The Market Is Smarter than You

Let me begin this post by admitting that there’s something I don’t know. I realize, dear reader, that this may come as a great shock to you. But yes, this does happen to many great men, even me.

Here’s what I don’t know. Yields on Treasury Inflation Protected securities (TIPs) are much lower than I would expect, and I have no idea why. The 10-year TIPs yield is a minuscule 0.71%. I would think it would be much higher. Even above 2%. This completely baffles me.

But here’s our lesson. I’ve seen a lot of smart folks go into finance and quickly leave the ring battered and bruised. This is especially true for people with backgrounds in engineering and math. The market chews these people up.

I think the reason these people fail is that they don’t have adequate respect for the market. Ultimately, that’s what investing teaches you. A person with lots of equations would simply conclude that, in our case, the market is wrong on TIPs yields, and prices will soon adjust.

Perhaps. But that’s often not the case. The market has its reason for its prices. Sure, they may not be good reasons, but they are reasons. As an investor, you have to deal with markets as they are, not as you or your model would wish them to be. It takes a lot of guts to say that an immense, highly liquid market is wrong. The market always knows more than you do. Always.

I’m not a technical analyst but one of its great benefits is that it dispenses with “why” questions at the outset. Why is IBM down today? The technician would say “who cares?” He has no idea why, nor is he interested. But he’s keenly aware that whatever the reason, IBM is in fact down. That part we can agree on. It’s the ability to face reality head on that’s key for investors.

Maybe the market is picking up new information that you don’t yet see. Maybe the relationship you think is solid is merely transitory. Maybe the prices are “wrong” but the factor causing them is large and powerful and can outlast your position. As Keynes famously said, “Markets can remain irrational longer than you can remain solvent.”

Please don’t take this to mean that markets are always right, or even efficient. The whole reason for this blog is to show people that markets can be beaten. But don’t be so quick to dismiss the market’s opinions as irrational.

Posted by on September 29th, 2015 at 12:05 pm

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.