The recent press accounts of Richard Thaler winning the Nobel Prize for Economics are ironic as to the outlook of the general media, politicians, and many academics. The New York Times headline was “Nobel Goes to Expert in Irrational Behavior.” The truth is irrational behavior is in the eyes of the beholder, not the individual performing the supposed irrationality.
All of my investment life I have been puzzled by how often some very intelligent people have consistently made bad investment decisions (and probably political ones as well). The classic sign of poor judgment is people being on the wrong side of market tops and bottoms. The definition of market tops and bottoms are when the markets are massively out of balance, with insistent buying or selling pressure.
For years I have been asking the very learned professors at Caltech involved with Neuroeconomics why people make bad decisions. It appears that there is a portion of our brain where we make our judgments, and it is closely linked with our memory. In most cases our decisions are aided or driven by past experiences that produced good or bad results for us. I suggest that this the way humans and animals make decisions. Thus for us individually that is the rational way forward.
Benefitting From Others’ Irrational Behavior
One day sitting in the second semester Economics class at Columbia University, I contrasted the young assistant or associate professor conducting the class with the first semester’s professor, C. Lowell Harris, a full professor and a consultant to Standard Oil. Harris was a Conservative thinker and was our first teacher of the murky science of Economics. On this particular day, I leaned over to my neighbor and said I wouldn’t trust the second semester teacher to run a newsstand. The new instructor’s pitch was equilibrium pricing, his argument was achieved with the aid of an “X” marked diagram of where supply and demand met. In the real world, I concluded that different customers were willing to pay different prices at different times and conditions for the same product or service. I was proud of my analysis.
I was very wrong and it took me a number of years to find the real value of the experience. The study of economics began with the study of philosophy, but actually had major lessons that could have been drawn from the Bible. Academic economists had in effect “Physics Envy” with their mathematical equations and reproducible laws. Thus many texts teaching economics became loaded with laws that worked some of the time and equations which collapsed when applied to reality. To them and their students, humans were meant to solve economic and investment problems with the use of equations if they were to be considered rational.
In the standard liberal arts education there was often a requirement to take a course in economics and this was particularly true if one was concentrating on political science, These requirements led to at least two generations of students expressing themselves in adult behavior believing in top-down thinking and that people would make decisions using formulas.
The recent Brexit elections and the 2016 US Presidential election and possibly the Austrian election are samples of voters not voting in favor of their current economics, but based on their feelings for change.
In an interview in this week’s Barron’s, one of the more financially successful Professors of Economics, Robert Shiller, sees the need for narrative economics. I agree. One example of the need to capture the critical elements of a change in direction is the study of the 1987 one day decline of 22.6% in the Dow Jones Industrial Average, the biggest one day decline in DJIA history. Very few of the reports on the day revealed that the Chicago’s future market did not have an uptick rule for futures to be shorted and that the New York Stock Exchange did. It was in the Chicago market that the automatic, non-price sensitive futures were executed as part of the portfolio insurance programs. Thus at the opening, the NYSE could not short to absorb the Chicago selling. This is an example of regulatory arbitrage, some of which exists today.
We all know that there will be major stock and bond market declines in the future, perhaps coordinated with economic recessions/depressions. What I don’t know is when, how deep, and the proximate causes. Since I don’t know these, the best I can do rationally is to look at conditions that have led up to other major disruptions. My Blog Post 488, Seven Steps to the Big One outlined my concerns. If you would like a copy, email me at Mikelipper@gmail.com.
my watch list is the battle between creeping enthusiasm and complacency as
- ETF/ETN markets dominated by trading entities, particularly in sector and countries.
- Short interest declining on major exchanges.
- China’s successful managing of the internal debt structure, can it last?
- There is no recognition that at some point the US dollar will decline vs. others.
A Rational Move I Have Not Made Yet
I am assuming that when we experience the next major decline it will be largely cyclical and most investments will survive and endure the inevitably poorly-written new regulations. Looking beyond that point for the eventual benefit of younger beneficiaries, I am considering secular investments that will pay off in twenty or more years.
During that time we will have three key trends:
- The population will grow particularly in Africa and South East Asia. The rest of the world will get older and some sicker.
- The amount of farming land will shrink.
- The price and quality of our food will rise.
On the basis of these trends I am looking for investments in the agricultural commodities arena. There are a number of funds in this classification who have an average year-to-date performance of minus 7.12%. At this point I have not done the work to select funds. What I have done, some time ago, is to buy Man Group plc. This is not a recommendation as I don’t know enough, but it is the largest distributor of trend-following commodity funds, and could be of interest to our professional audience.
Two questions of the week:
1. What are you watching for a top, and are you planning to do anything?
2. Do you have any knowledge on investing in farms and/or commodities?
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A. Michael Lipper, CFA
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