June 23rd, 2020

Adaptive Markets

Markets are evolving - not devolving. If we embrace change we will thrive, not just survive.  

Markets have been operating under a narrative/assumption for the last 40 years — that they're highly complex and far above the average person's comprehension. Therefore, an omnipotent intermediary has been necessary for average citizen and business people to understand finance, banking, and money. Whether that's accurate or not, isn't the topic of debate here. But the reality of it is that "times they are a-changin'"...and that narrative/assumption is being challenged, if not taken down, and being replaced with a new paradigm altogether.  

A good metaphor for this dilemma is that the markets are like a very complex language that you don't understand. It's easier to trust someone to interpret that language for you rather than to have to learn it yourself. Think of it like being fluent (reading/writing/composing) in English and wanting to communicate in Mandarin.  Mandarin isn't complex in and of itself, but it's difficult for a person totally unfamiliar with it to even know where to start. It's written differently, reads from a different direction, and has different characters and formations, but ultimately when translated, communicates just as effectively as English does. The key for person fluent in English trying to communicate in Mandarin (or a person fluent in Mandarin trying to communicate in English) is translation. Without a translation tool or human translator, there is no communication.

For the past 40 years, retail investors and many accredited/institutional investors (even though they prefer not to admit it) have been the English speaker in our analogy, and the financial markets have been the Mandarin speaker. Historically, there's been a translator – a financial advisor (for the retail Investor) and central banker (for the institutional investor). The financial advisor was there to assist with the translation between English and Mandarin at the individual Investor level, and the Central Banks were there to assist with translation at the Institutional level. You can imagine that a great amount of trust had been placed on both sides, by the investor and by Mr. Market, as both had lived with the perception that the situation genuinely needed to be translated.  

As you can imagine, this scenario, although functional for as long as the perception of necessary translation existed, has now been exposed for many inefficiencies. The previous paradigm is based on the following assumptions (you'll find the inefficiencies denoted in italics below each concept):

 

Assumption 1: Both sides (at both the retail investor level and institutional level) are dependent upon the intermediary (financial advisor and central bank translators) to relay the proper information at the appropriate time and make right-timed decisions that will protect all market participants.

This will no longer be accurate as technology is replacing this transmission mechanism with quantitative mathematics formulas that evaluate the market itself...not the narratives that are being 'delivered from the pulpit' so to speak. Investors have access to AI, algorithms, statistics, and information at rates of speed that were really not even comprehendible even 5 years ago. This will only increase based on Moore's Law (reapplied to AI and Lgo capabilities).  

Assumption 2: Both sides (Investors or Mr. Market) will never be able (or 'should' never be able) to understand one another in efficient ways, so they need to rely on a translator (intermediary) to help them. 

This is not how efficient and effective markets work. Throughout 5,000 years of human history, Investors and Mr. Market have always found a way to self-regulate. This is already returning to the mean. 

Assumption 3: The investors (especially retail investors) will never have the intelligence and education about finance and money necessary to make sound decisions 

This assumption is being debunked. Stash and Acorns (financial savings and wellness apps) have been two of the most downloaded apps the over the past 36 months. This tells you that financial knowledge and education are a premium for investors and they'll revert this equation to the mean. The most searched for term regarding web apps and investment apps is "investment apps to help me learn"...just saying. Millennials and Gen Z's (which includes many of the vigt.io team members) are not failures – they've been hung out to dry in regards to finance. 

Assumption 4:  Investors prefer to entrust their money to the hands of others to manage and maintain rather than them managing and maintaining themselves. 

This assumption has already been debunked and is massively changing. Robinhood surpassed the amount of users that Etrade had in 24 months.  It took Etrade 15 years to acquire the same amount! Millennial statistics show that they have very limited trust in financial advisors and legacy financial platforms. They're changing this paradigm with their actions, not their words. This movement has migrated across the entire space and has forever changed the investing and finance landscape. 

Assumption 5: What has happened in the history of the markets will continue to happen in the future.

This is a flawed logic that's taught in colleges and universities everywhere and is parroted on most networks. Markets are very dynamic and the only constant (just like in life itself) is change. History doesn't repeat. It can rhyme and there are patterns, but it never works EXACTLY the same way twice.  We need to monitor what's happening and not be so concerned about why it's happening. That makes us better investors. The why is very subjective.  The what is very objective. Choose your path wisely...

Assumption 6: The markets can be manipulated via interest rates and the velocity of money which can effectively season out periods of volatility and misallocation of resources.

One of the greatest science experiments of all time (central banking as we know it) is going to be coming to an end soon. Humans have tried to regulate volatility many times throughout history (this isn't the first central bank experiment), but they've all modified or vacated their experiments before their natural termination date/conclusion. It's mathematically and scientifically impossible to regulate out volatility in a random pattern – and life is a random pattern. We give them credit (central bankers). Best of intentions, but poor execution with this theory, and it'll have short term knock on effects that are hard to quantify right now - but later won't matter as progress always wins.   

Assumption 7: Information will always be withheld and only known by a small subset of market translators for their safe keeping and understanding.

It's simply impossible to withhold information anymore with the advancements in human communication devices and social vehicles, not to mention natural language processing tools. If you think we're lying, just know that the President doesn't rely on press conferences anymore for his basic rants or dissertations...he just tweets.   

Assumption 8: Mathematical sciences aren't applicable to the study of finance and human behavior. 

This is another debunked concept. Institutions are now creating entire behavioral finance and and behavioral economics departments – which we think is absolutely fantastic. Helping everyone understand themselves and understand money is one of the greatest things that we can do to advance our human race.  If someone knows and understands the value of their efforts, then they're better off.  Financial literacy is one of the greatest needs of our time. To improve it is work worth doing. 

Assumption 9: Markets are linear (move in one direction over a long enough time horizon).

If you think that markets always move up, you're wrong. Sure, indexing (which means throwing out the losers and keeping the winners) will create a smoother graph from bottom left to top right. Progress, both human and technological, typically moves up over time. However, to think that this is a straight line path is as delusional as it is fabricated. The straight-line path is only attainable in the short term via interventional activities like money printing (quantitative easing) or mathematics modeling (aka 'smoothing' ) because in the end, the deviation always wins.    

Assumption 10: Technology will be static, not exponential, and will have no impact on decisions on either side (Investors or Mr. Market).

Technology is the single greatest impactor on our human existence and always has been. Anybody heard of the wheel or the steam engine? They forever changed humanity and improved the quality of existence. Technology will have a massively positive impact on the relationship between investors (both individual and institutional) and Mr. Market in the next 10-15 years. People are longing for more and more technology and it's applicable uses are only going to grow. This is a good thing, not a bad thing.

 

As you can see, a lot of the assumptions that the English speaker had regarding the necessity of a intermediary to help with their Mandarin translation are now gone. The English speaker (Investor and Institution) and the Mandarin speaker (Mr. Market) don't need the translator they used to have. They have new translators – i.e., decision-making applications, data mining platforms, and algorithm computing. Both languages are still from different places, written in different languages, and will always move in both confluent and divergent directions simultaneously, but their translators are rapidly becoming digital thanks to technological advances such as AI, algorithms, decentralization, deep learning, educational interactivity, gamification, and more. The end user is taking control of their adventure with Mr. Market...which is exactly how life works.   

We are not suggesting that this will make the adventure any less of a mania, stop panics, or absolve the economic ecosystem of crashes or booms. That's yet to be done in human history and seems to be a part of the human experience. But we know that adaptation and evolution are at the core nexus of human history and the human story, and that the relationships between the interested parties in the markets are adapting.  If you believe that you things will always be the same, they might be. But just for you – not for the masses – because the herd evolves over time even if the individual digs their heels in. 

"Times they are a-changin" ...the relationship with Mr. Market is Evolving for Investors, not Devolving. Embrace it.  Become one with the force...of nature. 

Be adaptive. Be an investor. Embrace Mr. Market. You can learn what's relevant and applicable and you don't need a translator, just good translation tools. It's not Mandarin when you have good translation tools. You can be successful managing your own money. Take control of your finances. After all, it's part of the constitution remember..."unalienable rights of life, liberty, and the pursuit of (monetary) happiness." 

vig.io Adaptive Markets
TagsMacroGeneral InvestingTechnical AIAlgorithmsAdaptive Markets
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