[The Weekend Bulletin] #47: The Invisible Hand
Unseen forces that shape our investments, lives, and more.
A digest of some interesting reading material from around the world-wide-web. Your weekly dose of multi-disciplinary reading.
Adam Smith introduced us to the concept of The Invisible Hand in his seminal work, The Theory of Moral Sentiments. While his work describes the invisible hand as an unintended social benefit of an individual’s self-interested actions, interpretations of the term have since been generalised. Our interest lies in this board generalisation.
There are a number of factors that shape our lives - from gravity that keeps us grounded, to luck that determines the circumstances under which we are born, and go through most of our life, to the emotions that define us as an individual, to the social influence that forms the fabric of our civilisation. Individually, the influence of these unseen forces varies significantly on each of our lives, however, collectively, they give us our unique identity. Furthermore, some of the factors like gravity are more scientific i.e. they are both measurable and predictable. However, a majority of the factors are neither measurable easily, nor predictable. For the sake of this bulletin, It is these factors that we refer to as the invisible hand of our lives.
It may be worthwhile to differentiate between invisible and unknown here. We call these forces as unseen as we often fail to recognise their influence. However, most of these forces are well known to us. Thus, we can safely summarise the invisible hand as a force that has a significant influence but is varying and unpredictable, one that we know exists, but often fail to recognise the impact of. This issue aims to increase the awareness about such forces.
Markets are quoted in numbers, but what they trade in is emotions. Markets simply determine prices for risks and rewards over time. Among those risks are not just financial losses, but the surprise and fear and regret they bring. Among those rewards are not just monetary gains, but hope and greed and pride.
- Jason Zweig
Section 1: Investing Wisdom
One of my all time favourite quotes on investing is that ‘investing it simple, but not easy’. What makes investing simple are mathematical deductions likes returns being the sum of dividend yield, earning growth, and change in valuations. However, what makes it not easy is the fact the changes in valuations are not easy to estimate. A number of factors play an important role in determining valuation multiples, some of which act as an invisible hand, as this short note highlights.
On a related note, this article draws attention to a similar invisible hand because of which share prices of a slow growth company can react positively while that of a high growth company can react negatively. (An interesting occurrence was when a large tech company’s growth expectations fell from 3-4% to -5%, and then it reported a growth of -2% resulting in share prices rising to levels higher than those seen when the expectation was 3-4%).
This article is originally dated in 1998. While over two decades old, not only will the central idea of the article resonate, but so will some of the examples carried in it. It talks about an important invisible hand that masks itself as something that investors actively seek. This invisible hand is like sugar to the body; you’ll enjoy having it, not knowing how much harm it is causing to your body. Loved this quote at the end of the article:
Finally, remember the difference between the weather and the climate. On any given day, it can be warm and sunny or dark and rainy. But in the long run, the climate is more predictable. Investing is like that too: Just as June tends to be warmer than January and August sunnier than April, over longer periods investment fluctuations smooth themselves into more foreseeable patterns.
It is not often that an article on macro economics interests me. But this one really caught my attention. It draws an interesting correlation between equity valuations and demographics, with the invisible hand being fertility rates (which in my view is a real worry for a young country like India as it can shorten its demographic dividend by at least a decade). This article provides some food for long term thought.
For the true long term investors of the private variety, the biggest invisible hand working against them it a precise valuation of their holding. Confused? This short article explains why.
Lastly, the invisible hand applies not just in evaluating your investments, but also to your investment managers.For most fund mangers, there is nothing more important than adopting the long term mindset as it frees them from the vagaries of the short term random market fluctuations. However, most fund managers are unable to achieve this, due to an invisible hand that this article highlights.
When we consider a fund manager’s investment time horizon we often focus on how they apply their philosophy and process; with maybe some consideration as to whether their incentive package is aligned with this. But that is not sufficient.
Section 2: Mental Models & Behavioral Biases
One of the invisible hands that has the most influence on our lives, from our birth to death, is luck. It can both make us and break us, often, at the same time. But if luck is so important in life, then what about hard work? Should we put efforts in the pursuit of success or wait for the wave of luck to push us ashore? This article is one of the best explanation of situations where luck matters and others where hard work matters.
Section 3: Personal Development
Investors are in the constant look out for high moat business. A moat provides longevity to a company’s growth as well as profitability. Similarly, most of us would do well in our careers by developing a personal moat. In an era where technology is quickly commoditising skills, personal moats are the invisible hand that will gain importance not just for career enhancement, but also for survival. This article talks about why you should build a personal moat, what constitutes a personal moat, and how to identify one for yourself.
Section 4: Trivia
Imagine that you are rolling a ball down a slope. You have three paths to choose as shown in the following picture. On which path do you think that the ball will travel the fastest from the start to the end point? Leave your choice (A,B, or C) in the comments below.
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That's it for this weekend folks. I hope you enjoyed this issue; let me know your thoughts/feedbacks by commenting below.
Have a wonderful week ahead!!
- Tejas Gutka
[Oct 17, 2020]
P.S.
If you come across an interesting article that you feel is insightful and worth sharing with the community of readers of The Weekend Bulletin, please email a link of the article along with a short summary/note on why you like the article to: share2TWB[at]gmail[dot]com.