August 24, 2004
IRRATIONAL AFTER ALL?:
Mind
Over Money (Tom Walker, August 23, 2004, Atlanta Journal Constitution)
Terrorism is a new chapter of "behavioral finance," which deals with the emotional side of money management. Some experts believe emotion plays a bigger role in people's financial and investment decisions than is recognized by the traditional Wall Street theory -- that investors make rational decisions on the basis of their financial self-interest.Behavioral finance is based on the unspectacular notion that human beings
are emotional creatures whose behavior is guided only partially by
reason."I'm extremely skeptical, bordering on total cynicism, that any of this
stuff actually works," Richard Michaud, president and chief investment
officer at New Frontier Advisors LLC in Boston, said in a Bloomberg
News report.
Markets are obviously irrational to some extent. The question is, can a few smart souls take advantage of this information? There is a story, perhaps apocryphal, that a famous financier sold his positions just before the 1929 Crash when he realized his shoeshine boy was giving him stock advice (variously attributed to Joe Kennedy and J P Morgan). Also, the Peter Lynchs and Warren Buffetts of this world, while not getting it right every time, seem to have special insight into this hall of mirrors and can outperform the market to an extent. The article (registration required, unfortunately), makes the case for the war on terror exacerbating the irrationality of the current market. Posted by at August 24, 2004 12:52 PM
Buffett recognizes the irrationality of the market. His strategy is to choose the companies that he wants to own, based on their sustainable competitive advantage, and wait for them to go on sale at the right price. His dictum is that in the short run, the market is a voting machine; in the long run, the market is a weighing machine. Value will be recognized by the market over time, if not in the present.
Posted by: Robert Duquette at August 24, 2004 1:48 PMThe financier in question was Bernard Baruch.
Posted by: Fred Jacobsen (San Fran) at August 24, 2004 2:18 PMIn "Capitalism and Freedom" Milton Friedman makes the point that the depression was caused by banks failing and the Federal Reserve not living up to being "the bank of last resort". It makes sense, what would cause people to sell stocks unless they needed the money because their bank just failed? The Crash was a symptom, not the cause. Banks failings caused the depression. The shoe-shine boy had to sell his stocks because his account was bare.
Posted by: Joe Orzechowski at August 24, 2004 10:46 PM