Conversation at Panmure House

Key Highlights

• The market cycle pendulum is not mechanical, it swings (thought more of as a mood swing)
• Economics as a ‘dismal science’ as it’s not as repeatable, studiable and extrapolable
• “In theory there’s no difference between theory and practice, but in practice there is” - Yogi Berra
• Efficient Market Hypothesis
• In investing, participants are not rational and objective participants - they have moods
• What theory calls “inefficiencies”, I just think of as “mistakes”
• Sometimes prices are too high, sometimes prices are too low… but because prices reflect the collective wisdom of all investors on that subject, very few of the individuals can identify those mistakes and profit from them
• In the real world, things fluctuate between pretty good and not so hot. But in the markets, they go from flawless to hopeless. That’s the error. Because nothing is flawless and nothing is hopeless. But markets, treat things as flawless and hopeless.
• L90Y return of S&P is 10.5%, but in any given year it’s almost never up between 8-12%
• Why is return clustered outside that central range? Because of mass hysteria
• Explanation for the occurrence of cycles is “excesses and corrections”
• The excesses come from psychology, people get too optimistic, then too optimistic, then too greedy, then too fearful, then too credulous, then too skeptic. The big one is when they are too risk-tolerant or too risk-averse.
• When TV newsreaders talk about what happened to a stock…. giving you the impression that prices are the result of fundamentals and hence changes in price are changes in fundamentals… “Where do they go to find that out, because I haven’t found it yet?”
• The price of an asset is based on fundamentals and how people view those fundamentals
• Hence, facts and attitudes
• Any research that could capture changes in attitudes is important
• Superior investors have a better sense for the shape of the probability distribution that will govern future stock price movements, and thus a better sense for whether the expected return justifies taking on the potential negative events that lurk in the left-hand tail… there’s nothing in there about measuring, or anything mechanical
• Son (the growth investor) saying he’s not an optimist but a realist
• “But of course all optimists think they’re realists, and all pessimists think they’re realists”
• On info being so widespread, “readily available quantitative info with regard to the present cannot be depended on to produce superior returns”
• The Flaws in Passive Investing
• With greater move to passive, price discovery not established
• Potential for divergence between price and fair price increases, and free-riding (indexing) is not as easy to do
• So the irony is… Is that active investing is no good, passive investing works better, but only if people keep doing active investing
• The less people invest actively, the greater scope for the price divergence, the easier it is to find bargains… hence the irony
• Reflexivity - actions of the participants change the formula for success