The Zurich Axioms By Max Gunther
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Chaos is not dangerous until it begins to look orderly
Irving Fisher, a distinguished professor of economics a Yale, made a bundle on the stock market. Impressed by his combination of impeccable academic credentials and practical investment savvy, people flocked to him for advice. “Stock prices have reached what looks like a permanently high plateau”, he announced in September 1929, just before he was wiped out by the worst crash in Wall Street history.
It just goes to show you. The minute you think you see an orderly design in the affairs of men and women, including their financial affairs, you are in peril.
Fisher believed he had beaten the market by being smart, when what had really happened was that he had been lucky. He thought he saw patterns amid the chaos. Believing that, he believed it should be possible to develop formulas and strategies for the profitable exploitation of those patterns – and he believed, further, that he had in fact developed just such formulas and strategies.
Poor old Fisher. Fate let him ride high for a while so he would have farther to fall. For a few years his illusion of order seemed to be justified by the fact. “See!” he would say. “It is determined. The stock market is behaving just the way I calculated it would.”
And then – whomp! The bottom dropped out. Clinging to his illusion of order. Fisher was unprepared for his streak of luck to end. He and a lot of other misguided investors went tumbling down the drain.
The trap that caught Professor Fisher, the illusion of order, has caught millions of others and will go on catching investors, speculators, and gamblers for all eternity. It awaits the unwary not only around Wall Street but in art galleries, realty offices, gambling casinos, antique auctions” wherever money is wagered and lost. It is an entirely understandable illusion. After all, what is more orderly than money? No matter how disarrayed the world gets, four quarters always make a buck. Money seems cool, rational, amenable to reasoned analysis and manipulation. If you want to get rich, it would seem that you need only find a sound rational approach. A Formula.
Everybody is looking for this Formula. Unfortunately, there isn’t one.
The truth is that the world of money is a world of patternless disorder, utter chaos. Patterns seem to appear in it from time to time, as do patterns in a cloudy sky or in the froth at the edge of the ocean. But they are ephemeral. They are not a sound basic on which to base one’s plans. They are alluring, and they are always fooling smart people like Professor Fisher. But the really smart speculator will recognize them for what they are and, hence, will disregard them.
This is the lesson of the Fifth Axiom. It may be the most important Axiom of them all. It is the Emperor Axiom. Once you grasp it, you will be a cleverer speculator/investor than Professor Fisher was with all his vast scholarly attainments. This one Axion, once, you make it yours, will by itself lift you above the common herd of hopeful blunderers and losers.
Some of the grandest illusions of order crop up in the world of art. This is a world in which a great deal of money can be made with stunning speed. The trick is to latch on to low-priced artists before they get hot. Like Louise Moillon, a seventeenth century French painter. A woman recently bought a Moillon at a rural auction for $1,500. Within a year Moillon got hot, and the same painting sold in New York for $120,000.
That would be a nice adventure to have. It could give one’s balance sheet an encouraging boost. But how can you get in on the action? How can you tell when an obscure artist is going to attract that kind of attention?
Well, there are experts who say they have art pretty well figured out. They see patterns nobody else sees. They have formulas. They can recognize Great Art while it is still unrecognized and cheap. They can go to a rural auction where everybody else is stumbling around in the dark and say, “Wow! Look at that! It’ll fetch six figures next year in New York!” So your best bet is to consult a lot of these experts, right?
Sure. The Sovereign American Art Fund was founded on that basis. It was essentially a unit trust. It proposed to make its shareholders rich by buying and selling works of art. This buying and selling was to be done by experts, savvy professionals whose superior critical judgment could help them spot emerging trends and future Moillons before the rest of the art-buying would caught the scent.
A lovely illusion of order. It attracted investors big and small. The Fund sold out its initial public offering at $6 a share.
What nobody seems to have thought of is that in any game as dicey as art, a group of professionals can experience bad luck just as easily as a herd of blundering amateurs. The Sovereign Fund’s purchased masterpieces looked promising at first, and a few months after the initial offering the shares were trading over $30. Some of the initial speculators made some money, at least. But then gloom descended. The purchased masterpieces turned out to be less hot than had been supposed. Obscure artists go obscurer. One expensive painting was challenged as a forgery. The shares’ value plummeted. About two years after the Fund had opened for business, the trading price was 75 cents.
Wall Street mutual funds tell the same story. They illustrate with start clarity how futile it is to seek patterns amid the chaos – and in the end, particularly for the average small-time plunger, how dangerous.
Consider the seemingly limitless promise of mutual funds. These great agglomerations of the public’s money are managed by professionals of the the first magnitude. The educational attainments of these men and women are dazzling, and so are their salaries. Platoons of assistants see to their needs. Large libraries of financial fact and theory are at their disposal. Computer and other expensive gadgets take part in their cogitations. They are without a doubt the world’s best-educated, best-paid, best-equipped investment theorists.
And so, if it were possible to discern usable patterns amid the disorder, and develop a market-playing formula that worked, one might suppose these people would be able to do it. Indeed they should have done it long ago. So, far, however, he formula has eluded them.
The sad fact is that mutual fund managers are like all other speculators: they win some and they lose some. That’s the best you can say about them. All the high-voltage brainpower and all that money and all those computers have never been able to make them any cleverer or more successful than a long plunger with an aching head and a $12.98 pocket calculator. Indeed sometimes mutual funds as a group manage to do worse than average. Forbes magazine once charted the performance of funds’ unit prices in some bear markets and found that nine out of then fell as fast as or faster than stocks as a whole.
Fund managers continue searching doggedly for that magic formula, however. They search because they are paid to, and also – in many cases or most – because they genuinely believe there is a formula out there somewhere, if only they and the computers are smart enough to spot it.
You and I know, of course, that the reason why they can’t fid the formula is that there isn’t one.
Oh sure, you can make money by investing in a fund – if you are lucky enough to pick the right one at the right time. What it comes down to is that buying into funds is just as risky as buying individual stocks, or art works, or whatever your chosen game may be.
Some fund managers will be luckier than others in this coming year. Some will be hot. Their unit prices will rise faster (or fall more slowly) than average. But the question is which ones?
So, you see, we are back where we started. If you want to speculate in fund units, you are only dealing with the same kind of chaos you would encounter when speculating directly in stocks, art, commodities, currencies, precious metals, real estate, antiques, or poker hands. The rules of play should be same for you whether you are in mutual funds or anything else. Particularly with funds, don’t be lulled into perceiving order where none exists. Keep your wits and the Axioms about you.
And keep them about you whenever you read or hear investment advice. Most, advisers have some kind of orderly illusion to sell, for that is what sells.
Such an illusion is comforting and seems full of promise. Small-time investors who have been burned or feel they have missed opportunities through ignorance or fear – and who hasn’t? – will flock to an adviser who offers what seems to be a plausible, orderly approach to moneymaking. But you should regard all financial advisers with skepticism, and the more cool and bankerish they seem, the more you should distrust them.
The cooler and more bankerish a man is, the less readily will he admit that he deals with chaos, has never been able to figure it out, has no hope of figuring it out, and must take his chance like everybody else.
Alfred Malabre, Jr., is one speculator who learned his lesson well. Malabare, a Wall Street Journal editor, sough help with his investments when he was sent on a long assignment overseas. He wanted somebody shrewd and prudent to take care of his stock portfolio for him while he was away. It wasn’t a big portfolio, but naturally he wanted it protected. In case the market crashed or something while he was gone, he wanted somebody on the spot to sell him out or do whatever else seemed necessary.
So he looked around. As he tells the story in his book Investing for Profit in the Eighties, his eye fell on the First National City Bank of New York, now known as Citybank. Like most banks, Citibank offered a portfolio management service. If you had a lump of capital and didn’t want to play with it yourself – or were temporarily unable to do so, as in Malabare’s case – you turned it over to the bankers, and they would play for you. There was a fee, of course.
Well, okay, thinks Malabre to himself. This sounds like a good solution to my problem. Here’s this Citibank, one of the ten or fifteen biggest banks on the face of the earth. What these guys don’t know about money probably isn’t worth knowing. How can I go wrong turning my little pile over to them? When else am I going to find financial custodians more trustworthy, more prudent, more shrewd? They certainly won’t lose me any money while I’m gone, and who knows – maybe they’ll make me a bundle!
That was what Malabre thought.
He was suffering from a perfectly understandable illusion of order. What could be more orderly than a gigantic New York bank? An untutored lone plunger might diddle and fiddle and make a hash of a portfolio, but not a bank. A bank had to have formulas locked up in its vaults. A bank would always know what to do.
As it turned out, the bankers came close to wiping Malabre out. They bought him a bunch of Avon Products common stocks at $119 a share. Two years later it was trading under $20. They loaded him up with Sears, Roebuck at $110 and watched it sag to $41.50. They got him into IBM at just under $400, and it deflated to $151. Only by taking emergency action on his own did Malabre avert financial disaster.
That which hurts, teaches. Malabre will not soon forget the lesson he learned at Citibank. But you can learn the same lesson without getting hurt. The lesson is that you should be wary of any adviser who, looking around at the investment scene, claims to se anything but chaos. The more orderly it looks to the adviser, the less this man or woman merit your trust.
When you put your trust in an illusion of order, you lull yourself into a dangerous sleep. There is no Zurich Axiom saying specifically that you should stay awake, but the need to do so is implicit in all the Axioms. Don’t let yourself nod off. You could wake up and find your money going down the drain.
If you want to spend an instructive and entertaining afternoon watching illusions of order being constructed, go to your local library and sample the how-to-get-rich books. Even a small library is likely to have a shelf or two of them. You will find a wide variety of investment ventures represented – including, perhaps, some that appeal to you personally. How to get rich in real estate. How to hit the jackpot in rare coins. Killings in the philately business. Stocks, bonds, gold and silver …. the list goes on and on.
Notice a characteristic of these books. Most of them were written by men and women who claim they themselves were enriched by the given schemes. How I Got Fat on Pork Bellies goes the typical title.
Are these advisers telling the truth? Well, yes: the truth as they interpret it.
There is no reason to be unnecessarily cynical about this. We can assume we are being given an honest account in nearly every case: the adviser worked the scheme and banked a bundle. However, we are not obliged to let ourselves be suckered into the author’s illusion of order.
He believes he got rich because he found a winning formula. We know better. He got rich because he was lucky.
Any half-baked moneymaking scheme will work when you are lucky. No scheme will work when you are not. Some advisers acknowledge the commanding role of luck, as do the Zurich Axioms. The Axioms not only acknowledge it but are built on the basic assumption that luck is the most powerful single factor in speculative success or failure.
The majority of advisers, however, ignore luck, or pretend it isn’t there, or talk their way past it as rapidly as possible. Like the Citibank bankers, like the Sovereign American Art Fund managers, they are in the business of selling a soothing balm; an orderly approach, a feeling of being in control. Take my hand, kid, don’t be afraid, I know my way around. This is how I made it. Just follow these simple step-by-step instructions…..
Well, you can follow them if you like, perhaps to your doom. For a formula that worked last year isn’t necessarily going to work this year, with a different set of financial circumstances stewing in the pot. And a formula that worked for your neighbor won’t necessarily work for you, with a different set of random events to contend with. The fact is, no formula that ignores luck’s dominant role can ever be trusted. This is the great, liberating truth of the Fifth Axiom.
Luck’s role is illustrated not only by the fact that a given adviser can be spectacularly wrong, but by the equally telling fact that often you will find two sages giving exactly the opposite advice. For example, here on the shelf we have How Wall Street Doubles My Money Every Three Years, by Lewis Owen and The Low-High Theory of Investment, by Samuel C. Greenfield.
Owen says you should buy stocks whose prices are nearing or have hit twelve-month highs. His illusion of order is that some kind of “momentum”, as he calls it, will tend to make price movements continue. Thus, a rising stock will continue to rise. Greenfield says you should buy stocks whose prices are nearing or have reached twelve-month lows. His illusion of order is that prices seesaw in a roughly predictable fashion. Thus, a stock nearing a low will soon turn upward.
Both these sages cannot be right. In fact, neither is. The truth is that the price of a stock, or anything else you buy in hope of making a profit, will rise if you are lucky.