Markets are made of up of millions of people — emotional and biased — who do weirdly wild things for no apparent reason. And yet, somehow, the markets are rational?
Adam Smith (George Goodman) discredits the thought in an imaginative way in The Money Game. One of the running themes can be summed up by Australopithecus.
Australopithecus was the “missing link” in human evolution, an ape-human creature with a smaller-by-more-than-half sized brain.
Something with such a small brain can hardly be rational or logical. It must be driven by baser instincts. So Australopithecus represents the unknown and unmeasurable emotion of the crowd.
…the real test is how you behave when the crowd is roaring the other way. We know a little about some individual types, but the crowd, the elusive Australopithecus, is still largely an unknown, an exercise in mass psychology still not accomplished.
Smith’s subtle jab shouldn’t be lost either: evolution gave us bigger brains but kept the baser instincts. That interplay of the crowd and the constant pull on emotions is a feature of the Game.
It’s also a broader lesson. Many players of the game spend all their time trying to figure out what the crowd will do next, in the hopes of doing it first, all while ignoring their own behavior.
It’s not the only lesson either. What follows is a few more that stood out from the book.
The ability to unlearn, and not be stuck in our ways, is underrated:
It has taken me years to unlearn everything I was taught, and I probably haven’t succeeded yet. I cite this only because most of what has been written about the market tells you the way it ought to be, and the successful investors I know do not hold to the way it ought to be, they simply go with what is.
We have a bias toward action. Doing nothing is another option:
Nothing works all the time and in all kinds of markets… If you really love playing the Game, any action is better than inaction, and sometimes inaction is the proper course, if it has been taken after measuring all the measurable options. If a decision is made not to make a decision, that is just as much a decision as a decision which initiates action.
Knowing the future won’t guarantee success:
Even if, by some magic, you knew the future growth rate of the little darling you just discovered, you do not really know how the market will capitalize that growth. Sometimes the market will pay twenty times earnings for a company growing at an annual compounded rate of 30 percent; sometimes it will pay sixty times earnings for the same company. Sometimes the market goes on a growth binge, especially when bonds and the more traditional securities do not seem to offer intriguing alternatives. At other times the alternatives are enticing enough to draw away some of the money that goes into pursuing growth. It all depends on the psychological climate of the time.
Making the “right” decision won’t guarantee success either:
Logic, to an outsider, would say that you have a company selling at 10 and you go and do a lot of research on it and figure out the sales and the profits and you figure if they can earn one dollar it will sell at 20. So you buy it and wait and the story gets that they earn the one dollar and it goes to 20.
But the market does not follow logic, it follows some mysterious tides of mass psychology. Thus earnings projections get marked up and down as the prices go up and down, just because Wall Streeters hate the insecurity of anarchy. If the stock is going down, the earnings must be falling apart. If it is going up, the earnings must be better than we thought. Somebody must know something we don’t know. With all the analysts and all the research and all the statistics and all the computers, it is still possible to be 51 percent wrong, and you can do better than that by flipping a coin.
The investing secret sauce that gets mostly ignored:
Meanwhile — not that it means anything — there are few rich random walkers, and few rich Chartists. But there are some quite successful investors around who have no particular system. Perhaps they are the lucky holders of serial runs, perhaps they are more rational or have better access to information, and perhaps — something not taken into account in the austere statistical worlds — they are better students of psychology.
The value of being early and patient:
The most brilliant and perceptive analysis you can do may sit there until someone else believes it too, for the object of the game is not to own some stock, like a faithful dog, which you have chosen, but to get to the piece of paper ahead of the crowd. Value is not only inherent in the stock; to do you any good, it has to be value that is appreciated by others… If you are in the right thing at the wrong time, you may be right but have a long wait; at least you are better off than coming late to the party. You don’t want to be on the dance floor when the music stops.
Delayed gratification, compounding interest upon interest, is the other secret sauce:
What does the purposive investor seek? “Purposiveness,” said Lord Keynes, “means that we are more concerned with the remote future results of our actions than with their own quality or their immediate effects on our own environment. The ‘purposive’ man is always trying to secure a spurious and delusive immortality for his acts by pushing his interest in them forward into time. He does not love his cat, but his cat’s kittens; nor, in truth, the kittens, but only the kittens’ kittens, and so on forward for ever to the end of cat-dom. For him jam is not jam unless it is a case of jam tomorrow and never jam today. Thus by pushing his jam always forward into the future, he strives to secure for his act of boiling it an immortality.”
The Two Rules of The Money Game