Thursday, December 29, 2011

Bullish on Analogies

While I was preparing my essay today, I got involved in a lengthy back-and-forth with Rob Strong--who has an Economics degree--about Economics. As is often the case, this diversion seemed more interesting to me than what I was straining to work on. So, if you'd kindly wait until tomorrow to see the fruits of that daily strain, and to see further mixed metaphors, I'd be much obliged.

In that strained fruit's stead, I present. . . "Strong and Wanczyk Discuss Investing and Develop Ludicrous and then Incrementally Less-Ludicrous Analogies about Same" (brought to you by Maybelline: "Maybe She's Born with It. Maybe It's Maybelline.")

For a number of years, Rob has been developing a theory that the stock market cannot be intelligently navigated by an individual lay-investor. He believes, correctly, that there are many millionaires who have already outsmarted said lay-investor, that those people-bots have thought, 100 times, whatever clever thing the lay-investor has thought before the lay-investor gets out of his PJs.

But he also believes, perhaps incorrectly, that knowledge is essentially useless for the lay-investor in this context.

One of the great things about this discussion is that neither of us necessarily cares about it. And so it's perfect ground on which to construct analogies. The discussion becomes about whose analogy illustrates the debate more than it is about who's right.

Today, he began his argument with a forward of an article by the very tall libertarian Megan McArdle, a section of which I include here:

(Photo Credit: the awesomely-named David Shankbone)

". . .I am rather skeptical [that] specially clever investment allocations are really possible. We can argue about whether Warren Buffett's results are random chance or inherent genius, but here's one question we probably aren't going to argue about: neither you or I (or almost anyone else) is Warren Buffett."

Rob Strong:

"What I've been saying! (The bit about the impossibility of outguessing the market, that is.)"

Dave Wanczyk:

"I still think someone like me--who's minorly knowledgeable--could probably do better at investing than a dog could. I read this whole article. Please give me a treat."

Rob Strong:

"You know a lot more about roulette than a dog does, but neither of you can calculate the ball's trajectory on the fly. In the meantime, ten thousand millionaires wake up at 5:00 am every day and do nothing but look at balls. "

Dave Wanczyk:

"On the roulette analogy:

Dogs don't know any numbers. So I have a much better chance to win at Roulette than a dog. Just as I could probably make more money by investing in Apple than a dog could if he stepped on a button that indicated Taco Bell or Acer or Enron. He might step on Berkshire Hathaway. Good dog.

(This image will only appear on this blog when I am explicitly discussing canine-gambling).

The millionaires can't guess Roulette's results either. They have more balls perhaps. But unless the house always loses, or always wins, there's still a reason to know marginally more than not.

Entertaining but confusing analogy.

Meanwhile, many people know more about everything than I do, and though you make a provocative and useful point, I think it's hasty to say that I can't be somewhat successful by getting an edge on most people.

If the fix is in, it's in. Assuming the market's not fixed, I'd like to offer another analogy:

1) Adam Schecter [sic] knows much more about football than I do. (Aside: He's also an unbearable ass). But unless there's a deep conspiracy, he doesn't always predict the outcome. 2) I know more about football than my mom. 3) Adam Schecter will predict that the Packers will win. So will I. The Packers will win. 4) My mom believes the Bears are good because the last time she heard about them--1986--they were winning the Super Bowl.

So, if we all put our money in to a bookie, I do well on this bet. Companies are not sports, of course. Things are baked in that I don't know about that favor the Schecters. But, again, unless you're willing to say that the stock market is a total cheat, knowing more always helps.

An effective analogy you might employ: say I attempt to beat Gary Kasparov at chess. It doesn't matter how much I learn. He's going to beat me every time.

However, when I invest, I'm not always playing against G.K. Chessterton (there it is Homer, the cleverest thing you've ever said, and only Rob was around to hear it). I may be investing with Gary Kasparov. So, if I learn The Amazon Gambit, for instance, we will both defeat the investor who's still caught up on The Snackwell's Defense.

The fact that I may be making money at the expense of others is a separate concern. Believe me, I have considered withdrawing my funds on account of the recent Occupy (un)pleasantness. However, I also don't know enough to ultimately decry our brand of capitalism.

Enjoyable discourse."

Rob Strong:

"I love this discussion.

Why does the dog need to recognize numbers at all? He could bet red (or 33) all night and statistically tie every strategy you would devise to beat him.

[Note from Wanczyk: See a forum on dogs in casinos here].

As regards your football analogy: picking the winner of a football game is like picking the winner of, say, global profits. It's just a fact that one company will have the most profits in a given year, and while your mom might have great affection for Chevrolet, people who are paid to know about stocks will know with a high degree of certainty that Exxon will make more profits this year. Your mom uncontroversially loses this wager.

But investing in the stock market is more like wagering on the point spread. You mom picks the Bears for historical reasons, or even based on the color of their jerseys, and she'll win her bet about half the time. Adam Schefter [not sic], with all his expertise, loses his point-spread bets about half the time (I assume). Nobody beats the spread (in the long run), because like the price of a publicly traded stock, it is a product of the hive mind, the Market. In both cases, experts spend their waking hours devoted to figuring out the correct price (or spread), and if the Market disagrees with them, the price/spread will tend to correct towards the "true" value."

[Note from Wanczyk: Rob seems to be putting his faith in experts and in the hive mind. Do the experts beat the hive mind? Schefter doesn't beat the spread].

Dave Wanczyk:

"We have come to a very useful analogy. I think it's still possible, however, to have some sense of what the hive mind will do by knowing more about the hive mind and the hive mind's(') foci.

Say the spread on the Packers-Bears is 10 points in the Packers' favor. Everyone knows the Packers are good. But I've noticed that they will be particularly good against the Bears' passing defense. I assume that most others haven't noticed this, or haven't noticed it enough.

Similarly, Apple is set to sell many IPads. That has helped determine the price of Apple stock. But I believe the Indian economy won't be as bad as the hive mind thinks, so I predict, because of my knowledge, that even more IPads will be sold in India, and the stock will outperform.

I won't beat the spread every time. Apple won't sell more IPads every time.

But that's why they play the game."

Rob Strong:

"But here's the thing: most others have noticed these things about iPads and India, because it's their job to do that. You might happen to be right on any individual bet, but over the course of a year, you will not be right more often than the South Asia Consumer Tech Markets analyst at Goldman Sachs, or the one at Merrill Lynch, or Credit Suisse, and the three dozen at whatever the big Indian bank is.

You might flip 100 coins this year, and get 53 heads, and think that you're really good at flipping coins and that you've earned a 6-head return on your coin flippery. This is a false inference. Next year you will flip 46 heads, and you will blame the Greek public sector for your woes, and you will also be wrong then.

The people who constitute the hive mind also have people who are paid to know about how the hive mind thinks. And those people have computers that respond to hive-movements faster than you can click "confirm trade". "

There's no free lunch, there's no hundred dollar bill on the sidewalk, and there is no slack in the stock market left for non-expert individuals to pick up. (The slack was picked up at 9:30:01 AM by a computer in suburban Connecticut). Any gains from specific trades should be attributed to good fortune and a generally-rising market, no matter what story someone tells himself about how he outsmarted the world."

Dave Wanczyk:

[Then proceeded to offer further analogies about surfing, carnival-barkers, chess (again), and, finally, ITunes. Suggested that he had both won and lost the argument. Realized, as it got dark outside the Athens Public Library, that he spent his day this way instead of analyzing Pork Belly Futures. Rejoiced].


Rob Strong said...

I thank you for fact-checking my opening-bell joke to read 9:30am.

I continue to love this discussion, since it reminds me of things I was once supposed to know about.

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