As you all may know, Volkswagen recently suffered enormous market cap loss due to admitting fraud. In one of my previous posts, https://feynmanresearch.com/2015/11/11/14-2/, I remarked that the situation was not as dire as most people think. What I didn’t realize at the time, was the reason why I wasn’t apprehensive about the scandal like a lot of other people were. That reason was second order-thinking, a concept introduced by Howard Marks in his excellent book” The most important thing”.
Second order thinking works essentially this way: you look beyond the immediate and obvious consequences of an action. Let’s say you eat a delicious hamburger at McDonald’s: first order thinking would be that the burger feels viscerally good and you don’t worry about gaining weight, increased cholesterol and blood glucose levels and so forth. Second order thinkers would look beyond the immediate euphoria that eating that burger might provide and consider the long-term effects of consuming that burger. Similar logic applies to what Volkswagen is going through right now.
The market reacted reflexively upon learning the negative news, and penalized Volkswagen beyond what the actual market value loss from the scandal could be. In addition to second order thinking, we also have the System 1 and System 2 at play here. The concept of System 1 and System 2 was introduced by Daniel Kahneman, a renowned psychologist. System 1 is basically our emotional and intuitive way of processing events, which although it is often accurate, it can mislead us in matters where logic is required. System 2 is our logical, rational way of thinking which can override our emotional, system1 thinking.
In Volkswagen case, system 1 was initially activated because once we see negative news, it is ingrained in our biology to respond with the fight or flight mechanism. Most people flew away from Volkswagen, and for those who stayed this scandal represented, and still represents an opportunity for the savvy investor to acquire shares for depressed prices.