Dying to Invest

Pain and Gain

Death, they say, is a great leveller and historically it’s the case that this has been true. Back in the early part of the twentieth century the richest man in the world, Nathan de Rothschild, couldn’t stop tuberculosis taking his life. Today, of course, fifty cents could have saved him. On the other hand Steve Job’s vast wealth has helped him survive pancreatic cancer via the best medical treatment on the planet. Maybe, in economic terms, death isn’t what it was.

No matter, the Grim Reaper will eventually take Apple's saviour from us as he will us all. Sex is designed to mix genes to help humanity in its never-ending fight against microbes seeking to destroy us: infinite longevity would come at the price of eventual human annihilation, always assuming we didn't do the job ourselves first. In economics as in science, however, we advance one death at a time and death has been one of the most important subjects for economics: no pain, no gain.

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Sharpshooting the Investment Gurus

Hitting a Barn Door

Take a rifle and randomly spray bullets at the side of a barn. Invite some gun-toting friends around to see your handiwork and accept their lavish praise as a dead-eyed sharpshooter, knowing all the while it’s an illusion. The trick is to paint the targets after you’ve made the bullet holes.

This, the Sharpshooter Effect, is essentially how many business gurus and investment analysts make their living. Worse, the effect affects statistical analysis of data that are genuinely important, like clusters of birth defects. The problem is that we’re not very good at distinguishing randomness from order and this causes us no end of grief as we pursue illusory patterns in the belief that we’re being smart.

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Eat Your Stocks

Much Ado About Nothing?

Scientists study stuff which exist: physicists the physical laws of nature, biologists the nature of life and psychologists the human mind. Economists, on the other hand, study money: which is surely a figment of the human imagination.

Given the ephemeral nature of the subject it’s a wonder that there’s any mileage in spending any effort on the subject at all, but huge amounts of time and money are expended in doing so. So if money is fundamentally unreal, what the hell is economics all about?

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Quality Signalling for Quality Stocks

Exeunt Investor

Making money from trading stocks should be ridiculously easy; after all,all you have to do is buy low and sell high. Which makes it a recurring mystery as to why so many people so often do the opposite. After all if you buy something at £5 and it drops to £4 it’s cheaper, right?

It’s not just with stocks that this problem occurs, although it’s just not so obvious elsewhere because we tend to buy goods and keep them rather than re-selling. Generally when we’re buying something we don’t understand too well we tend to look for signals that tell us whether it’s of a decent quality or not. Often one of the main signals we use is the price, such that a higher price is believed to identify goods of higher quality. Ergo, if the price goes down then that’s signalling something too: in the case of stocks, that we’ve made a mistake. Exit investor, followed by losses.

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The Small Cap Trap

Rampaging Elephants

The theory is that small capitalization stocks offer great rewards. After all, as Jim Slater pointed out in The Zulu Principle: “elephants don’t gallop”. Well, apart from when they’re being chased by a psychopath, armed with an elephant gun, in a bulldozer. As the last few years have shown, even behemoth sized corporations can grow startlingly quickly if they’re priced to go bust and then get bailed out by obliging governments.

Still, the idea that smaller cap companies offer outsized rewards is hard to shake. To the extent that share price grows with earnings then it ought to be easier to double the price of a small company than a large one. Which is, more or less, true. The only trouble is that it’s probably more likely you’ll see it sink to zero.

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In Value, Risk is Not Reward

Free Lunches

In looking for a free lunch many long-term investors gravitate towards value investing where the evidence is that so-called value stocks offer excess returns over medium term periods. This approach, however, brings with it a range of issues of mental discipline that can cause all sorts of strange behaviours, including an unreasoning attachment to stocks that have no merits whatsoever, apart from their consistent appearance on stock filters of a certain kind.

Over and above this, though, there’s a problem with the way that value investing is conceived. To the extent that it offers improved returns the general belief is that it does so by ensuring that the investor takes on more risk. This is exactly the wrong way for most investors to proceed: we want more returns for less risk. And done properly that's exactly what value investing can achieve for us.

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Spamanomics

Choking on Spam

Spam is a habitual hazard of publishing your email address. Sadly if you don’t tell anyone how to contact you won’t get contacted, so spam is an unfortunate reality of life. However, spammers aren’t jamming up our inboxes for the fun of it, they’re pursuing a business model with measurable success.

Of course spam isn’t simply an economic issue, it’s a problem for investors as well because so-called stock spam is surprisingly effective at manipulating markets. Micro-cap investors need to be careful that they don’t choke on the stuff.

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Breaking the Guild of Macroeconomists

Economic Entertainment

In an entertaining piece Economics is Hard. Don't Let Bloggers Tell You Otherwise Kartik Athreya of the Fed in Richmond has suggested that financial bloggers are a mentally incontinent bunch, pathologically incapable of stopping themselves from opining on financial matters on which they actually offer no insight. Now, leaving aside the question of whether we want our professional economists to be entertaining, this opens up the question of whether untrained commentators can provide any useful insight into matters financial.

The answer, speaking as an economically untrained scribbler, is almost certainly no: the vast majority of financial blogging opinion on any matter of prediction is worthless and that which isn't is indistinguishable from the rest. Unfortunately this is a conclusion of limited usefulness, because most trained economists can't actually offer any useful predictions either and following Athreya's prescription would almost certain deny us any opportunity for useful advances in the world of macroeconomics.

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A Keynesian Theory of Mind

The Mental Cell of Autism

Autism is one the crueller tricks that nature plays on human beings, leaving sufferers isolated, incapable of making social connections and effectively trapped within their own heads. Although the causes aren’t fully understood some of the consequences are, and chief among these is the inability of sufferers to take on the perspective of others. This failure to develop a so-called theory of mind means they simply can’t understand the needs and motivations of other people.

According to John Maynard Keynes a proper theory of mind is just what an investor needs to keep one step ahead of the crowd, although others feel that Keynes’ approach to investing is tantamount to chasing returns all the way to poverty. It raises the question, though, as to how much a person’s genetic makeup determines the type of investor they are. Are effective value investors really just socially inept wallflowers or simply extremely focused individuals?

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