Darwin and Siegel
By Bob Wood, MMNS
Over time, as I have studied the history of the markets, I have become convinced that what passes for conventional wisdom is anything but that. We still hear the trite sayings and tired old maxims about â€œinvesting for the long term,â€ that â€œstocks always go up over timeâ€ and that being fully invested is the best way to go. Yet, I am convinced that these maxims are responsible for more investor losses than gains.
|Prof. Karl Popper|
Instead, I find information in more unlikely places that helps me boost clientsâ€™ long-term stock performance. One source is the work of Karl Popper, professor of Logic and Scientific Method at the London School of Economics from 1949 to 1969. I discovered references to his work while reading books by some of the smartest people in finance, George Soros, famed hedge fund investor, and Nassim Taleb, author of the books The Black Swan and Fooled by Randomness. Both of these thinkers, who have done well for themselves in the markets, point to their esteem for Popper and describe how he has inspired and led them in the right direction in their pursuits of market profits.
In a collection of Popperâ€™s essays, I found a little gem that many others may not have though meaningful. This nugget of information involves Popperâ€™s opinion of the work of Charles Darwin, author of the well known Origin of Species, a controversial treatise, to say the least, in todayâ€™s society and halls of education. While Popper thinks highly of Darwinâ€™s work in general, he is not convinced that it shows how the future of human development will unfold.
I have spent much time thinking about this passage from Popperâ€™s lecture on Historicism from 1936. Yes, it goes back that far and has been sitting there, waiting for the philosophical investorâ€™s consideration for all this time, seemingly with few seeing or appreciating it. Popperâ€™s contention with the Theory of Evolution centers on whether any degree of certainty exists with how Darwin draws conclusions. Popper believes there is not certainty and explains as follows:
â€˜â€™But can there be a law of evolution? Can there be a scientific law in the sense intended by T.H. Huxley when he wrote: â€˜.he must be a half-hearted philosopher who.doubts that science will sooner or later.become possessed of the law of evolution of organic forms – of the unvarying order of that great chain of causes and effects of which all organic forms, ancient and modern, are the links.?â€™
â€˜â€™I believe that the answer to this question must be â€˜No,â€™ and that the search for the law of the â€˜unvarying orderâ€™ in evolution cannot possibly fall within the scope of scientific method, whether in biology or sociology. My reasons are very simple.
â€˜â€™The evolution of life on earth, or of human society, is a unique historical process. Such a process, we may assume, proceeds in accordance with all kinds of causal laws, for example, the laws of mechanics, of chemistry, or heredity and segregation, or natural selection, etc.
â€˜â€™Its description, however, is not a law, but only a singular historical statement. Universal laws make assertions concerning some unvarying order, as Huxley puts it, i.e., concerning all processes of a certain kind; and although there is no reason why the observation of one single instance should not incite us to formulate a universal law, nor why, if we are lucky, we should not even hit upon the truth, it is clear that any law, formulated in this or in any other way, must be tested by new instances before it can be seriously taken by science.
â€˜â€™But we cannot hope to test a universal hypothesis nor to find a natural law acceptable to science if we are for ever confined to the observation of one unique process. Nor can the observation of one unique process help us to foresee its future development.â€™â€™
Exactly! It seems so clear to me, though you may feel free to interpret that passage as you wish. You can even decide that it is meaningless to your investing efforts. But I hope youâ€™ll take another look at what Popper proposes. To me, it means a lot indeed!
I do not claim to be a philosopher or great thinker, but a certain simplicity in this passage, to me, validates much of what I do as an investor. I have long run opposite to what passes as conventional wisdom, and the work of todayâ€™s financial academics, who fill their books and our heads with information on how to invest, fails one simple but critical test: it doesnâ€™t work!
We hear again and again that asset allocation, diversification and staying invested for the long term are the best available methods for investing success. Yet we just canâ€™t find many people using those methods and succeeding in making money over long time periods.
Countering what Popper wrote and having become more familiar to investors today is Jeremy Siegel, professor of Finance at the prestigious Wharton School of Business. He has written several books on investing and is considered an expert on the markets, which I consider — rubbish.
Call me a fan of Charlie Munger, partner of Warren Buffett, who has called Siegel â€œdementedâ€™â€™ — â€˜â€™for comparing apples to elephants in making future predictionâ€™sâ€™â€™ about market direction. Can you believe Siegel has the nerve to tell us that he can see the future for the markets? At least it seems that way in his latest book, The Future for Investor, excluding the fourth re-hash of his well-worn Stocks For The Long Run.
My objection to Siegelâ€™s body of work is that he looks at what has happened in the past and extrapolates those events and returns into future performance. For instance, he claims that a losing ten-year period for stocks has never happened, even though we are now reading about and experiencing the â€˜â€™Lost Decadeâ€™â€™ for investors in our domestic markets.
As Popper declared about evolution, the story hasnâ€™t yet been told in its entirety. It is still unfolding and cannot be considered scientific law, since we have yet to witness a full cycle from beginning to end. We cannot assign causal connections to future events, since so many big variables are changing. Future outcomes will not necessarily look like those from the past. Just because we buy value stocks that have previously outperformed others gives no assurance that they will outperform in future cycles as well.
Siegel looks at what has happened previously but seems to avoid implications from how much times and the world have changed since the early or mid-1900s. Then, America was a rising power, technologically and demographically, and past market returns considered far fewer investing options than have been available in more recent periods.
As Popper has noted, humans observe what the past reveals, make some decisions influenced by the past, and make other decisions that are different enough to change future outcomes. We all can see how the world has changed economically. Consider the resurgence of countries like India and China and the immense implications affecting the world economy — as well as our domestic stock market.
Simply too many options exist for investors now that were not available in the past, and our economy has changed dramatically from the one based on manufacturing and exporting in the past. Our debt-burdened, service-oriented economy is so much different than economies from past periods, and Siegelâ€™s treatise glosses over that factor entirely.
Just because small cap stocks have outperformed other investments in past cycles means nothing when we assess future performance. That past out-performance often leads buyers to bid up small cap stocks to valuations even higher than those in past cycles, since investor confidence has risen with comfort from the historic record. Neither may stocks out-perform bonds over longer time periods, since this thinking comes from the same false confidence supplied by past records. And the vastly different economic picture seen now in the U.S., with a weaker middle class and heavy concentration of wealth in the hands of a very small number of us, presents a wholly different set of possible outcomes for future stock market performance.
For my financial philosophy, Iâ€™m siding with the thinking and work of Karl Popper regarding his observation relating to outcomes espoused by the Theory of Evolution: investing theories such as Modern Portfolio Theory are not scientific laws. Take it for what you will, but to me, that thinking and brief quote from Popper are more meaningful than all the books written by Siegel and many others. And now I know why one of the great investors of our time, George Soros, thinks so highly of him.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., firstname.lastname@example.org.