Lessons in Stock Picking from the CIA: What Investors Can Learn from the Successes and Failures of Intelligence Operations in the 20th Century

Quarterly results, earnings calls, economic releases, management meetings and expert insights have long been the core of financial analysis, but big data is fast becoming the new frontier for fund managers. Even a cursory check of google trends shows that big data search queries have increased 20 fold in the last 4 years. On top of that it is increasingly being used as a buzzword in industry conferences, research and articles to showcase the advent of Fintech and the opportunities it presents for investors.

Institutional investors, even individual investors, now have access to unfathomable amounts of information. Technological advances in computing power and algorithmic complexity of even the last few years now allow digital data to be processed automatically and near-instantaneously. Much of the explosion in the quantity of data is being driven by new technologies such as mobile phone GPS signals, purchase transaction records, satellite imagery, and posts to social media – technologies that never existed only a few decades ago. The sheer depth and breadth of the data we generate daily really cannot be overstated. We generate some 2.5 quintillion (25 x 10^18) bytes of data every day, and IBM estimates that about 90% of the data in the world today was created in the last two years alone! If you don’t believe me, check out these incredible numbers by US software company Domo which show just how much data is created every minute by the following means:

  • Email users send 204,000,000 messages
  • Google receives over 4,000,000 search queries
  • Facebook users share 2,460,000 pieces of content
  • Tinder users swipe 416,667 times
  • WhatsApp users share 347,222 photos
  • Twitter users tweet 277,000 times
  • Instagram users post 216,000 new photos
  • Amazon makes $83,000 in online sales
  • Pandora users listen to 61,141 hours of music
  • Apple users download 48,000 apps
  • Yelp users post 26,380 reviews
  • Skype users connect for 23,300 hours
  • Vine users share 8,333 videos
  • Pinterest users pin 3,472 images
  • YouTube users upload 72 hours of new video

Understandably, the implications of harnessing this information to better understand business and consumer behaviour is seen as a veritable goldmine for active investors. And many are already making huge inroads into collecting, evaluating, and ultimately monetizing this new alpha through data science. For investors at the cutting edge of this relatively new field of stock selection, the WWW abbreviation synonymous with the dotcom bubble is now the VVV of the big data bubble – more Volume, more Variety, and quicker processing Velocity. Many investors and data providers are committing huge amounts of human and financial capital in the hope of uncovering new, untapped alpha signals – a new path for the financial industry but one that is well trodden by others, most notably by global intelligence services.

Intelligence agencies employ several intelligence gathering methods which utilize human, signals, geospatial, and measurements and signature intelligence. Combined and analysed correctly, this mosaic of information more often than not results in successful operations. However, the technical affluence of the US has often led to an infatuation with technological methods of intelligence gathering at the expense of on-the-ground research.

CIA case history clearly demonstrates that when decisions are made based solely using technical data, incorrect human intelligence, or without human intelligence at all, major errors and failures have occurred.

Operation Zapata, known today as The Bay of Pigs, was an intelligence failure in which the CIA trained exiles to overthrow Fidel Castro’s regime. The operation was a total failure, largely because of inadequate preparations, insufficient political backing, faulty assumptions about what the Cuban population thought of the Castro regime, and what it might do in the wake of the invasion. A former case officer asserted that it was a lack of human intelligence on the ground in Cuba which led to the failure of the Bay of Pigs and resulted in global tension and Kennedy’s greatest fiasco. Moreover, the human intelligence that had been collected by British intelligence in Cuba, that was made available to the CIA, indicated that the Cuban people were predominantly behind Castro, and that there was no likelihood of mass defections or insurrections that the US had anticipated.

The intelligence failures of the United States to fully utilize human resources would continue with the 1979 Iranian revolution. The intelligence problem here can be attributed to the US’s inability to perceive Iranian discontent with the Shah. This could have only been detected by on-the-ground intelligence gathering. This was then rendered a failure since it took no cognisance of primary data collection. The failure to anticipate the coup can be attributed to limits placed on collection by policy makers. Intelligence officers were prohibited to make contact with citizens in the souks (markets and bazaars) who were opposed to the Shah. This would have been considered offensive to the Shah and the Shah’s regime. Instead, U.S. intelligence were constrained to rely on the shah’s secret police, Savak, which had an institutional interest in denying that any opposition existed.

Shortly after the Bay of Pigs, the US faced yet another challenge in the Cuban Missile Crisis which resulted in success not a failure, solely because of the use of primary human intelligence. The Cuban Missile Crisis occurred between the US and the Soviet Union during October 1965, over the placement of Soviet missiles in Cuba. Reconnaissance flights over Cuba discovered the movement of the missiles utilizing satellite imagery which they deemed capable of striking the United states which was subsequently corroborated from intelligence received from a Cuban refugee that had seen Russian missiles on a truck in Cuba. Although the world seemed to be on the brink of nuclear annihilation, the US employed human intelligence sources which proved essential and critical to the decisions made by policy makers. Oleg Penkovsky was a colonel in Soviet military intelligence who provided invaluable intelligence to the US. The information Penkovsky provided allowed the Kennedy administration to know the amount of time the Soviet missiles took to assemble and become functional. This allowed Kennedy to pursue a diplomatic option, which resulted in Russia removing the missiles from Cuba in exchange for concessions from the US. The human intelligence provided by Penkovsky had averted a disaster and saved the world from nuclear destruction. Had the timely, first-hand account of the Soviet Union’s capabilities not been available, Kennedy would have been forced to act on the existing intelligence based upon images of missiles capable of hitting the US mainland which had the potential to result in disaster.

When we examine key US intelligence successes and failures of the 20th Century, the emerging pattern clearly confirms that no single or unique form of intelligence gathering ought to be considered in isolation. Human intelligence and insight should never be overlooked since it has the capacity to validate or invalidate other information sources and even introduce new learnings and new information!

Similarly, in the world of investment management, there is no panacea, no single form of data which can consistently deliver alpha – be it fundamental, technological or economic – or even a combination of all three. Fund Managers traditionally rely on a mosaic of inputs which are analysed collectively to facilitate a better understanding of the investment merits and risk-return profiles of any particular asset.

For Investors, there are valuable lessons to be learned retrospectively from the history of US Intelligence operations. Fund managers would be wise to pay close attention to human intelligence gathering and to ensure that it is incorporated into, and forms an intrinsic part of their collective data base. In doing so and by combining the human intelligence element through primary research, Investors can better manage risk and optimise the potential for success.

 “Those who cannot remember the past are condemned to repeat it” George Santayana

By | 2018-02-01T19:53:11+00:00 September 26th, 2016|Article|0 Comments