"The game of professional investing is intolerably boring and overexacting to anyone who is entirely exempt from the gambling instinct; whilst he who has it must pay to this propensity the appropriate toll."
This quote from Keynes is found early in Chapter 1 of Adam Smith's 1967 (but truly timeless) classic, The Money Game. In fact, for years it featured prominently in the quarterly newsletter I wrote, Musings From the Lyons' Den, as it resonated deeply with me. I recently re-read the book and found that its eternal insights not only could apply just as readily today but also that much of my investment philosophy was either formed by or is consistent with the themes Smith outlined in his book.
The book, written under a pseudonym by George Goodman, provides an overview of the "game" of investing and money management. Goodman is particularly taken by the psychological aspects of the stock market and other forms of financial trading. Because of this focus on the emotional element of investing, and because human emotions change so little over time, the book's insights are as valid today as they were when written.
A common thread of the book is that the participants in this game of professional investing are seeking something else in addition to monetary, risk-adjusted gains. That, if the game could be perfected and boiled down to mere aggregation of statistical inputs into a known and accepted equation, other people would perform those tasks and the game players would move on to something else. The thrill of competition, the juice of positive and negative returns and the constant struggle to know the unknowable form the real essence for the game players. I felt this to be true when I read the book thirty years ago and I know it to be true today, after twenty years inside the industry. It's why you see so many very old investors - people retire from work, not games!
In chapter 1, Smith writes that it has taken him years to unlearn everything he was taught because we are taught how markets should work, while successful investors merely deal with how they do work. In returning to this, I felt that Goodman would have been an early proponent of the field of Behavioral Economics. The differentiation between textbook people, or Econs as Kahneman refers to them, and people in the real world ("humans" to Kahneman) are a furthering of the theme that people are not perfectly rational in their economic endeavours, despite how useful that assumption is when devising scholastic theories.
Given that mere economics do not dominate market activity, in Chapter Two Smith provides sage advice from Fidelity's great Mister Johnson - "The first thing you have to know is yourself. A man who knows himself can step outside himself and watch his own reactions like an observer." I have found this insight to be more useful than any other in my career. I have a theory that portfolio management is most similar to poker in that math dominates in the long run, luck in the short-run and emotional understanding is the underlying key to rising above the crowd in both games. Part of knowing oneself is to know which strategies one can employ effectively and which one cannot. Perhaps there are 50 valid approaches in which to structure an investment portfolio, just to pick a number. The truth is, due to one's own emotional makeup, maybe only 10-15 will work for any one individual and which ones those are differ from individual to individual. Often, what makes a strategy a losing one is less whether it is theoretically sound than whether it is emotionally suited to a particular investor. I, for one, have found that despite having a fairly good ability to spot overvalued securities, and maybe even to make money shorting them on paper, I am not emotionally suited to trading from the short side and I do not add value when attempting to do so. Due to knowing this about myself, I can believe both that I should not short and that others can, and should, do so profitably. And I'm comfortable with that.
Another great, and very applicable line, from Johnson is "When the music stops, forget the old music." I would suggest this applies to the commodity/China story, whose music led the charts from 2003-2008 and whose adherents keep thinking it's coming back into style. The post-2009 bull market is a new groove, man.
Smith has some great insights on crowd behaviour as well. He refers to a stack of research reports on Motorola saying-at 212, and 184, and 156, and 124, and 110- that now the stock is a buy. He notes that in 1961, the whole world was going to go bowling but that in 1962, Brunswick managed to "make it from 74 to 8 with scarcely a skid mark."
But his deep insights come through in summing up crowds, noting that no one, after reading his comments, would ever want to be part of a crowd again, "and yet the fact is that it is really quite comfy to be part of the crowd." I would add that it's no fun being apart from the crowd as the crowd is usually right for quite awhile, even though they are "right" at the wrong prices for the last phase of the move. I've learned over the years that I have the ability to stand athwart the crowd but not to yell stop, to paraphrase William F. Buckley, Jr. By this, I mean I can miss a party but not maintain a short position against it, regardless of its efficacy.
One of the odder pieces to read started with the still-true observation that, "in every cycle, there is some industry whose stocks do not just rise: they go up 500, 700 percent." That seems a permanent part of the landscape. What stunned me was the reference to the fact that the airline stocks had performed that feat in the then most-recent cycle! In my lifetime, airline stocks have been perennial dogs, looming bankruptcies and, in the best cases, dead money! So, the parameters of the game remain the same but the names and players change.
Part II of the book is a still-relevant overview of the field of technical analysis. I'm about 95% a fundamentalist (and zero % a macro-forecaster) but I have respect for those who take an artistic approach to charts and technicals, attempting to discern from them, as Smith puts it, "if not what is everybody else doing, at least what has everybody else done?" One of Smith's characters says of technical analysis that it isn't the chart, it's the man who reads the chart. Perhaps that's why I actually prefer a technician who understands what the fundamentals are. Who lives and breathes what fundamentally-driven investors discuss. I can't help believe that understanding the drivers of the price movement helps to interpret the price movement. But I still think technical analysis is more of an input into the equation than the equation itself.
Similar to preferring to avoid the crowd, the little people and the odd-lotters (people trading in less than 100-share blocks) are discussed (and disdained). A line from the text could have been applied almost verbatim to 2012's market: "the odd-lotters continue their selling-on-balance, replete with a puerile confidence that the 'bad' economic news they read in the papers will shortly be 'understood' by the market." Replace "odd-lotters" with "online investors" and "read in the papers" with "see on The Daily Show" and you have a description of the continued 2012 mass redemption of mutual funds three year in to a huge bull market!
The description of how battle-scarred, aged investors (who experienced the brutal bear market of the 30s) refused to participate in the go-go market of the late 60s and were usurped by a bunch of young tigers, represented by Gerry Tsai, played out in a very similar manner in the late 90s when old economy stocks stalled out, leaving their value-investor-owners befuddled and unable to join in with the day-traders and momentum investors willing to trade companies for high multiples of page-views and infinite multiples of not just earnings but sales! The names and facts had changed but the animal spirits had remained the same.
A cute tale about three young kids working for The Great Winfield in a Kid's market - Billy the Kid, Johnny the Kid and Sheldon the Kid - is even more interesting given that Sheldon the Kid is big on Western Oil Shale because the western United States sits on a huge pool of shale oil reserves and "the technology is coming along fast." Well, it's here today, in any event!
Presciently, in chapter 19, Smith is visited by a gnome of Zurich who warns of the coming move off the gold standard by the United States. Interestingly, most of the doom-and-gloom arguments made by the gnome would still hold and, in fact, are still being made today. The apocalyptic outcome feared then and now has still yet to really unfold. But it may, someday it may.
The following chapter deals with confidence in the system and contains what I consider a bit of a dire warning - "the problem is universal. It is that governments are now held responsible for the welfare of the people. The aspirations of the people can outrun their ability to pay for them, and nobody has yet found a way to create answers to the aspirations out of thin air." Except, I fear, Ben Bernanke! To the question of whether it can all come tumbling down, the correct and worrisome answer given is, "Sure, it can all come tumbling down. All it takes is for belief to go away." That, in itself, is the strongest argument for the gold standard as opposed to what Jim Grant calls the PhD standard.
A funny tale of trying to exchange U.S. Dollar Silver Certificates demonstrates the futility of the exercise and the fact that my own Silver Certificate is of no more than souvenir value. But I'll keep it nonetheless.
Some things about the game have changed. An amusing description of a Motorola presentation, where earnings are guided down, led not to a stampede for the telephones but rather, since "they are security analysts, not newsmen, ... they use the Olympic heel-and-toe walk instead of the outright sprint" would be unnecessary today as the release would be illegal in such a forum and the keyboards at the ready. (Still, the reaction would be mimicked emotionally.) As well, one is unlikely to read references to crowds being "everywhere distinguished by feminine characteristics" in that the crowd "does not reason, it only thinks it reasons." Even if quoting Le Bon, today this would be prefaced with a rather stern disavowal!
But the truth of the matter, as I see it, is that this book, by walking through the portfolio management landscape with the psychological aspects as its roadmap, remains as enlightening a treatise on the "game of professional investing" today as it was when it was written. Track down a copy, pour yourself a full glass of port or a fine claret, and prepare to be amused and informed.