The Market Has No Memory. Should We?
“The strength of my kids is that they are too young to remember anything bad, and they are making so much money they feel invincible.” The Great Winfield
According to efficient market theory, the market has no memory (though perhaps it does have some in the form of the momentum factor?). People, on the other hand, tend to remember their wins and losses vividly. They keep score, collect trophies, and accumulate scar tissue. But their memories can quickly get in the way.
In the book The Money Game, written during the 1960s bull market, a portfolio manager nicknamed the Great Winfield proudly shows the author his team of young analysts who he calls his “kids.”
“My boy,” said the Great Winfield over the phone. “Our trouble is that we are too old for this market. The best players in this kind of a market have not passed their twenty-ninth birthdays. Come on over and I will show you my solution.”
“This is a kids’ market,” he explains. The kids were willing to buy computer leasing companies because the need for computers was “practically infinite” and earnings would rise “a hundred percent this year, double next year, and will double again the year after. The surface has barely been scratched.”
Unlike the author, the analysts were not being held back by the the bad memories of bear markets past.
“Look at the skepticism on the face of this dirty old man,” said the Great Winfield, pointing at me. “Look at him, framing questions about depreciation, about how fast these computers are written off. I know what he’s going to ask. He’s going to ask what makes a finance company worth fifty times earnings. Right?”
“You can’t make any money with questions like that,” said the Great Winfield. “They show you’re middle-aged, they show your generation. Show me a portfolio, I’ll tell you the generation.”
“Look at him, that middle-aged fogey. He’s shocked. A portfolio selling at a hundred times earnings makes him go into a 1961 trauma. He is torn between memory and desire.”
Stanley Druckenmiller went through a similar experience. I wrote about how he was promoted by his first mentor precisely because of his lack of experience. Druckenmiller was made the director of equity research “for the same reason they send 18-year-olds into war”:
“Because they’re too dumb to know not to charge. The small cap stocks have been in a bear market for 10 years [this conversation transpired in 1978], and I think there’s going to be a huge, liquidity-driven bull market sometime in the next decade. Frankly, I have a lot of scars from the past ten years, while you don’t. I think we’ll make a great team because you’ll be too stupid and inexperienced to know not to try to buy everything.”
Hence when the Iranian revolution began, Druckenmiller “put 70 per cent of our money in oil stocks and 30 per cent in defense stocks.” He went all-in on an obvious trade because of his youth and inexperience.
Now listen to this brief moment of Peter Lynch joking about bottom fishing:
“That's called bottom fishing in the stock market. Very, very difficult. I've had a rough go with it. Standard Oil of Ohio this year fell from 90 to 60 and I told everybody the stock is not gonna go any lower.
Then I went to 50 and I said ‘this is it, no lower.’
As it went through 40, I said to people ‘this is it.’
Finally when it got down under 30 and people said what do you think of SOHIO, I said, ‘what is SOHIO, I don't I don't know that company.’ I absolutely backed away from it.”
It’s a funny little bit. But what if it’s true? What if backing away from the loss was useful to him, necessary even? What if he was describing an essential function performed by his mind that kept him effective?
Lynch’s job was to pick a portfolio of stocks for his investors and beat the market. Learning from his mistakes was important. But it was more important for him to not let any outcome impair his thinking. Could he be effective if he moped around and felt angry, defeated, and depressed for days or weeks after bailing out of a losing position?
George Soros was annihilated during the 1987 crash when he dumped his portfolio at the lows. It was a moment that illustrated two characteristics: Soros’s emphasis on risk management (survival) and his confidence in finding profitable future opportunities in the future. Druckenmiller called him the best loss taker he’d ever seen:
“If a trade doesn’t work, he’s confident enough about his ability to win on other trades that he can easily walk away from the position.”
However, this confidence in trading profitably in the future rested on Soros’s ability to quickly rebound mentally. Only a few weeks after what Sebastian Mallaby called “perhaps the worst call of his career,” Soros put on a “gutsy, leveraged position as though nothing untoward had happened.”
In the book George Soros: A Life in Full, when asked about the minutiae of a currency speculation, Soros joked that he could “only remember the future.”
I suspect that Soros and Lynch, and perhaps others, engaged in selective and deliberate forgetting or at least compartmentalization. It reminded me of Napoleon Bonaparte who was very good at removing distractions from his attention:
“Different subjects and different affairs are arranged in my head as in a cupboard,” he once told a minister. “When I wish to interrupt one train of thought, I shut that drawer and open another. Do I wish to sleep? I simply close all the drawers, and there I am — asleep.” How to Win Wars and Influence People: Andrew Roberts on Napoleon Bonaparte
This is not say great investors don’t have good memories (many seem to have photographic ones) or that we should not invest time in post-mortems and learning from history and mistake. As Ray Dalio put it: “pain plus reflection equals progress.”
But there is a danger of getting stuck in this failure-driven learning loop of contemplation that can leave us with self-doubt and hesitation. And the more emphasis we put on memory and lessons from specific situations, the more we may close ourselves off to situations that share similarities but should be viewed with fresh eyes.
In The importance of forgetting, Lauren Gravitz highlights research into people suffering from “severely deficient autobiographical memory (SDAM)” - people who are “unable to vividly recall specific events in their lives.” Interestingly, the researchers found that people with SDAM did well when presented with tasks that required abstract thinking. They were not constrained by a lifetime of episodic memory.
On the other end of the spectrum, people with “highly superior autobiographical memory (HSAM)” have an exceptional memory of minutiae, such as the clothing they were on any given day. However, “these individuals tend not to be particularly accomplished and seem to have an increased tendency for obsessiveness,” perhaps because they are unable to “extract themselves from specific instances.” The strength of their memories became a mental cage trapping them in the past.
“Why do we have memory at all? As humans, we entertain this fantasy that it’s important to have autobiographical details,” Oliver Hardt, a cognitive psychologist studying the neurobiology of memory at McGill University in Montreal, Canada, says. “And that’s probably completely wrong. Memory, first and foremost, is there to serve an adaptive purpose. It endows us with knowledge about the world, and then updates that knowledge.”
Forgetting enables us as individuals, and as a species, to move forwards.” Lauren Gravitz, The importance of forgetting
After showing the author his team of kids, the Great Winfield explains:
“The strength of my kids is that they are too young to remember anything bad, and they are making so much money they feel invincible,” said the Great Winfield.
“Now you know and I know that one day the orchestra will stop playing and the wind will rattle through the broken window panes, and the anticipation of this freezes us. All of these kids but one will be broke, and that one will be the multi-millionaire, the Arthur Rock of the new generation. There is always one, and we will find him.”
We learn by studying history and our own mistakes and actions. But if we hold on to our memories too tightly, we close ourselves off from the present. We view new situations through an aging and outdated prism. In your quest for knowledge and better understanding, don’t be afraid to forget.
Thought provoking read. In Howard Marks latest memo “Bull Market Rhymes
“ he highlights the brevity of financial memory which you might enjoy reading if you haven’t already.
I absolutely loved this article. Thank you for the reminder that we will make mistakes but we gotta let them go.