One Expert’s Opinion
“Remember the order in which we form abstract beliefs:
1. We hear something;
2. We believe it;
3. Only sometimes, later, if we have the time or inclination, we think about it and vet it, determining whether or not it is true.
[Someone asking] ‘Wanna bet?’ triggers us to engage in that third step we only sometimes go to.” — Annie Duke [Thinking in Bets]
How often do you read market forecasts?
Do you base your buy/sell decisions on other investor’s actions?
Annie Duke’s ‘Wanna Bet?’ concept and approach to decision making highlights the pitfalls of investor’s behavior. The idea is predicated on humans frequently stating their beliefs with little to no prior research or due diligence.
It is often only when these beliefs are challenged, that we then re-evaluate our claims.
Every day, investors are inundated with financial news, macro forecasts, stock tips, and the ubiquitous predictions touted by market ‘experts’.
Given this relentless deluge of investment narratives, it is not surprising that many of us fall victim to story-based investing. Instead of financial analysis and empirical research, our investment decisions often stem from the subjective commentary that we’re exposed to on a minute-by-minute basis.
If questioned, could you sufficiently explain the thesis behind each investment in your portfolio? Or, “Wanna bet?”
The danger for investors, is that we’ve already placed our bet in the market before someone can ask “Wanna Bet?”. At that point, it’s too late for vetting our investment thesis.
“There are three causes of a rise in the prices on the exchange and three of a fall: the conditions in India, European politics, and opinion on the stock exchange itself. For this last reason the news is often of little value, since counteracting forces [may] operate in the opposite direction.” — Joseph de la Vega (1688)
According to 17th century author Joseph de la Vega, the stock market only moves for three reasons: politics, conditions in India, and opinions on the exchange. The driver of all three reasons, however, are narratives.
One can readily imagine a 17th century pundit forecasting how political developments in Europe will effect the Indian economy, and ‘What it Means for Your Portfolio’.
On the Dutch stock exchange during this period, a small group of speculators realized how easily influenced their peers were by individual trader’s decisions, and the short-term news cycle. Manipulating the market, therefore, was as simple as providing traders with the ‘hot tip’ that they scoured the exchange for each day.
An effective system was quickly developed in which the savvy speculators accidentally dropped notes around the exchange that held misleading stock tips:
“If it is of importance to spread a piece of news which has been invented by the speculators themselves, they have a letter written and [arrange to have] the letter dropped as if by chance at the right spot. The finder believes himself to possess a treasure, whereas he has really received a letter of Uriah which will lead him into ruin.” — Joseph de la Vega (1688)
Their victims, the unsuspecting traders, eagerly snatched the fallen notes and traded on the nefarious tips. Predictably, the trades were beneficial to the authors of these notes, as they often encouraged traders to bid up the prices of shares that the speculators owned.
The success of this trick is a testament to many investors lack of independent analysis, and due diligence. Dutch traders seldom questioned the quality of companies referenced in these notes, and purchased their shares solely because of another investor’s intent to do the same.
‘There has to be a reason he’s making this large purchase. He must know something!’
Two hundred years later, investors were still falling prey to the very same trick. Daniel ‘Uncle’ Drew, the notorious 19th century speculator, implemented a variation of the Dutch system using his handkerchief:
“In order to get the price of the stock as high as possible before beginning to sell it short, he [Drew] visited a NYC club where stock traders congregated. Sitting down on a particularly hot day, he pulled a handkerchief out of his pocket to mop his brow. As he did so, a small piece of paper fell onto the floor… After he left, the other traders pounced on the paper, which just happened to contain a ‘bullish’ piece of news on the Erie. They then proceeded to frantically buy the stock”
Before laughing at the investors that fell for this simple trick, consider whether our behavior is truly any different today.
While we may not invest because of a note we gathered off the floor, many of us certainly buy/sell based upon the predictions and actions of other investors. Following these narratives with no independent research, however, can quickly becomes a case of the blind leading the blind.
What if you had followed this prediction in 2004?
“HA! I believe that it is virtually certain that Google’s stock will be highly disappointing to investors foolish enough to participate in its over-hyped offering — you can hold me to that.”
— Hedge Fund Manager (2004)
Tokushichi Nomura, founder of the modern Nomura Holdings, was fortunate enough to begin his investing career during a Japanese bull market in the early 1900s. As the overall market continued to soar, Nomura seemed to profit on every investment he made.
Despite his successes, Nomura remained a disciplined investor, and turned to his research as the market began to feel frothy.
After comparing valuations in Japan against other global markets, he concluded that Japanese stocks were overpriced, and due for a correction.
On a dime, Nomura sold all his stocks (at a profit) to fund his new investment: a large short position on the market. These ‘shorts’ would profit if the stock market fell.
Unfortunately for Nomura, however, his fellow investors did not share this bearish outlook. Each day, the disciplined investor watched with agony as the overvalued stocks continued to climb higher. For just as Nomura’s short positions made money if the market declined, he lost money if the market went up.
Margin calls started pouring in as Nomura’s positions began to plummet.
When creditors came to his office seeking repayment, Nomura hid under his desk to avoid confrontation. He even hired an enclosed rickshaw to transport him through the Tokyo side streets so that no one could watch his movements.
Despite the financial and emotional toll, Nomura doubled down and purchased additional short positions. While many of his peers were swept up by the bull market euphoria, Nomura was grounded by his empirical research showing that stocks were overvalued.
To others, however, Nomura appeared to have gone mad. Why did he insist on continuing his failed bet against the market?
When he asked a friend, Shibayama, for a loan to finance his margin calls, Shibayama urged him to reconsider. Nomura maintained his conviction:
“He [Nomura] handed Shibayama a list of all his personal assets and pledged them to the bank. ‘I am betting my life that I am correct. If someone considers a matter thoroughly and does nothing, the outcome is the same as if he had considered nothing at all. I have never been wrong.’”
Two days later, Nomura’s data-driven investment thesis came to fruition. Japanese stocks began to slowly decline, before then plummeting 88% in a matter of months.
Nomura’s discipline paid off handsomely, as he profited $80M (2018 dollars) from his short bets.
The contrasting stories of speculator tricks, and Tokushichi Nomura’s empirically driven investments provide ample lessons for investors today.
In the 17th and 19th centuries, traders that relied upon tips from other speculators were met with heavy losses as the market moved against them. Rather than conducting thorough research and placing their conviction in the stocks that they purchased, they mistakenly placed it in the author of the tip, who gave poor advice.
Conversely, Tokushichi Nomura ignored the sentiment and predictions of everyone around him when he made his investments. Since his thesis was derived from independent analysis and data, however, it was easier to maintain his conviction.
When the market asks “Wanna Bet?”, an investment thesis backed by empirical research allows you to confidently take that bet. If your thesis is based upon the opinion of another investor’s actions or narrative, however, it may have been best to just fold…