Finance for Non-Finance People, Issue #2
How the H does the stock market really work?
“It is a tale / Told by an idiot, full of sound and fury, / Signifying nothing.”
OK Macbeth is talking about LIFE there, not the stock market, but… same-same?
All day long, every trading day of the year, millions and millions of frenzied trades happen on the New York Stock Exchange, the largest in the world.
Eighty percent of the value of the stocks traded thereon is held by so-called “institutional investors” (pension funds, investment banks, insurance companies, etc.).
The fact that the remaining 20% of that value is now held by so-called “retail investors” (i.e., you and me, in our cute little Schwab accounts) is actually pretty staggering, and is reflective of a huge upswing in recent years, which is itself reflective of all sorts of phenomena. Point being, the average Joe/Jane is getting into stocks in a big way and in a new way. We could talk about why that is, but for our purposes today it’s just not that important. What we want to know is just What is everyone doing?
It’s really just three big things. Ready?
Three big things
Most retail investors are just moving stocks around.
The average stock today is held for just 5.5 months. Contrast that with the average holding period in the 1950s of 8 years (LINK).
This means that a majority of retail investors are driven by FOMO.
This means that the mentality of the average investor is one of speculating and trading, not investing.
This means that the average investor does not subscribe to the definition of investing that Benjamin Graham gives in The Intelligent Investor:
“An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
This means that very little has changed since Jesse Livermore (LINK).
Most big funds are also just… moving stocks around.
People who get paid a TON of money to pick the stocks that go into a mutual fund utterly fail to beat the market over the long term (LINK).
People who get paid a TON of money to pick the stocks that go into a hedge fund utterly fail to beat the market over the long term (LINK).
If you are a money manager, and your job — which pays for your kids’ private school tuition, your club membership, your vacations in St. Barts — is dependent on the fact that, while you can match the market (easy), or you can beat the market (hard), but you will get fucking fired if you underperform the market, guess what? You are strongly incentivized to look an awful lot like the market.
Also, reminder: even if you are a brilliant money manager who can outperform the market, unless you outperform by a HELL of a lot, after fees you will… more or less match the market.
Also, reminder: a lot of money managers can’t, for example, buy some weird tiny company that will go up 100x in five years because they manage, e.g., a “large-cap growth” fund, which means they have a mandate to buy Microsoft, Apple, Nvidia, Amazon, Tesla, Meta, etc., and are forbidden from buying anything else. And when Microsoft, Apple, Nvidia, et al., constitute such a huge percentage of the market, you will… MOLMTM.
Behavioral psychology explains way more about money than most of us realize.
Market go up, people buy.
Market go down, people sell.
Needless to say, this is the opposite of “buy low, sell high.”
The meme stock craze, the existence of cryptocurrency, the fact that Nvidia’s market cap (stock price x number of shares outstanding) is about equal to the GDP of France, all reflect the fact that, at least as far as money goes, humans are often lemmings and clowns.
I am not (just) talking about retail investors. I am talking about “the market,” 80% of which, you will recall, is the big money.
In what is indeed “one of the most famous [stories] in popular finance literature,” Isaac effing Newton lost millions in the South Sea Bubble (LINK). The more you read about money, the more you see that this is not an oddment of history but an evergreen verity of human psychology.
Elon Musk, Cathie Wood, Sam Bankman-Fried, Elizabeth Holmes — some are fabulist felons, some are just fabulously rich fabulists. But all of them understand and have profited from the fact that human beings have a powerful urge to gamble and speculate.
RIP Daniel Kahneman.
That’s nice. What are the implications for me?
Don’t speculate; invest.
(If you are buying individual securities) Buy low; buy smart; don’t sell.
(If you are buying the market as a whole) There is no “good time” or “bad time” to get into the market. Buy now; keep buying; don’t sell.
Remember that the smartest people in the world are, when it comes to money, often lemmings and clowns. Don’t try to be smart. Temperament > smarts every day of the week.
Remember that William Goldman’s famous line about Hollywood — “Nobody knows anything” — could easily have been said of Wall Street. Let that free you from feeling as though this is some secret smoke-filled room of finance gurus to which you are forbidden access. I mean, it’s there all right, but they’re all back there getting stoned on options and derivatives and commodities futures and the Fed and crypto and fees and biotech and AI and junk bonds and all manner of esoterica that has very little to do with ordinary people, and from which you can absolutely abstain. Keep sober and carry on. Trust that you can just do your thing, make modest and intelligent investments, and put together a DIY retirement fund for yourself and your family that will make money and which won’t make you want to poke your eyes out.
You’ve got this! You can do it!
See you next time with more exciting news of $ for non-$ people!
