Joel Greenblatt recently did a Talks at Google (video is embedded below). You might remember him from such books as The Little Book that Beats the Market and You Can Be a Stock Market Genius. He also ran a very concentrated portfolio that produced mind-boggling returns.
Greenblatt told the story about recently teaching a class of 9th graders. He started the class with an experiment. He brought in a big jar full of jelly beans, passed out index cards, and asked the kids to guess the number of jelly beans in the jar.
So the kids tried to count the individual jelly beans or the rows of jelly beans or found some other ways to come up with their best guess. Then they wrote their guess on their card.
Once they were done, he went around the room a second time, asking each of them again. Only this time they could keep their guess or change it if they wanted to.
Here were the results. The total number of jelly beans in the jar was 1,776. The average of the first guess, written on the cards, was 1,771 jelly beans. But the average of the second guess, when he went around the room, was only 850 jelly beans. Greenblatt explained the results this way:
I explained to them, the stock market is actually the second guess. Okay? Because everyone knows what they just read in the paper or what the guy next to them said or what’s on the news and are influenced by everything around them. And that was the second guess and that’s the stock market.
The cold calculating guess, when they were counting rows and trying to figure out what was going on, that actually was the better guess. That’s not the stock market, but that’s where I see our opportunity.
It turns out it’s hard to always be cold calculating robotic investors when there are so many things floating around influencing our views. In his jelly bean experiment, groupthink was one problem. The average guess was cut in half because the kids were influenced by each other’s answers. This same behavior can drive markets.
Someone does what the next person is doing, who happens to be doing what the next person is doing, who is doing the same thing. If enough people pile in like this, it can have a huge impact on stock prices, which usually doesn’t end well for investors turned lemmings.
However, for investors who are able to go against the crowd, when the crowd wants to do the same thing, this presents an opportunity. Greenblatt admits that it’s not easy. He also believes that investor behavior is getting worse, not better:
Your job is to be cold and calculated and unemotional. Unfortunately, people are human. It’s good for us, but the stats are against you. That’s why I think the indexers get it right for the wrong reasons. They mostly are saying the market is efficient and have other explanations for why you can’t beat it. I think the market often gives you opportunities, but it’s very difficult to take advantage of them for behavioral and agency problems. Those are much more powerful than just saying, “Oh, behavioral and agency problems.”
The people are people. And it’s been happening forever. I don’t think it’s getting better. I think time horizons are shortening. There’s so much, all that data, you know.
Look. When I started my first firm in 1985, I used to write quarterly letters and they read something like this, “We were up 3% last quarter. Thanks a lot.” That’s what it sort of said.
Now, you know, we have $10 or $20 billion endowments that need to get our results weekly. I don’t know what they do with them. But we now have to do that. And most of them do a good job with it, but that’s just the way of the world.
If you keep measuring things in shorter periods and you can measure them and there’s more data, it doesn’t make it better. It makes you more susceptible to emotional influence. So that world is getting better.
The last man standing is patience.
You know, we call it time arbitrage. Other people call it time arbitrage. Just being patient, that’s in really short supply. That’s not getting better. Things are moving to faster and less patience. So that’s really the secret.
This shrinking short-term view that Greenblatt is talking about is why a long-term perspective and sticking to your process is so important.
A lot of people claim to be long term investors but really they’re “long term investors” until the next potential crisis or until their strategy stops working or until a fund with a better past return comes along. That’s not long term investing. It’s not even investing. It turns out that’s losing.
The short time horizon is a highly competitive environment and it keeps getting shorter because more people want to play that game.
Few people are playing the time arbitrage game. That’s where the advantage is. The race to be first presents an opportunity to be last.
- Even Best Stock Pickers Can’t Beat Bots – Bloomberg
- A More Complex View On Value – L. Swedroe
- Your Brain Wasn’t Built to Handle Reality – B. Ritholtz
- Caution Signals Are Blinking for the Trump Bull Market – R. Shiller
- Diversification, Adaptation, and Stock Market Valuation – Philosophical Economics
- What We Said When the World Changed – M. Housel
- Howard Marks: CFA Society India – Youtube
- Automation Makes Things Cheaper, So Why Doesn’t It Feel That Way? – HBR
- 23 Things Artificially Intelligent Computers Can Do Better/Faster/Cheaper Than You – S. Godin
- Airlines Make More Money Selling Miles Than Seats – Bloomberg