36John R. Miles?

  And how does that tie to the concept of anchoring? I've been recently rereading Thinking Fast and Slow by Danny Kahneman. And I know that his work with Tversky, they really examined how people estimate things differently depending on whether numbers are presented ascending or descending. What does this have to do with markets?

• 31:57Speaker 01

  Yeah, so I think anchoring, it could be linked to the overreaction that I mentioned earlier. So one of Kahneman and Fersky's famous experiments, they took a series of numbers and they are participants to try to multiply them. So one group saw one times two times three times four times five times six times seven times eight, and the other group saw eight times seven times six all the way to one. Now, the answer is 40,320, but the participants were not even close. So those who started with one times two, they estimated 512. Those who started with eight times seven, they guessed 2,250.

• 32:38Speaker 01

  So over four times more the others, just because they saw the eight times seven first. And so this was a very famous study highlighting anchoring. We just look a lot at the most salient bits of information, which may well be the numbers that came first, the eight times seven versus the one times two. And so then how does this play out in financial markets? Is that we may over extrapolate. So if assessing a company depends on looking at 10 years of past performance, we might just focus on the last quarter because that's in the news and that's what we're hearing about. And even if that last quarter was a very lucky quarter, maybe it's a bookstore and the last quarter was the fourth quarter. And obviously, sales are going to be higher because of Christmas.

• 33:23Speaker 01

  We forget that. We don't look at the more long-term trend. We just latch on to that last quarter, just like an England football fan would be looking at Thomas Tuchel's last result rather than all of his wins before then.

• 33:38John R. Miles?

  Thank you for sharing that. The next thing I wanted to talk about was moods. Because one of the things that you explore in the book is that markets absorb collective mood. So how does this pertain to crowds? If you have a collective crowd, that mood all of a sudden becomes remarkably irrational. What happens then to the markets because of that mood?

• 34:08Speaker 01

  What will happen is that the market may move significantly away from fundamentals. And so this is actually quite counterintuitive because there are arguments that crowds should lead to wisdom and collective intelligence. So there was a very famous book called The Wisdom of Crowds by James R. O'Wicki. And what he started with was an example of a county fair where you had to guess the weight of an ox. And so many of the people who came to county fair, they're not farmers, so they have no expertise in this, they might be running a cafe. And so they submitted their bids and some guessed too high, some guessed too low. But the average guess was actually very close to the actual weight of the ox.

• 34:50Speaker 01

  And so this highlighted how crowds can be wise because you're looking at people's collective intelligence and while anybody could be individually off, these biases cancel out. But this is actually not the case in financial markets, which is why I gave a different answer to your question. Why? I think there are two things which are different in financial markets. One of them is biases and psychology is that nobody gets emotionally attached to the weight of an ox, but we do get emotionally attached to particular companies. So maybe electric vehicles, we want electric vehicles to succeed. We see them as a solution towards climate change. And that's why we might all be overbidding EV companies. And that's why they were in a bubble in the early 2020s.

• 35:36Speaker 01

  The second is herd behavior. So when you submit your bid, your estimate of the ox's weight, you do that in secret. But right now you can see what everybody else is doing. If you are chatting to your friends, it might be that you hear that they are into Bitcoin and you don't want to be missing out. It could be that you're speaking to colleagues, particularly if you're a trader yourself. Or you could nowadays talk to people that you have no idea who they are. So if you're on Reddit and you go to the Wall Street Bets forum, then it stings to be the lone person downvoted because you're somebody exercising caution about artificial intelligence. And there have been experiments like Solomon Ash's experiments on conformity,

• 36:21Speaker 01

  where we will conform to even random people because it stings to deviate from the crowd. And so this is why, rather than leading to collective intelligence, actually crowds should lead to collective folly. If some people have said something wrong, then others follow. That could be the equivalent of somebody shouting smoke fire in a theater and everybody leaves that theater even though there's no problem.

• 36:43John R. Miles?

  It seems like what you're saying is that oftentimes markets have been driven more by compelling stories or fear of missing out or other things like that, rather than underlying fundamentals. So why does that make the narratives that we hear so much more persuasive sometimes than the evidence that's right in front of us?

• 37:04Speaker 01

  Because people love stories and this has been here since maybe the dawn of humanity. Is before we had writing, we had the oral tradition where people would explain things through story. So if you wanted to tell your children not to go walk too closely to the river, you don't explain that, oh, if you fall into the river, you will drown because the oxygen content of water is less than of air. You will say, well, there's a sea monster who'll come and gobble you up. And so that's much more compelling. And so right now we love to hear stories. And so if you hear about that friend who made double their money on crypto,

• 37:44Speaker 01

  that is really salient compared to a statistic that the average person loses money on crypto. So if the story is from somebody salient, it could be an influencer, it could be your friend. You think, well, that could apply to me right now, even though that story is irrelevant. Because what happened to crypto over the last six months is not a guide to what it will do over the next six months. So we latch on to stories and we put too much weight on them compared to the power of large scale data, which combines maybe a thousand data points rather than just one.

• 38:17John R. Miles?

  And Alex, I have to tell you, I've been susceptible to this as well. I have a really close childhood friend who has killed it in the crypto markets. He's made 50 or 60 million, but it's all he does. And where I have lagged behind him is since he's day trading and is constantly looking at the ups and downs, he's able to get in and out on a quick basis. Whereas I am looking at it more from a long-term perspective. So I miss some of the trends that he sees. But it's interesting how I followed his guidance and thought, because he could do it, I could do it too. You're right, it's, we sometimes see things like that and think, just because they did it, we can get into it too.

• 39:01John R. Miles?

  So stories at times can lead to financial downfall, as they did in my case.

• 39:06Speaker 01

  Yeah, absolutely. And we often don't realize differences between us. So he's able to look at this every day, whereas you're doing other things. Or you could have just different investment objectives. So maybe he's able to take an extremely long-term perspective. You might be concerned with your mortgage being refinanced next year. And so you might not be wanting to make the same investment decisions because your investment objective is different.

• 39:33John R. Miles?

  Well, I do think this has a lot of parallels to our last discussion because we really went into last time, how identity shapes the information we're willing to accept. And I think what we're uncovering here is stories as they relate to markets.

• 39:50John R. Miles?

  Really become powerful because they reinforce who we believe ourselves to be and then then influences our decisions when it comes to the markets. Is that a good way to kind of think about this?

• 40:01Speaker 01

  Yes, absolutely. And we often start with our own vantage point. And then because of confirmation bias, we will interpret data and evidence in support of that vantage point. So if I'm somebody who believes crypto is going to be a revolution, it's decentralization and democratization of finance, that I'm naturally going to be latching on to stories of Instagram influencers investing in this and not realize that there could be thousands of other people who are investing, losing money, and they're never going to be posting about this on Instagram. And similarly, if I'm somebody who's very skeptical about financial markets, thinking, well, they're just run by a load of crooks, then I'm going to be putting my money into cash. And then this is, to my mind,

• 40:43Speaker 01

  losing out on one of the biggest inefficiencies in stock markets, which is known as the equity premium puzzle. So what is this? So the average return on the S and P 500, let's say in the last 10 years, it was 15%. In treasury bills, it was 3%. So that difference is 12%. And you may say, well, that 12%, that's not free money because the stock market is risky. But people have analyzed, what should a fair return for risk be? And the actual difference that you get in the stock market is way higher than whatever should be fair compensation, given the level of risk. So the stock market is a good deal over any reasonable time horizon. So in the final chapter of the book,

• 41:24Speaker 01

  I give 20 simple principles for people to start investing better. And one of them is just play the game. So to invest in the stock market rather than having your money in cash, yes, it may be that there's short-term fluctuations. And yes, I might not like traders or have, I might be suspicious about the financial industry. But let's put those sort of emotions aside. You are here to invest for your and your family's financial future. And over any reasonable horizon, the stock market is a good investment, particularly given the power of compounding.

• 41:54John R. Miles?

  Alex, one of the chapters I wanted to spend some time on, and it kind of connects to what we were discussing about earlier, is chapter six, because I really found that this was, to me, one of the most important chapters. And that the whole chapter revolves around that markets consistently underestimate intangible assets. So earlier, we were talking about things in companies, like the importance of belonging, matter and trust, et cetera. And in this chapter, what you're really saying is that things like culture, innovation, reputation, human capital, matter far more than what people give them credit for. Can you unpack this a little

• 42:37John R. Miles?

  bit? And then I'll ask some additional questions about it?

• 42:41Speaker 01

  Absolutely. And I'll first start by unpacking it over two separate levels. Level number one is people will often view the value of a company based on tangible factors. So that might be plants and machines and buildings, or something like product soul, those are things that we can see. We know that Apple is a great company because we see everybody with their iPhones and iPads. But actually, one of Apple's biggest sources of advantage is the people. And you don't see the people, but it's the people who are not only creating the current iPhone and Apple Watch, but will create future ideas and future products that we don't yet see. And that is where a lot of the value of a company comes from, is these intangible factors, such as innovation or corporate

• 43:24Speaker 01

  culture, or customer trust. Then the level two is even if people realize that, and many people do realize, yes, what matters is whether a company is innovative, or whether it treats its work as well, we don't know how to measure it. Why? Because we might go back to quantitative metrics. So we might measure innovation by looking at how much money a company spends on R and D. But the amount of spending doesn't tell you anything about the quality of spending. You could be burning loads of money on Google Glass, which ends up not being a, not generating a viable product, or you could spend your money on something which really does end up outperforming.

• 44:06Speaker 01

  Again, to use the sports analogy, the teams that spend the most money on players are not necessarily buying the best players. What I want to measure is the innovation output. So there were studies that show when you look at patents, both the quality of patents and also how innovative those patents are, that is a better measure than just R and D spending. When you look at employees, as I mentioned earlier, people might look at more superficial metrics, such as the percentage of women or minorities in the workforce, that doesn't capture cognitive, and it doesn't capture equity and inclusion of corporate culture, which will allow people to express their different viewpoints. So there's the two levels here. So number one is people don't think that they're important compared to the tangible stuff. And there's number two, there's the people who do think it's important, but will still try to measure

• 44:51Speaker 01

  something intangible using quantitative measures, because finance people are naturally people who like numbers, and they don't like something which might be more qualitative.

• 45:02John R. Miles?

  So I want to talk next about the environment and how this relates to ET and Candy. So in the book, you talk about the movie ET, and you talk about two different companies, Mars and Hershey. And I kind of think Mars got it wrong, and Hershey got it right. But how does this all relate to each other?

• 45:25Speaker 01

  Yes, this is a great question, because this is about the power of a brand. Every investor will know, well, the quality of the brand really matters. But what's tricky is, well, how do I measure brand? And in particular, how do I measure brand in a way that other people are not going to notice? So for me now to say, oh, let's just buy Coca-Cola shares, because Coca-Cola has got an even stronger brand than Pepsi. Well, people know that, and it's probably already going to be in the price. What this section of the book looked at was the role of movies. So why did I use ET? As is rather notorious now, is that when they were scripting that movie, they wanted a trailer of Candy to lead ET out. And so they initially approached Mars, and Mars turned them

• 46:10Speaker 01

  down, which now is seen as bad a decision as the record company who turned down the Beatles, claiming that guitar groups are on the way out. So instead, they approached Hershey, and Hershey said, yeah, please use Reese's Pieces, which was not a, which was a nascent product at the time. And this has led to a huge bump in Hershey Reese's Pieces sales. Now, what is interesting is that you know ahead of time what movies have which commercial tie-ups, because they often will release this in a press release. But what studies found is that only once the movie is shown on opening day, do does the market incorporate that information. So when they see your product

• 46:52Speaker 01

  being placed in a blockbuster movie, yes, the stock market reacts, because that is again salient, it is tangible, we see the movie. But if it's just in a press release, it's one of many headlines where others are about new earnings, or we ran to New Bird AI, that you're being featured in the movie might just be less salient, and so it doesn't get as much attention.

• 47:16John R. Miles?

  So you go from looking at movies in this chapter to later on, you're talking about algorithms and L L M Ss. Where does all of this play out in how we need to start thinking about allowing humans to be freed up to focus on nuance and uncertainty, and how this relates to investments, investors, markets, et cetera?

• 47:43Speaker 01

  And this is again, a good and important question, because you might think, well, with, in the age of AI, a lot of the inefficiencies that I find in the book, they might go away. So you could get an AI tool to scan all of the news items to look for product tie-ups in movies, and form a trading strategy based on that. And I will admit this, there are certain things that I think AI might be able to look for. But number one, it's important to understand the psychology so that you can point your AI tools at it. So for me, highlighting the importance of movie ties, that is necessary for you to get AI to exploit the strategy. And number two is, I think there are certain things that AI will still not be able to evaluate, no matter how sophisticated it is.

• 48:26Speaker 01

  So one analogy I like to use, although it's not in the book, is one of job interviews. So more recently, people are now using psychometric tests in the job interview. And that is something where people think, well, it's going to be unbiased, it's not going to be people looking at their old boys' club, they're trying to have some scientific way of looking at that. But still, we don't evaluate people only according to the psychometric test. We will want to interview people, somebody. Why? Because we know that there's certain things that the psychometric test will not be able to capture. And now people are looking at even broader sources. So the Duolingo CEO is now asking taxi drivers, how did this person treat you in a taxi? And that is something relevant. And so in an AI

• 49:11Speaker 01

  world, when AI gets even better at analyzing things such as even movie tie-ups, or patent numbers and patent quality, not just R and D spending, I still think there will always be certain things for humans to look at. Maybe I want to invest in a retail company. I'm not just going to look at it as sales from my office. I'm going to walk into the shops, see how customers and workers are being treated. I might look at an angry customer, and how the customer service deals with this person. And the more AI is able to deal with the quantitative stuff, I think the more human time might be freed up for these other things. And we might have more innovative sources

• 49:52Speaker 01

  of information, just like the Duolingo CEO asking the taxi driver about whether you should hire that

• 49:59John R. Miles?

  I'm sorry I'm jumping around on you. I'm just going into some of the things I thought were interesting in the book at this part. And one of the things I want to talk about is a section of the book that you have called The Perils of the Pedestal. And I'm going to introduce this is I'm a big Philadelphia Eagles fan. And last year, one of our star players got on the cover of Madden 2006. And no one wants their player on the cover of this because there's, and it played out true for him. It seems like the year that they get on the cover of the game, they have one of their worst years. And that's exactly what happened last year.

• 50:41John R. Miles?

  But in the chapter, you talk about Mark Zuckerberg back in 2010, being named Time Magazine's Person of the Year. You fast forward to 2026 Zuckerberg, I don't think he'd be on Time Magazine's Person of the Year. But what does this peril of the pedestal have to do with financial markets? And why did you choose to write about it?

• 51:03Speaker 01

  Absolutely. So this is part of Chapter Seven, which is on how the market underreacts to very important sources of information. So Chapter Six, which we just discussed, was underreaction to intangibles such as employee satisfaction and brand and innovation and even movie tie arcs. Chapter Seven looks at underreaction to the most important person within the company, which is the CEO. So we've seen some companies with some great inspirational CEOs, others with people which create toxic cultures, or they overinvest, or they're just focusing on maximizing their bonus. And there's lots of important signals about the CEO, but the market just underreacts to. Why?

• 51:44Speaker 01

  Either it doesn't notice the information, or it does know the information and thinks it's good when it's actually bad. And so the Time Magazine example is one. So when your CEO is named CEO of the Year, you might think, well, this is great. I want to even more buy into this company because it's got a great leader at the helm. And this is also something where this will mean that other employees will join this company and maybe regulators will back away from finding it. Suppliers are more willing to supply to it. But what the evidence finds is that is actually a lot of overreaction here, where this leads to them, the CEO, being seen as a hero and a cult that nobody can challenge them.

• 52:26Speaker 01

  So the problem of root thing that you mentioned gets even more pronounced. And it means that the CEO can end up taking board seats, writing books, joining other businesses. They sometimes have suspiciously low golf handicaps because they can get away with behavior that they couldn't have got away before they could became CEO of the Year. And so what the evidence suggests is that you want to sell out of these companies where the CEO becomes a star. But because the market here, it doesn't just ignore the information, it reacts the wrong way to the information. It thinks that this is positive when it's actually negative. This is where there was the hidden opportunity.

• 53:02John R. Miles?

  Since we were just talking about the C-suite, in your experience, Alex, what do you think separates leaders who create lasting enterprise value from those who simply are creating the appearance of success?

• 53:14Speaker 01

  Well, I think one important thing is the horizon that they have. And so some of my work is on the importance of incentive horizons. Am I given, say, shares in the company that I cannot sell for 10 years or 20 years? Because if so, then my incentive is to invest in sometimes unglamorous stuff, such as corporate culture, developing a place where people feel psychologically safe, maybe tackling my carbon footprint. That's not something that will pay off immediately, but it might pay off in 10 years' time. Whereas there might be other CEOs who are focused on short-term bonuses, or even worse, adulation. They might do flashy rebrands or big mega mergers, or they might be concerned about

• 53:57Speaker 01

  just using the company as a piggy bank. So it was the CEO of Tyco who threw a, I think it was a $2 million party for his wife's 40th birthday, charging half of it to Tyco. And this really matters. And what I'm suggesting in this chapter is we can use a lot of these publicly available signals to tell us a lot about the CEO as the CEO's character.

• 54:19John R. Miles?

  So AI is becoming increasingly sophisticated, even faster than even the experts thought it might. Yet your book really outlines that human judgment remains indispensable. As AI becomes more powerful, do you think markets become more efficient? Or do our emotional biases simply evolve?

• 54:41Speaker 01

  I think markets will become more efficient. And I think I would be a Luddite or too wedded in my idea of behavioral finance if I was to give a different answer. So I think markets will become more efficient because AI is able to process information better. But I still think there will be a significant amount of residual inefficiencies. I don't think efficiency can always be perfect because there will always be added sources of information, certain things which the AI cannot handle, such as, say, customer satisfaction, or what is it like to walk into a store and get a feel or a smell for the store? AI might also have its biases that might be putting more weight on quantitative rather than qualitative information.

• 55:24Speaker 01

  So just in all other fields and all other types of markets, if we like to be like Al Roth and expand it to other types of markets, let's say the sports players market. Yes, people are using Moneyball-type strategies, being inspired by Billy Bean. But there will always be then advances, thinking, well, what is the next generation of statistics which people haven't looked at? So with baseball, I think what Billy Bean was about was looking at walks, not just hits. And then now people are looking at, well, what is the character of this baseball player? Is this somebody who will live up to their potential? Or to use the analogy that we just looked at, get caught up in their own hype and think, I'm a great young athlete and I don't need to try anymore. There's been so many stories of people with great potentials which are not fulfilled.

• 56:07Speaker 01

  That is something that, again, a human with experience might be able to evaluate better than AI. So I do think AI will make markets more efficient, but I do believe that there will be jobs for professional money managers for many decades to come because there will be certain things that humans will still be better at doing.

• 56:22John R. Miles?

  Thank you. And in the book, you write about the future being man plus human rather than man versus machine. And it made me think of another observation that Al Roth shared with me. He argued that when we ban markets, we rarely eliminate the man, we simply change where it shows up. And my question to you is, as algorithms begin to make more decisions for us, do you think our biases disappear? Or do they simply migrate into different parts of the system, kind of following his logic?

• 56:58Speaker 01

  I think they will migrate to different parts of the system because we all have biases. And if those biases are no longer being used to evaluate sales forecasts or earnings numbers, because AI is going to be doing that for us, our biases will then manifest in the qualitative stuff that we will be assessing ourselves. It may well be that if I go into a store and then everybody in the store looks like me or has a similar background, I might think, oh, this is a good store to buy in, rather than one in which people might have different backgrounds. You're always going to have these familiarity-type biases. And so they will just manifest in whatever decisions we give people. Yes, in a post-AI world, we will give people different types of decisions, but there will

• 57:40Speaker 01

  still be human mistakes and fallacies, which are fallibilities, sorry, that was my own fallibility with that word, and human fallibilities, which will be influencing the decisions that we are entrusted with.

• 57:52John R. Miles?

  And then lastly, Alex, if every Passion Struck listener remembered just one lesson from the madness of markets, one idea that would help them become wiser in their careers, relationships, leadership, perhaps their lives, what would you hope that lesson would be?

• 58:08Speaker 01

  See the other side. And so why I'd say that is you can apply this both within markets and within broader life. Within markets, it may be that I'm really excited about AI and I think that it's going to take over the world, I'm going to buy. What is the other side is, well, might this have already been priced in? It's been on a tear for the past few years. Maybe the stock price already reflects this. Or maybe there's concerns about it and there's people arguing that we should be putting this, the developments on hold before we really know whether this is going to be safe for humanity. And not only can we apply this in markets, we can apply this in anything. So before taking a decision, be this to change jobs, maybe take the other side. Am I just wanting to change jobs because of some microaggression or I'm just overreacting to this?

• 58:52Speaker 01

  Or to relocate or to break up with a partner? Any decision that I'm going to make, try to look at the other side. And if I can't look at this objectively, get a friend or somebody who you can trust to disagree with you to make the case for the other side.

• 59:05John R. Miles?

  Alex, similar to your last book, this one is extremely well researched and that research is very well applied throughout the book. And what I took away from reading it is lesson, the book, isn't about outperforming the market, it's about recognizing the cognitive habits that influence every important decision we make, from investing and leadership to relationships in life, as you were just pointing out. Where is the best place people can go to learn more about you, your work, pick up this book, everything else?

• 59:35Speaker 01

  Thanks for asking, John. The book is called The Madness of Markets: Why Smart Investors Make Crazy Decisions and How to Exploit Them, will be available in any good bookstore. But my work more generally, I'm very active on LinkedIn in particular, under Edmans, that's A-E-D-M-A-N-S. My website, alexedmans.com, has my academic research, but on LinkedIn, I tend to produce more short-form articles commenting on a particular situation. So that is a more lighter touch way of keeping in touch with my work.

• 1:00:04John R. Miles?

  Alex, thank you again for the honor of being back on the show and I can't wait for your next book after this one.

• 1:00:11Speaker 01

  It's a huge pleasure to be back. Thank you so much for inviting me, John.

• 1:00:14John R. Miles?

  Alex, thank you so much for this conversation. What I keep coming back to is how easily we can confuse what's visible with what's important. The loudest information isn't always the most valuable information. The most measurable thing isn't always the thing that matters most. And the consensus isn't necessarily the truth, simply because millions of people believe it. Alex's reminder to see the other side is deceptively simple. Before you make the decision, ask, what am I missing? What would someone who disagrees with me see that I don't? Because sometimes adapting doesn't mean moving faster, it means learning to see differently. And that brings us to our next conversation.

• 1:00:58John R. Miles?

  What if one of the biggest things holding you back itself isn't fear itself, but a story you've been telling yourself to stay safe? On Thursday, I'm joined by Scott Simon and Dr. Gregory Stock, the co-authors of the book of questions, Courage. Scott is the founder of the Scare Your Soul Courage Movement, and Gregory is the author of the bestselling book, The Book of Questions. And during our conversation, Scott shared one question from the new book that he says cuts straight to the core.

• 1:01:29Speaker 02

  In my courage work, the number one area where people struggle the most isn't about physical courage or even ethical courage, it's the ability to ask and answer hard questions. And that comes from deeply inside of each one of us. And I think that's where a beautifully crafted question comes into play. A great question kind of allows us to get below the surface, to connect with deeper parts of ourselves.

• 1:02:01John R. Miles?

  That's next time on Passion Struck. If this conversation gave you a new way to think about your own decisions, take a moment to follow Passion Struck on YouTube, Apple Podcasts, or Spotify, and share this episode with someone who could benefit from it. If you have anything that you'd like to share with us about today's episode, you can do it on Instagram, the Substack, the Ignited Life, or on our other channels. And if you haven't already, check out The Mattering Effect coming October 6. Until next time, stay passionate, stay purposeful, and stay passion struck.