One forward, two responses, re the "collective/hive" and oh-so-manipulateable
At 11:28 AM 2/18/99 EST, you wrote:
>The Dumb Smart Market
>By James Surowiecki
>In yesterday's piece on the recent fortunes of Dell Computer (which
>only worsened today), I suggested that even though some of the
>market's most popular stocks--Dell, Microsoft, Coke, Cisco--seemed
>to be outrageously expensive, in fact if you looked at the
>comparative return on invested capital (ROIC) of these companies you
>found that their uniquely high valuations were deserved. Then, more
>dubiously, I argued that it's no coincidence that the best companies
>in terms of ROIC were also the most highly valued, even though most
>investors have never even heard of return on invested capital. The
>market is recognizing value, even though it couldn't say why.
>How is this possible? In the simplest terms, you might say that
>markets are collectively intelligent even when the actors who make
>up those markets are individually dumb. Consider these two examples,
>which I've taken from Michael Mauboussin, an investment strategist
>at Credit Suisse First Boston and probably the most interesting
>thinker on Wall Street today. Mauboussin teaches a class every year
>at Columbia Business School, and every year, before one of his
>classes, he hands his students a form and asks them to estimate
>IBM's assets at the end of 1989 (not a number that you would expect
>even business students to know exactly). Every year, without fail,
>the mean of all the responses is within 5 percent of the actual number.
>Here's an even stranger one: every year, Mauboussin assembles a
>good-sized group of people (100-125 people) and gives them a ballot
>for the Oscars. On one side are the six most popular
>categories--Best Picture, Best Actress, Best Actor, Best Supporting
>Actor, Best Supporting Actress, Best Director--and on the other are
>six more estoeric categories. To play, each participant chips in a
>dollar and then guesses who will win the Oscar in each category.
>Obviously, some of the participants know a lot about the movies and
>about the Oscars, and some know very little. But without fail, the
>group's mean response across the 12 categories does better than any
>single human. Two years ago, the group got 11 out of 12 right, while
>the best human only got nine right.
>I don't know about you, but I find these stories absolutely eerie and
>absolutely instructive. Taken together, what they seem to suggest--I
>want to say "prove," but I'll refrain--is that the collective
>response of a group to any question of knowledge is going to be both
>the best response possible (the Oscar example) and a remarkably
>accurate response as well (the IBM example).
>If the question in the case of the stock market, then, is "Which
>companies have the greatest long-term value as businesses?"--and
>this is the basic question, even if it gets framed in other
>ways--then the market's answer to that question is, much more often
>than not, going to be right, as it has been, and is, in the case of
>Dell, Microsoft, Coke, Gillette, and Wal-Mart.
>This doesn't mean that markets are always right, which is to say that
>it's not exactly just a restatement of efficient-markets theory. For
>instance, it often takes time for the market as a whole to
>recognize a company and think seriously about its business model and
>its valuation. (Which is why if you'd bought Dell in 1996 you'd be
>reading this on a yacht.) But there's a more important reason why
>markets aren't always right, too. Experiments like the ones that
>Mauboussin does work best when all the actors make their guesses
>independent of what everyone else is guessing. In other words,
>neither the IBM nor the Oscars experiments would work if people
>shouted out their answers one by one, because hearing the answers of
>others would shape the decisions of those that followed.
>But in the stock market, of course, people are always shouting out
>their answers, both in the form of the stock ticker but also on CNBC
>and on TheStreet.com and here in Moneybox. As a result, the market
>is subject to manias and panics, which you might define as periods
>when investors are only worrying about how everyone else is
>answering the question, instead of what the right answer is. In the
>long run, though, the right answer is what the market cares about,
>which may explain why someone like Warren Buffett is a great
>investor, since the right answer appears to be the only thing he
>You, perhaps, have wondered what a dog of Dow looks like. I submit to you
This article elegantly makes my point against centralized government
control: Government bureaus arrive at solutions based on the opinions of
one or a very few powerful and brilliant (at least in their own minds)
individuals who interact with each other and with dogmatic/ideological
political forces. The decisions they make and the solutions they propose
will (almost) always be inferior to those collectively arrived at by
millions of individuals experimenting in the real world, free of politics
and ideology, and interacting only as they adopt approaches others have
found, emperically, to be successful.
To figure out where to cross a river, Government worthies conduct studies,
hire consultants, request appropriations, consider all the alternatives,
make speaches, and ensure that their ideas are congruent with the latest
ethnic/feminist/egalitarian ideologies, and eventually declare where the
ONE best place to cross is, after sufficient modifications are made to the
riverbed and surrounding environment.
Real people, left to themselves, simply wade in and quickly find dozens of
natural fords no more than knee deep, without worrying if any of them are
Politically Correct. Government wants to prevent this experimentation.
The author is describing the benefits and wisdom of a version of this
Nort (Greg Norton of Semitool)
Actually it is just another take on the efficient market hypothesis, with
the caveat that there is a time delay in correct valuations being reached.
:) Interesting article, though. It is also a restatement of the
fundamental theory of investing: stocks have a price that they are actually
worth and over time their valuation will move to that price. If you can
just figure out what that price is . . . Worrying about what everybody
else thinks is the correct answer is more useful for investing in the short
term, however. It's just a question of style.
Fundamentalist: "Eventually the market will realize that this stock is
really worth x"
Technical Analyst "In the meanwhile I'll make money while people try to
figure out what the stock is "really" worth"
Figure out what is going to happen
Figure out how the market will react
Set a time frame
Figure out how to cash in
Ian (Ian Welsh, Manulife, Toronto)