“Davidson” on Markets, Regulation and Reading..

• Posted by ToddSullivan
• on May 27th, 2011

“Davidson” submits:

The markets should be viewed as the net/net historical growth of human standard of living. Viewed as history one can see various influences:

1) The effect of the CEO on corp financial and then stock price performance,
2) The effect of Business Cycle and the various measurements provided by current data series,
3) The larger influences of government directed social engineering and the inflationary effect which had a 30yr cycle 1965-1997,
4) The effects of shorter term government regulation and investors locating loop holes with which to reek havoc and last but not least the fundamental effects of society’s evolution and adjustments to changing circumstances.

What occurred in the period of 1871-1933 was totally changed with the introduction of FDIC insurance. The break that one can see about 1940 is entirely due to the introduction of FDIC insurance, the greater regulatory powers of the Fed et al and the associated industry fees to make rescue self supporting. Prior to 1933 when banks in small towns went under, often it took all the banks in the same town under with all the savings, including homes and anything that had that bank’s loans against them. It wiped out years of hard won individual savings. Once the FDIC changed this, the economic growth rose by a factor of ~3.5x simply because these types of capital losses stopped occurring and society stopped having to reboot from scratch for the financial failures of others. Beginning after 1933 and it appears that this kicked in ~1940, society began to grow step wise up a series of higher lows due to FDIC.

Regulation by itself still does not prevent disaster, but used as it is by the FDIC coupled with self insurance was a significant social advancement.

More than this, the 1933 Banking Act results on our economic success clearly demonstrates that markets are a human system which can be structured for improvement!! When one begins to think of markets as a human creation, one should quickly conclude that mathematics as a tool has limited use and should not be overly relied upon.

The markets are not bits and pieces that can be analyzed by mathematical algorithms, but a human system that is evolving. One cannot take the historical average of 40yrs and make some statement about a current market P/E or etc. One must identify the themes that have influenced market prices over the short, intermediate and longer periods and then determine what each has contributed to price. Being that markets are a uniquely human means of exchanging individual productivity for items of survival and improvements in standard of living, one must recognize that market psychology causes fuzziness in any mathematical relationships one can identify and simply learn to live with it. Those who look for mathematical precision in markets miss its fundamental nature.

My view is that markets should be studied as human history with simple mathematical trends to show the general relationships. Mathematics has only a minor use in making predictions as humans can change conditions tomorrow and make such predictions laughable. The best one can do is to monitor the current trends, compare them to past trends and relationships and state whether it appears that conditions are currently over or under valued. As soon as one tries to predict what is going to happen the next 5min, tomorrow, next week, month or year one has stepped well beyond one’s knowledge.

My strongest suggestion to you for reading is to read history, bios of JP Morgan, JD Rockefeller, Pinker’s books on how the mind works and etc. Society has often been benefited by very few individuals with great talent, i.e. Alexander Hamilton, George Washington and etc. Try to study personality types and how humans range from the very logical unemotional business types to the very emotive trust fund babies, i.e. left brain vs. right brain. Your investment thinking will benefit greatly by incorporating all this information and you will see how rich, generous and creative society is, but how some can also be very self-advancing and scurrilous towards others. Then you well begin to identify those CEOs who treat their positions as if they are fiduciaries and enjoy running a highly productive enterprise as if this were a religious calling. The Buffett CEOs are like this. Once you get to this level of understanding, investing becomes identifying the people, the valuation levels of individual stocks and asset classes and the broad conditions in which all are immersed.

The battles we feel we are fighting today began with Hamilton vs. Jefferson and the 1st Bank of the US. There are those to whom understanding finance is natural and obvious, i.e. Hamilton and those to whom business and finance is simply an evil, people starving, degrading activity that should be taxed to death, i.e. Jefferson. This is left brain vs. right brain. They never understand each other! Once one views things by historical perspective and in the human context, then one’s investing becomes along the lines I have suggested and if all do this then we can cause as significant and as positive affect as that of the FDIC!

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