Uncommon Sense. Pape Scott
were given names such as Lehman (since deceased), Morgan and Kleinworth (maybe he meant Kleinwort). When Marcovici was promoting these furry financiers, a Financial Times blog suggested that his company, Rat Traders, had ‘come up with an economic and efficient solution, available from any zoology department, pet shop or nearest sewer'.
So you want a piece of the rodent action? Marcovici can be contacted through his Cayman Islands address. Just Google rattraders.com.
If you think no-one would take Rat Traders seriously, then consider this: I was contacted at the time by a friend who spends much of his time sitting on a beach in the South Pacific. He provided me with a link to the website and asked me: ‘Do you think this would really work?' Now I said earlier that everyone draws their investing credibility line in a different place. I'll admit this guy's line was drawn a few standard deviations from the mean, but it does prove the point. One man's joke is another man's trading gem.
And before you totally dismiss the ability of rats to trade claw to toe with humans, consider a study outlined by US psychologist Philip Tetlock. It might be that rats have more of what it takes to become successful traders than humans do.
Tetlock described a study that pitted the predictive powers of a single Norwegian lab rat against a classroom of Yale undergraduates.7The study was set up so that food appeared on either side of a simple maze in which the rat was housed. On each occasion, the side on which the food appeared was largely randomly determined. But there was an underlying bias: it would appear on the left side of the maze 60 per cent of the time and on the right 40 per cent of the time. Statisticians call this a random binomial process.
Sven, the rat, quickly worked out that if he hung around on the left side he'd win more often than he lost. The undergrads insisted on trying to work out patterns and sequences, chasing the randomness with futile explanations. They performed worse than the rat.
I don't want to talk too much now about what's coming up later in the book, except to say that humans can learn a lot from this rat's behaviour. Successful investing is not about always being correct; that's only ever going to happen in your dreams. Investing is about operating in a world that's largely characterised by randomness. Like the rat, successful investors lose plenty of times. But, also like the rat, successful investors set out to win more than they lose. Like Sven, they've worked out ways of tipping the odds in their favour. And the whole time they're doing it, they're watching most other investors behaving like the Yale undergraduates – looking for and often believing they've found patterns where they don't exist.
It's now time to make a powerful point.
Every story in this chapter has described a person or group of people who truly believed they were onto a winner. Whether it was drawing lines on stock charts, studying sunspots or buying specially trained rats, each believed they possessed a market-beating method. Each drew their ‘credibility line' in a position they believed was correct. You might have been amused at some of their beliefs, but remember they weren't laughing at themselves.
So where is your line drawn? You probably reckon it's in the right spot. Chances are it isn't.
The reality is, investing is not like most people imagine. Options aren't clearly defined, even to those with years of market experience. It's not a predictable or decipherable puzzle solved eventually by attending enough investment conferences, reading the best-selling investment books or following the best financial guru.
Most of the gurus that you believe have the answers are really just like you – wearing a blindfold in a room full of blindfolded people. Fundamentally they possess more chutzpah than market intelligence. They declare to the world, ‘I know where I'm going, just follow me'. And because everyone is blindfolded, no-one realises the guy making all the noise is simply taking them all on a trip to nowhere.
If you don't want to be one of the guru-following multitude, you must read, learn and, most importantly, start thinking for yourself. Then, just like Sven, you'll have the tools to work the odds in your favour. But the tools have to be rationally based. They have to be repeatable. Only then can you hope to beat the market – that is, of course, unless you beat it by plain dumb luck.
Chapter summary
• Question all advice, particularly when it's delivered in a dogmatic way. While chance dictates that it might predict an outcome, often it won't.
• Not everything you believe to be true actually is.
• In the field of investing, success doesn't rely on always being correct. Rather, success is achieved by pursuing logical methods that tip the odds in your favour.
2
THE ART OF PREDICTION
It was an unusually warm day for a Melbourne winter, one of those sunny days July occasionally delivers – not a breath of wind or a cloud in the sky. I was crossing the pedestrian bridge over the Yarra River that connects Flinders Street Station to the Southbank business precinct. In 10 minutes I would be addressing the clients of a large financial advisory firm. Despite my iPod pumping out Led Zeppelin, my mind was busy running through the presentation.
My presentation was largely about prediction. Audiences love hearing about those big, and very wrong, predictions – the bigger the gaffe the better, and the higher the profile of the ‘gaffee' the better. TV personality economists, presidents, chairmen of the Fed, CEOs – they all make dumb predictions that leave them with egg on their faces. There are books full of their dumb predictions, so there's little point in repeating them here.
Okay then, just a few.
In July 2007 Ben Bernanke, then Chairman of the Federal Reserve, stated: ‘Employment should continue to expand … The global economy continues to be strong … financial markets have remained supportive of economic growth.'
Bad call. The US economy collapsed into recession five months later.
On 17 May 2007 Bernanke had said: ‘We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.'
The following year the fallout from subprime triggered the world's worst financial crisis in 80 years.
The irony is that Bernanke was a student of the 1929 Crash. And below is an extract from an editorial published in The Wall Street Journal on 3 September 1929. The Dow Jones Industrial Average had just closed at its all-time peak of 381.17:
Wall Street entered the autumn financial season in a definitely optimistic frame of mind. With railroad traffic showing steady gains, and production in the major branches of industry continuing at a high rate, the earnings prospects of the principal corporations with shares listed on the Stock Exchange were looked upon as extremely promising. Sentiment regarding the credit outlook was reassured by the activities at the Federal Reserve authorities in placing funds at the disposal of business through bill purchases in the open market. With trade and credit conditions favorable, buying orders accumulated in large volume over Labor Day, and the forward movement in the main body of stocks was vigorously resumed in the early dealings … Bullish enthusiasm was stimulated by the return of United States Steel to leadership in the industrial division.8
Like a boat full of oblivious oarsmen rowing towards Niagara Falls, there's not a single hint of imminent danger. The next month the 1929 Crash hit, and less than three years later the Dow had collapsed by 89 per cent.
At the epicentre of 2008's GFC were mortgage providers Fannie Mae and Freddie Mac. On 16 July 2008 Bernanke said that Fannie and Freddie were ‘adequately capitalized' and ‘in no danger of failing'. Just weeks later the US Treasury committed to a $200 billion bailout to save the two insolvent institutions. Financial markets and economies around the world went into a tailspin.
Okay, enough of that. If I keep going we'll be here all day. Back to a more general discussion, starting with those who believe prediction is possible – the Nostradamus set. This type of thinking is exemplified by Harry S. Dent, Jr., who states in his book The Next Great Bubble Boom: ‘Today there is an attitude that nobody can predict the future … that there are too many complex variables that can impact it. But this is obviously nonsense.'9
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