Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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December 10, 2023

Understanding Mr Market


Here is something we call elucidation, Is it the truth? Or merely a description? David Byrne, American Utopia

My thoughts exactly – Sometimes, you read things that speak directly to you. It unlocks an observation about the world you were aware of but had struggled with. The connection is so real you wish you had written the words. A recently published book by a former fund manager, Patrick Schotanus, called The Market Mind Hypothesis, Understanding Markets and Minds Through Cognitive Economics, spoke directly to me despite its ungainly title and restrictive price tag.

Who saw it coming? – The book bridges economic theory and financial market reality, attempting to answer the question the late Queen posed when she visited the London School of Economics (LSE) in 2008. Seven weeks after Lehman Brothers collapsed, she asked her hosts why nobody saw it comingTo the extent anyone has answered her perfectly reasonable question, it has not come from within the economics profession. Instead, more of the answer is emerging from the collective thoughts of market practitioners, and Schotanus’ book is the latest offering.

Mr Market – Financial market participants often refer to the market mood. Benjamin Graham, the father of value investing and much beloved by Warren Buffet, talked about Mr Market, a conceptual persona Buffet has often referred to. Mr Market, being only human, emotionally gyrates around the more certain rational value derived by security analysis to which price will eventually gravitate, or so value investors believe.

Imperfect knowledge – In his book The Alchemy of Finance, George Soros wrote about understanding the market’s mind. Soros studied at the LSE in the 1950s under the Austrian philosopher of science, Karl Popper. The contradiction between Popper’s theory of knowledge, emphasising man’s imperfect understanding of the world, and the theory of perfect competition, postulating ‘perfect knowledge,’ disturbed the young Soros. His dilemma led him to his theory that markets are reflexive and fallible, in marked contrast to the prevailing orthodoxy. While many academics attacked the intellectual rigour of Soros’s philosophy, it is harder to question his investing success based on its application.

Self-harming razor – Another former fund manager, strategist Russel Napier, contends, in his support of Schotanus, that although behaviourists have modified the robotic rational economic man of the classical tradition to allow for humanity’s biases, this is just the start of a more radical journey into a new heterodox economic theory. Frank Knight, the father of the Chicago School, described economics as suffering from mechanistic monism; others have described it as physics envy, the reduction of everything to quantification and mathematical rigour. Einstein may or may not have said that everything should be made as simple as possible but not simpler. However, mainstream economics has used Occam’s Razor too often and turned what should have been a closer shave into an act of self-harm.

Animal spirits – None other than John Maynard Keynes, the father of macroeconomics, allegedly said the problem with the absolute pursuit of certainty is that it is better to be roughly right than precisely wrong. Graham, Soros and Keynes were all investors of some note. They were market participants and market philosophers. They understood crowds make good decisions under certain conditions, as described in The Wisdom of Crowds. But they can hallucinate under other conditions, as described in Popular Delusions.

Meanwhile, in Vienna – Investors know markets are messy, chaotic, and inefficient. They are not smoothly rotating machines requiring periodic lubrication and adjustment by their well-meaning operators described in textbooks. No, markets are more like us; they are complicated, emotional, and fallible. Economic theory has more to learn from psychology than from physics, and unsurprisingly, it was a group of economists from Sigmund Freud’s Vienna, known imaginatively as the Austrians, who understood the wrong direction conventional economics was heading. Karl Menger, Ludwig von Mises and Friedrich Hayek rejected the aggregation of economic data and the application of mathematics. Instead, they strove to understand the nature of human action. They evolved a subjective theory of value focusing on price theory and the role of knowledge in solving the allocative economic problem. However, mainstream economics, epitomised by the LSE, treats the Austrian tradition as a now-defunct branch line.

Perfect knowledge – Mainstream economic thought holds that financial markets are efficient, and since everything is already accurately priced, there is little or no hope of beating the market. The best any investor can do is match market returns through passive index investing. Passive investing allocates capital according to historic benchmarks. It allows investors to access market returns for little direct cost. However, its ultimate unintended consequence is dysfunctional capital markets, which cannot price new risks in changing market dynamics, a failure which ultimately deters new entrants from joining public markets.

Gut feel – The Market Mind Hypothesis (MMH) holds that economics’ mechanical worldview based on rational automotive economic agents leads to faulty thinking and practices. Instead, MMH offers a worldview akin to that of complexity theory. Behavioural economics accepts that human biases disrupt our otherwise rational brain’s factory settings. MMH aligns more closely with 4E Cognition Theory, which holds that cognition does not occur solely in the head. It contends that our mind is embodiedembeddedenacted, and extended through extra-cranial processes and structures, such as the gut biome. The philosophical point is the age-old dilemma of our physical and cognitive dualism, begging deep questions regarding the state of human knowledge and how we perceive reality. Ultimately, the question becomes, what is human intelligence?

Fear of BS – As Governments advance plans to regulate Artificial Intelligence (AI), there is no accepted, pre-agreed understanding of human intelligence. Much rests on the potential for Natural Language Processing (NLP) to jump the perceived gap between advanced predictive text and Artificial General Intelligence (AGI), the type capable of turning the world into a pile of paperclips. Many of those in the field of AI fear the latter dystopian future. In contrast, options trader turned writer and philosopher of probability Nassim Taleb maintains that we are frightened of AI because it is better at bullsh**ting than we are. Taleb, also a student of Karl Popper, thinks human hubris and conceit about the level and nature of our intelligence drives our fears of AGI. He has long railed against mechanistic rational economic man and ideas such as normally distributed probability. Like Soros, Taleb has made super-normal financial returns in periods of financial crisis.

Adaptation – By understanding the market’s mind, an investor can use its periodic mental illnesses, phobias and behavioural tantrums to exchange value for their benefit. As Taleb said, Not everything that happens happens for a reason, but everything that survives survives for a reason. Machinery is deterministic; it exists by design for a reason. Complex adaptive systems such as humans and markets do not, but they survive for a reason, advancing our knowledge one failure at a time and allowing us to consider ourselves clever. But we systemically overestimate our cleverness, giving people like Taleb and Soros opportunities to profit from the resulting crises.



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