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Human Error

Human Error

 

The Information is Out There

Here’s an interesting fact to ponder: over the decades, our ability to get information to the general public has leveled the playing field for almost every investor. With far swifter access, shouldn’t we expect significantly lower market volatility and why hasn’t that happened?

We believe human error explains the difference.

 

Do My Eyes Deceive Me?

You’ve probably heard the saying that “to a hammer, everything looks like a nail.” Now, consider how even the most sophisticated investors differ in their interpretations of big events like falling interest rates. We’ve read almost every kind of opinion and one can find an interpretation to support any position you may want to take – yikes!

Now, let’s further complicate our picture by observing that human beings generally feel good when we read a credible analysis that supports our view of the world. Further, if our day-to-day interactions are also mostly positive, we can even feel confident we see the world in a true and honest way. Except, we don’t without adjusting what our senses tell us.

What?

Let’s explore some examples.

The philosopher/mathematician Betrand Russell wrote many years ago that viewing a square dining room table from any angle other than directly above the table forces our brains to “normalize” the shape so that we agree the table has perfect 90-degree angles with four equal sides. What we are actually seeing when we are standing next to the square dining room table, however, is actually closer to a parallelogram and our brains adjust.

Similarly, when I view objects in perspective I can be deceived unless my brain adjusts. When I hold my thumb close to my eye and compare that to a person standing further away, both appear equal in size when clearly they are not.

Finally, we all remember the “telephone” game where each person in the circle whispers to the right what they just heard from their left. When we examine what each person actually says to the other, we see the message shifting pretty quickly with just a simple sentence.

We can justly conclude humans are mistake machines with less than perfect senses, so it’s unreasonable to think we would view the same events in the same way.

 

Confirmation Bias

Now, imagine what happens when folks digest and communicate the meaning behind the latest unemployment and inflation data? While that information is not whispered, its meaning comes with lots of uncertainty about our likely future. For example, we have watched inflation come streaming down without the Federal Reserve having to raise rates high enough to trigger a recession. Going forward, there is every sort of “informed credible opinion” today telling anyone who reads them that (1) the stock market will continue to break records, and (2) we are going to crash. How is anyone supposed to navigate so much noise?

And that’s where our personal limitations hit us hardest. While we might have our Life UnLocked interpretive model for digesting and projecting the economy, it’s not at all like someone else who swears by the Leading Indicator Index (“LEI”) and the “Sahm” Rule (for future unemployment.) Our model says we are in a soft landing, we will experience reasonable growth and inflation will stay a bit above 2% while someone watching the LEI and the Sahm Rule is preparing for a big recession and renewed inflation.

That’s a very big difference and what makes it so much more confounding is everyone can find lots of supporting data for their widely differing views. These views drive how we position our portfolios for that projected future so are these differences good or a fatal flaw in the system?

 

Variety is More than a Spice

We think differing views are important for markets to function well. Imagine a world where everyone held the same opinion. Would anyone ever buy or sell a share of stock in a world where we all:

  • Knowand agree the value of everything at every moment;
  • Havethe same preferences; and
  • Wantthe same thing at the same 

For example, if we all held the same opinion about the best house to own, who would own it and how would it stay stable when everyone else wants that same home in just that one location? Seems more like a Lord of the Flies world than a peaceful and content one where we all agree.

Strangely, we must be thankful for disagreement because it powers a continuous auction of stocks every trading day. It’s an auction that:

  • Livesin the form of a “bid-ask” spread, or the difference between where sellers and buyers are at any moment of the day; and
  • Mimicsa trading floor where buyers and sellers stare each other down until someone blinks and moves the market.

 

Who Is the Idiot?

A question every trader asks internally after every trade. It’s natural to believe one of us is correct and the other wrong when the truth can be so much more complicated.

Let’s examine a stock that is a member of the S&P 500 index. Not all buying and selling will be driven by whether the stock is going up or down:

  • Anydeeply traded stock is also likely held by funds that have to buy and sell shares as orders come into the
    • Thefund is not expressing a view on the stock price in that moment so much as fulfilling its obligation to maintain the correct ratio of stocks held in the fund and as part of its contract with clients holding that
    • Canaccount for more than 50% of all trades on any given 
  • Companiestrade their own stock for various 
    • Buyingshares to fund programs like a share-option or stock bonus 
    • Buybacksbased on the Board of Directors’ view of the 
    • Sellstock at the market price to raise capital for 

With more than half of some of the most popular stocks trading for reasons other than the view on that specific stock, we can see more than just a diversity of views driving stock prices – there are technical reasons some stocks get out of line with what we might call the fair price.

When we find a bargain, it’s often not because the market is run by idiots, but rather something has gone wrong in the bid-ask auction. Sometimes, it’s a lack of general information about the stock, like the bargain we found in fixed-to- floating preferred stocks in 2022-2023, or it’s a stock being dragged by forces other than peoples’ belief about the fair price. There are myriad other reasons for prices to move, including:

  • Rumors;
  • Fearmongering/Cheerleading;
  • Apeer company reports a major event;
  • Wall analyst reports or comments;
  • Companypresentations at conferences; and
  • BlackSwans
    • Avery bad event like COVID or a world 

But what about those who sold to us because they believe in a very different world? Are they idiots or important bits of information? Paraphrasing Warren Buffet – “it’s not the thing I didn’t see coming that killed me so much as the thing I knew for sure was true that turned out to be wrong.”

That last sentence should force every investor to pause and consider how our deeply held beliefs may be wrong. For some investors, this heart-stopping moment happens when cold hard reality crushes those closely-held beliefs. One might even argue that larger losses happen most often when risk is not properly understood because we held the wrong belief.

While Life UnLocked has our closely held beliefs about risk, how the economy functions and how we hope the companies we own will operate each day; we also listen to ideas that challenge our beliefs in case our results do not synch with our expectations. While an open mind is good, we temper openness with the skepticism of experienced professionals who regularly spot scams, traps and ambushes – the world is both ugly and beautiful.

 

Life UnLocked Partners, LLC is a Registered Investment Advisor (RIA) registered with the state of California, providing investment advisory services where registered or exempt from registration. Registration does not imply a certain level of skill or training. Investing involves risk, including potential loss of principal. Past performance is not indicative of future results. This material is for informational purposes only and does not constitute investment advice or a solicitation to buy or sell securities. For more information, please request our Form ADV or visit www.lifeunlocked.partners.