Introduction
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.
"Rational Investing is not What You Think - Weekly Blog Post # 493"
No comments yet. -