The Infallibility of Human Greed
What the 1600s Amsterdam Stock Exchange Teaches Us About Human Behavior
Too Long, Didn’t Read? Quick Highlights:
There are three major competitive advantages in investing: informational (knowing a meaningful fact nobody else does); analytical (cutting up the public information to arrive at a superior conclusion) and psychological (that is to say, behavioral). Informational and analytical advantages are harder to come by, therefore long-term investors must assess if they have the behavioral aptitude to succeed as an active investor.
The world continues to innovate and technological progress is increasing at a rapid pace, but observations from the 1600s Amsterdam Stock Exchange teaches the patterns of human behavior never change. Study history to learn these patterns.
Patience is a prudent and profitable trait. While the market is often efficient, specific assets can occasionally be mispriced in the short-term and are attractive opportunities for those willing to utilize time arbitrage to their advantage. Buy right, sit tight.
Everyone is biased, including ourselves. Recognize the biases you have and double-check how they may apply when you make decisions. This will lead to better decision making and over time, better outcomes.
One of the only certainties we have in life is that we will all be wrong again. If you want to be a successful active investor, you must manage your portfolio allocations cautiously and not outsource decision from others. Conviction is earned through hard work, it cannot be borrowed.
Price often drives narrative, not the other way around.
Take ownership of your decisions, the best investors do.
Long Term Investing is Closer to Psychology than Math
Finance Twitter or “FinTwit” as many call it, is an amazing resource if you know how to use it. Like any platform, there is a lot of noise, but there is also an abundance of insight that can make you a better investor. One thing that makes Twitter great, is the meritocracy of ideas. Since you are allowed to create anonymous accounts and do not have to use your real name, the accounts/tweets with the best ideas generally get the most engagement.
In the spring of 2021, after engaging in a thoughtful conversation with another user, we asked if they would talk to us in real life. Given their relevant insights on Twitter, we assessed they were a seasoned investor and figured a meeting would be worth the time. They agreed, under the condition they remained anonymous.
This is when we met Bill (or so he claimed). Bill was born in the mid-west and grew up as a self-proclaimed nerd. He studied History in college because it was what he “liked reading growing up”. During his senior year of college, he realized that History did not exactly provide a high paying career path and after speaking to friends, he decided he was competent enough with numbers–despite his liberal arts degree–and subsequently networked his way into a hedge fund job on Wall Street.
It was here that Bill shared a profound insight:
As the world moved more digital, I noticed that it became substantially harder to compete as a traditional long/short investor. Information and analytical arbitrage was difficult to find. I thought I’d eventually be replaced by a computer and would ride the job out a few more years in the meantime. Then, after a few more years of experience, I discovered something eye opening…I began to see the patterns of human behavior in the same manner that I studied as a History major…and let me tell you, the human psyche never does change….fear and greed are infallible….I found my edge.
– Anonymous Bill
Later in our conversation, Bill said:
Despite common belief, an individual only needs an average level of intelligence to be a Hall of Fame investor. So why isn’t everyone beating the market for a 20+ year period? It’s because most people lack the behavioral edge. The behavioral edge is what distinguishes the greatest of all time from the rest.
– Anonymous Bill
This was a particularly intriguing comment from Bill because of the parallels with legendary investor Nick Sleep’s thoughts from his June 2005 shareholder letter.
There are three competitive advantages in investing: informational (I know a meaningful fact nobody else does); analytical (I have cut up the public information to arrive at a superior conclusion) and psychological (that is to say, behavioral).
Sustainable competitive advantages are usually a product of analytical and or psychological factors, and the overwhelming advantage with regard to Nomad (Nick Sleep’s Fund) is the patience of the investor base and the alignment of that disposition with the analytical and psychological traits of your manager. It simply would not work otherwise. In the investment objective section of the Nomad prospectus, we say that our job is to “pass custody [of your investment] over at the right price and to the right people”…and that “the approach will require patience”. That’s what investing is, at least for us.
“What you are trying to do as an investor is exploit the fact that fewer things will happen than can happen”. We spend a considerable portion of our waking hours thinking about how company behavior can make the future more predictable, and lower the risk of investment. Costco’s obsession with sharing scale benefits with the customer makes that company’s future much more predictable and less risky than the average business and that is why it is our largest holding. Our smaller holdings are less predictable but in certain circumstances could do much better as investments. We are just not sure that they will as their “cone of uncertainty” has a much greater radius than at Costco.
-Nick Sleep (Nomad Partnership Letters)
Some of the best minds think alike. This is hardly a coincidence.
Study History. Learn from Prior Behavior.
As the discussion with Bill continued, Bill explained why he believed understanding fear and greed could help improve decision making and described a scenario he faced in 2008.
In the depths of the Great Financial Crisis (GFC), Bill started doing diligence on Amazon. When he spoke to other investors, nearly everyone he spoke with-in the investment research industry told him not to buy Amazon given the macro landscape and valuation uncertainty.
For context, Amazon had barely escaped from the 2001 tech bubble, dropping +90% while many tech peers went bankrupt. During the GFC, Amazon also experienced a substantial decline.
The consensus during the GFC was that Amazon was an interesting business generating value to consumers but profitability remained elusive and the concerns of the general economy overshadowed any value that Amazon was creating.
Bill found it increasingly odd that most people believed the value proposition of online e-commerce, but were simply too scared of making a buy decision in a macro market given the collapse of Lehman Brothers a few months earlier.
Exhibit A:
After performing independent diligence, Bill thought that not only did Amazon have an increasingly relevant value proposition to consumers in e-commerce, but also Amazon’s B2B offering, Amazon Web Services, had both strong developer adoption and immense optionality as a future revenue driver.
Amazon had a massive fix cost requirement for its own e-commerce sites, so when I realized that they were taking a fixed cost and turning it into a revenue driver, I thought this could be the greatest business in the world. They have to incur the cost either way and any incremental cost should be relatively minor…but the potential upside could be huge.
Additionally, people we’re so worried about the macro economic environment, I realized that people were overweighting the macro environment in their investment process and completely ignoring how incredibly profitable this company could be.
– Anonymous Bill
Bill claimed he began buying shares in late 2008 and early 2009 and has continued to add to this day.
In hindsight, Bill was obviously correct, and assuredly Amazon resembles an outlier example, but his advice on human sentiment and behavior is nonetheless informative:
The point of my story isn’t I invested in Amazon, as I know it is rare to find an Amazon and honestly there was luck involved there. The point I am trying to make is that humans are inherently emotional creatures who have a strong recency bias. When everything is falling apart around them, people look to that and react like the world is going to end. When everything is great, people assume that things will be great forever.
I’m not a macro expert and never will be, but when I come across an interesting business that everyone is telling me not to touch for whatever reason, that perks my curiosity. These are the situations you need to ask ‘Why?’
If consensus is overwhelmingly one way, there is potential for amazing odds in your favor, especially if you are patient.
– Anonymous Bill
Near the end of our conversation, Bill gave us a piece of advice about how to be a better investor.
Study History. Learn from the patterns of human behavior.
Your boss will probably think you are wasting time, but little do they know, the people and events of the past can give you more insight than anything you’ll ever read in the Wall Street Journal or in equity research…besides, isn’t it better to learn from their mistakes instead of your own?
– Anonymous Bill
Over the following months, we took Bill’s advice to heart and made a new effort to study the patterns of history. Topics ranged drastically, from the industrial revolution, to Genghis Khan and the Mongol Empire. Eventually, we came across a fascinating short book that partially inspired this post. It was written by Joseph de la Vega, a Jewish merchant and philanthropist who witnessed first hand the madness of the Amsterdam Stock Exchange.
Confusion De Confusiones [1688]: Portions Descriptive of the Amsterdam Stock Exchange
Joseph de la Vega was born around the 1650s in Amsterdam into a family of Spanish and Portuguese Jews. While little is known about his early life, historians believe that Joseph was originally directed towards a career as a rabbi, but later decided he wanted to be a businessman. Joseph also clearly loved to write. In addition to Confusion De Confusiones, there are at least 6 other works attributed to him.
In the preface to Confusion De Confusiones, Historian Hermann Kellenbenz writes:
The author stressed in his book that he had three motives in writing the dialogues: first, his own pleasure; again, for those who were not active in the trade, he desired to describe a business which was on the whole the most honest and most useful of all that existed at that time; and, lastly, he wished to describe accurately and fully the tricks that rascals knew how to employ in that business. In this last connection his purpose was in part to warn people against entering into the speculation by acquainting them with the deceitful measures, but especially to un-mask the evildoers. He compared the life on the exchange to a labyrinth, and assured the reader that he certainly did not exaggerate: what he wrote might give the impression of a hyperbole or extravagance, but it was really no more than a true description of the conditions.
-Introduction, Confusion De Confusiones (Hermann Kellenbenz)
The book is written as a conversation between 3 characters: the merchant, the philosopher, and the shareholder. Both the merchant and philosopher have heard about the Amsterdam stock exchange but do not fully understand it. The shareholder, an experienced trader, explains to them how transactions take place, what the transactions entail, and common deceptions and tricks that arise on the exchange.
We won’t summarize the entire book, but we will lay out the case that 1688 and 2021 share similarities.
The First Dialogue
…it should be observed that three classes of men are to be distinguished on the stock exchange. The princes of business belong to the first class, the merchants to the second, and the speculators to the last.
Every year the financial lords and the big capitalists enjoy the dividends from the shares that they have inherited or have bought with money of their own. They do not care about movements in the price of the stock. Since their interest lies not in the sale of the stock but in the revenues secured through the dividends, the higher value of the shares forms only an imaginary enjoyment for them, arising from the reflection . . . that they could in truth obtain a high price if they were to sell their shares.
The second class is formed by merchants who buy a share (of 500 pounds) and have it transferred on their name (because they are expecting favorable news from India or of a peace treaty in Europe). They sell these shares when their anticipations come true and when the price rises. Or they buy shares against cash, but try to sell them immediately for delivery at a later date, when the price will be higher (i.e., for which date a higher price is already quoted). They do this from fear of changes in the [political or economic] situation or of the arrival of [unfavorable] information, and are satisfied with [what amounts to] the interest on their [temporarily] invested money. They consider their risk as much as their profit; they prefer to gain little, but to gain that little with [relative] security; to incur no risk other than the solvency of the other party in this forward contract; and to have no worries other than those bound up with unforeseen events.
Gamblers and speculators belong to the third class. They have tried to decide all by themselves about the magnitude of their gains and, in order to do so, . . . they have put up wheels of fortune [willing to risk it all]…Today there are as many speculators as merchants or lords.
– Joseph de la Vega
COVID-19 convinced the average person that they could outperform the market, especially in the short term. 2020 set a record in trading volume for short term options contracts which continued to be broken in late 2021.
Despite being hundreds of years apart, de la Vega’s description of the participants in the markets largely remains unchanged: there are as many speculators as merchants.
The Second Dialogue
Whoever wishes to win in this game must have patience and money, since the values are so little constant and the rumors so little founded on truth. He who knows how to endure blows without being terrified by the misfortune resembles the lion who answers the thunder with a roar, and is unlike the hind who, stunned by the thunder, tries to flee. It is certain that he who does not give up hope will win, and will secure money adequate for the operations that he envisaged at the start.
Owing to the vicissitudes, many people make themselves ridiculous because some speculators are guided by dreams, others by prophecies, these by illusions, those by moods, and innumerable men by chimeras….these stock-exchange people are quite silly, full of instability, insanity, pride and foolishness. They will sell without knowing the motive; they will buy without reason. They will find what is right and will err without [merit or] fault of their own.
– Joseph de la Vega
We at Deliberate Capital believe that patience is a prudent and profitable trait. While the market is often efficient, specific assets can occasionally be mispriced in the short-term and are attractive opportunities for those willing to utilize time arbitrage to their advantage.
While we won’t always be correct, sustainable competitive advantage lies within inactivity on both sides of the investment process. We are rather slow-twitch, meaning that we don’t rush to make buy decisions (most companies do not deserve our capital) since few companies meet our investment bar.
Additionally, we are very slow to make sell decisions. While the phrase is cliché, taking a private equity approach to the public markets, there is something to be learned from private equity’s inability to liquidate their portfolio easily. PE investors are essentially forced into using time arbitrage (at least for 3-5 years).
Having backgrounds in PE we prefer to think like owners, which allows us to think in years, or decades, as opposed to quarters. Only major changes that would seriously affect our thesis in 5 years would cause us to consider selling an investment.
We readily admit that the decision to hold a few select businesses will mean there will be times when we will underperform, and when we decide to sell an investment, we are likely to not sell at the top. However, we believe in order to outperform in this industry, you have to know the game you are playing, select the right game for your temperament, and execute unwaveringly against the plan.
A recent 13F (a quarterly report filed with the SEC that discloses equity holdings for institutional investment managers with over $100mm in AUM) from Valley Forge Capital Management (VFCM) had a lot people on twitter triggered by their inactivity.
VFCM 13F Summary:
Triggered Twitter Crowd:
Oddly enough, they define the game they are playing on their website as “…we believe that having the proper temperament and discipline are keys to superior investment returns. Practicing patience and remaining unemotional through market swings allows VFCM to take advantage of opportunities when we see others behaving irrationally or fearfully.”
Sounds like they defined their game and are playing it as defined (VFCM Founder Dev Kantesaria Principles). Everything else is noise.
We agree with InnocenceCapital here.
There is an advantage that lies in the ability to do nothing. Buy right, sit tight.
Third Dialogue
It is particularly worth remarking that in this gambling hell there are two classes of speculators who are so opposed to one another that they represent antipodes in their decisions and, as I believe, in their destinies.
The first class consists of the bulls, they are those members of the Exchange who start their operations by purchases, just as if they were lovers of the country, of the state, and of the Company. They always desire a rise in the price of the shares; they hope that by reason of good news the market will be suddenly stirred up, and that prices will rise high rapidly.
The second faction consists of the bears. The bears always begin operations with sales. Some of them even surpass Timon of 82 Athens who loved Alcibiades only in order to share his mission, namely, to be the destroyer of his native country. These bears must be fled like the plague, and one must take their part only on extraordinary occasions, as, for example, to catch a Bichile (which is the Dutch children's word for "butterfly"). This last is an expression used to signify a chance for a quick profit, a chance that will flutter away from you if you do not grasp it promptly, and will escape if you do not bag it quickly.
The bulls are like the giraffe which is scared by nothing, or like the magician of the Elector of Cologne, who in his mirror made the ladies appear much more beautiful than they were in reality. They love everything, they praise everything, they exaggerate everything…The bears, on the contrary, are completely ruled by fear, trepidation, and nervousness. Rabbits become elephants, brawls in a tavern become rebellions, faint shadows appear to them as signs of chaos. But if there are sheep in Africa that are supposed to serve as donkeys and wethers to serve even as horses, what is there miraculous about the likelihood that every dwarf will become a giant in the eyes of the bears?
– Joseph de la Vega
Whenever we get together with family or friends who are not in finance, a funny conversation ensues.
They almost always say ask, “Hey, you work in investing, what stock should I buy?”
It’s always cringeworthy.
Why?
There are many reasons we hate it when people ask us this, but recently spent more time thinking and realized that de la Vega’s description of both bulls and bears presents a helpful explanation.
Everyone is biased. Ourselves included.
We are very careful with the decisions we make but since we are relatively concentrated in a few select investments, this presents us with a much larger potential for having a behavior bias. When news comes out on Elastic or Sea Limited, we have to assess this new information and determine how this affects our original thesis. Most of the time, the bad news doesn’t derail our original investment thesis and business as usual ensues, but we also recognize that we are viewing this information from the context of our own book.
Since we own these positions, de la Vega would probably describe us in the same way as he described the bulls of the Dutch stock exchange, “The bulls are like the giraffe which is scared by nothing.”
Additionally, if every time someone asked us what stock they should buy, if we responded with a specific name, say Elastic, this would further imbed our bias. The more people we tell about our decision inherently makes it more difficult to change our decision in the future when new information is presented. If news came out that would affect the probability of a going concern, it would be almost impossible to admit we were wrong then sell.
One of the only certainties we have in life is that we will be wrong again.
We’ve spent a lot of time studying businesses and investing but we still have so much to learn. We are going to be wrong and would hate for someone to put their lifesaving into an investment as a reliance on our decision making, because when that company draws down 40%, they will most likely make another rash decision to sell without understanding the rationale as to why.
While we may be bullish on our investments, we also look at the context of each investment based on our portfolio with which we have full visibility . This is not true if we start giving out recommendations. Just because we think an investment poses an attractive risk/reward ratio, does not mean we allocate 100% of our portfolio towards it. Risk has to be viewed in the context of the portfolio and the risk tolerance of the capital contributed. We can only manage risk properly when we have full insight into the capital contributed and portfolio weights. This is impossible to do for another individual in a single random conversation.
Following the crowd is easy. Price often drives narrative.
Everybody who did not join in the jubilation was regarded as a fool, and everyone who sold shares was looked at as a tenacious and deadly enemy of his own interests, each sale being called foolishness, madness, and a crime
– Joseph de la Vega
Watch this video if you have the time, as it is a powerful demonstration of human behavior. Most people will wait to make a decision once the crowd has already decided.
In equites, this same narrative is reflected in stock price changes with the crowd becoming bullish after a company’s share price has already increased substantially.
They aren’t the first guy dancing, they are the last.
Earlier this year, Viacom, a multinational media and entertainment company had its stock price appreciate 175% in 3 months without a large fundamental shift in the businesses operating performance.
Many equity research reports we’re incredibly bullish and justified the stock price increase given a new streaming offering with some even basing their estimated valuation on 2025E TAM.
Raising PT. Sell NFLX to Buy VIAC.
–Needham Equity Research (February 25, 2021)
On March 22, 2021 Viacom announced a ~$3bn stock offering (rightfully so), the share price decline began but was quickly exacerbated when it was discovered that Archegos Capital Management, had been building a massive leveraged long position using equity swaps (simply investment banks buying Viacom stock on behalf of Archegos). When the offering was announced and the share price declined, the banks called Archegos to post additional margin and Archegos didn’t have the money.
The investment banks subsequently sold the stock to reduce their risk and the share price crumbled (down 67% from the March 22 peak)
The entire story is well covered and we won’t go into more detail but recommend these readings if you are looking for more information (Bloomberg, ZeroHedge, CNBC, Net Interest)
Take ownership of your own decisions–the best investors do.
Additionally, people love investment recommendations because 1) they can point to someone else’s prior success as “due diligence”, and 2) they can transfer blame if it goes awry.
“Warren Buffett bought Alibaba, that means it’s a good investment because Warren Buffett is such a smart investor.”
When a stock decision turns out well, you will hear, “I bought that stock cheap.” But, when things turn out bad, “He convinced me it was a good decision.” This same phenomenon happens in sports. Listen closely to your friends when the team they are rooting for wins, they’ll most likely refer to that that team as “We” (i.e. “We won!”). Then listen how they change their association if the team loses, they’ll likely refer to that team as “they” (i.e. “they lost!”).
When Grayden and I decided to start publishing on Substack, we did it because writing helps us articulate our investment thoughts more clearly and gives us a record of how we were thinking at the time of our investment. It allows us to go back to the record of decision and conduct a post–mortem, i.e. what did we get right, what did we get wrong, and how can we improve.
Ultimately though, it forces us to be accountable. These decisions are published on the internet for anyone to read forever. We have no one to blame but ourselves if things go wrong.
Take ownership, the best investors do.
During the financial crisis of 2008-2009, Monish Pabrai’s high concentrated funds fell about 67 percent before staging a rapid recovery. At his 2009 annual meeting, he told his shareholders, “Most of the mistakes in the funds occurred because I was stupid. They didn’t happen because of market issues.” He highlighted several “dumbass” errors he had made analyzing stocks such as Delta Financial and Sears Holdings, which were crushed. Almost none of his investors abandoned him. The lesson: “You go as far out as you can on the truth variable and the payback is huge.”
I have in mind real speculation, not the honest business in shares, for what is fair in the latter is dubious in the former…
– Joseph de la Vega
This is a brilliant post. Just found your substack and your posts are very high quality. Looking forward to reading your future posts.