John Kay’s Obliquity

Oblique

Many of the great mistakes of history, including the problems financial markets have continualy re-experienced, have been caused by a basic error of judgement – the idea that it’s possible to define, plan and control the outcomes of the world around us despite the rampant uncertainty we daily take in our strides. So instead of relying on expert judgement and feeling our way carefully towards outcomes we’ve found ourselves traduced by people with tunnel vision and a strong but unjustified confidence in their ability to navigate unerringly to a correct solution, whatever that might be.

This is the argument presented in a new addition to the popular literature on human decision making by the economist John Kay. At the heart of this book, Obliquity, are many arguments readers here will find familiar, but perhaps the most notable is the idea that those economists who argue that people are irrational are wrong. It’s the economists who misunderstand the nature of human decision making, not their subjects,

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Physics Risk Isn’t Market Uncertainty

Physics Envy

The idea that economics should be modelled on the concepts of physics has been prevalent for the best part of a century. It’s a deliciously engaging idea, that the steadfast and unbending rules of science should be the template for the queen of the social sciences. The only trouble is that in economics human beings are part of the system and don’t tend to behave as economists would wish them to.

On the other hand the ideas generated by analogies between physics and economics have generated a whole bunch of truly great economic ideas and are the basis of the whole of microeconomics. Although it’s tempting to argue that these ideas don’t truly make sense it’s actually quite hard to make this accusation stick. Economics and physics are connected – only just not quite the way economists like to imagine.

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Exploiting the Anomalies

Less Guts, More Gain

Given that it’s well established that people are behaviourally biased and that market prices are impacted by these biases you might think that it ought to be possible to profitably trade on the underlying anomalies that these generate. However, by and large, it seems that this doesn’t happen, either because the anomaly vanishes as soon as it becomes widely known or because it’s not actually possible to trade on the thing for one technical reason or another.

If this is the case then behavioral finance ends up being an interesting research area but one that’s difficult, at least for ordinary mortals, to exploit other than through the tried and trusted means of learning to ignore the instincts of our guts. Still, as you might expect there are people out there seriously looking at whether there are profitable trading strategies that might be exploited. The slightly surprising answer seems to be that there are.

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Dark Pools and Adverse Selection

 

Friendly Highwaymen

Scientists believe that a great deal of the universe is in hiding, being made up of dark matter which, rather inconveniently, refuses to interact with anything else and is therefore almost undetectable. In a similar fashion many stockmarket trades are now being carried out in so called dark pools, where they're supposed to be similarly undetectable. Unfortunately, despite what many users of them think, you don't need to construct a super-collider to detect trades in dark pools.

These dark pools are one way for investors to move large blocks of stock without alerting others to what they’re doing. They’re anonymous trades of indeterminate volume carried out in murky corners of the securities industry. As usual the industry argues that it’s doing investors a favour. That’s “favour” in the same way that a highwayman saved his victims from having to carry heavy bags of money about .

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History’s Financial Shadow

Wealth Depends on History Not Geography

Jared Diamond in his superb book Guns, Germs and Steel outlined a theory of human economic development that regards Western Europe’s original pre-eminence in this regard as being contingent on geography combined with a large slice of luck. Great book though it is more recent work casts doubt on the main findings. Increasingly it looks like success in economic terms depends less on geography and more on history.

Quite how history impacts differential economic development as seen in the world today is a booming and fascinating area of research. Teasing out the relevant factors from a jumble of data is a difficult and delicate art but one theme seems to be increasingly prevalent. It rather looks like current economic success and failure is predictable from the robustness or otherwise of institutions established hundreds of years ago. History casts a long financial shadow it seems.

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Greed’s Not Good For Shareholders

Don't Aim to Maximise Shareholder Value

When we look at the genuinely successful business people of our time, that happy band of folks who’ve created true shareholder value, enriching themselves and their followers to an astonishing degree, we find an extraordinary thing. The vast majority of these people are not particularly interested in money and their companies are generally not dedicated to some New Age declaration of shareholder value maximisation.

Greed is not a quality that seems to drive the world’s greatest creators of shareholder value and creating shareholder value is not the aim of the companies that are best at it. In fact we can pretty much guarantee the alternative: wherever you find over-rewarded executives presiding over companies whose main aim is to increase their market capitalisation we should pick up our skirts and get the hell out of it. Corporate greed is bad for ordinary shareholders.

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Looking for a Demographic Dividend

Listen to the Non-Economists

A few years ago that noted economist P. J. O’ Rourke opined that deciding whether to buy stocks or not was easy. He pointed out:

“We baby boomers have caused everything since 1946. We’ll keep buyings stocks until we retire. But when we hit sixty-five, we’re going to sell stocks. And the stock market is going to go down. And we’re going to wet ourselves.” (Eat the Rich)

As usual, PJOR was more right than the real economists, whoever they are.

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No Need For A Drawdown Drama

Get Out Less

Whenever markets go into free-fall we see a certain drama play out: participants firstly refuse to believe things are going wrong, then gradually subside into confusion before eventually capitulating and demanding that something needs to be done and that someone’s to blame. Generally, of course, the people most to blame are the ones in the mirror in the morning who’ve either let greed get in the way of good sense or fear in the way of opportunity.

Sadly these people are obviously getting out too much and not spending their evenings studying the statistical lessons of stockmarket history. What these tell us is that although we can have no idea how markets will next go loopy we can guarantee that they will. And every year that they don’t just makes the slippery slope that much steeper.

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Anatomy of a Growth Investor

Martinis in the Jacuzzi

The twentieth century gives us many examples of great investors but it’s an interesting fact that these are almost from the value side of the tracks. From Ben Graham to John Templeton and from Bill Ruane to Warren Buffett the men – and they’re all men – who’ve made extraordinary returns were all originally value investors.

With a single exception. Standing alone as a self-confessed, all-in growth style investor is Philip A. Fisher, who initially learned his investing skills during the downturn in the early 1930’s. Reading anything by Fisher is like sitting in a bubbling Jacuzzi sipping on a vodka martini and contemplating an evening of gentle debauchery with the Arts faculty: both a pleasure and an education.

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