THE RATIONAL ANIMAL

Fishing Atlantic salmon is no ordinary fishing. When salmo salar returns from its ocean journey to spawn in its natal river, it totally stops feeding. Anglers casting artificial flies along the river seek to annoy it enough to incite it to rise to the fly and gobble it, presumably to clear the pool of this unwanted distraction.

Sometimes, a salmon will dart towards the fly and take it aggressively. Other times it will totally ignore it and rest in its pool before resuming its upstream voyage. Other times it will rise lazily towards the fly, take a look and either take it in its mouth or simply ignore it and slowly return to its resting spot. That same fish may keep rising to the same or another fly, sometimes taking it, sometimes ignoring it. Or, it will play with the fly, pushing it with its nose or tail or rolling over it, totally frustrating the angler, even more so if the darn fish keeps doing the same trick over and over.

When a generally rational person like me spends some 24 hours over 3 days casting flies hoping to catch the elusive Atlantic salmon, he can’t help but wonder what exactly is the animal spirit within this rather unique specie. The pike, trout and bass I used to fish in my younger days were true animals: they saw food or anything resembling food, they generally quickly went for it, took the bait and ended up on my dining table. Most people fishing Atlantic salmon will be very, very happy with one catch per day.

So why am I so keen spending a fair amount of money fishing such a strange animal? Why are there so many people doing the same each year, knowing so well that the odds are totally stacked against them?

Because of the satisfaction of winning, against the loaded odds, of inciting this resting fish to leave its comfort, rise to my fly, take it, and then landing this incredibly powerful fish after a spectacular fight during which the odds of me still losing the battle are not trivial.

I treasure this sport because the potential reward, for me, is well worth the money and time. There is an unquantifiable potential reward which, even with low probabilities, keeps me investing time and money on this fish, year after year.

I consider my fishing to be totally rational. Not doing it is almost inconceivable. I need the fun, the challenge; I like the preparation, the camp, the river, the guides. I truly enjoy my fishing mates, the excitement before my first cast, the jolt of adrenaline on the first rise; I relish the battle after the fish refuses to take the fly, me versus him, him the teaser, me the sucker. It may take 10 minutes, 30 minutes, many different flies, but I will play him as long as he wants. And if he finally takes, its my talent, my experience, my patience, my luck against his strength, his spectacular jumps and desperate head jerks, his endurance and his luck. And if he finally gets netted, the satisfaction is immense, even more so as I watch the guillie carefully release this beautiful duelist back to his river, hoping to see him again next year, larger, stronger, maybe smarter.

In truth, the animal spirit actually refers to people like me, who will do seemingly irrational things even against clearly unfavourable odds.

The famous economist and investor John Maynard Keynes figured us out in 1936:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

The urge to action, rather than inaction. There is nothing irrational in this, quite the opposite. Humans need to be active, do something.

Investors are humans. They read that the economy is ok, profits are rising, the Fed remains investor-friendly given the quiet inflation. Tough to sit on our hands, do nothing, watch the parade sitting on boring and useless cash. The urge to action, rather than inaction.

Stocks are expensive? Most people agree, but we keep buying. In fact, it’s when stocks are expensive that buyers are most numerous. The urge to action.

Atlantic salmon fishermen know the dilemma. It’s where fishing is expensive that the odds of success are the highest. The dearest outfitters are on the best rivers, they have the best pools where more salmons will pause their journey upstream to rest. Most likely, these pools are not very far from sea so the fish is fresh and vigorous, unlike near the end of its upstream voyage when he is tired, hungry and focused on the spawning task.

The higher the price, the better the odds. Totally rational.

Tops of equity cycles, when valuations are the highest, get the crowds. That’s when the excitement is best. The media front page the action. Markets are active and buoyant. Everybody is in and frantic. This is not boring “buy and hold, wait and hope”. It’s catch and release, cast again to another quick success.

This is big fun, fashionable. Party talk. The adrenaline keeps you in. No time to sit and rest on the sidelines, watch the stocks jump. This is peak action time. You ought to go. It may not last long but all your friends will tell you that if you want to make money, now is the time. As my dear friend Bob used to say, “if your fly is not on the water, you ain’t catching any fish”.

All rational.

Summertime, and the livin’ is easy
Fish are jumpin’ and the cotton is high  

My fishing dates are truly prime time. I know salmon fishing, I know the river, I know the pools. I know when to go, when not to go. I have made the errors before and I have learned. I do my own research, generally dismissing popular fishing lores.

I am willing to pay up, but only for certain dates on certain particular rivers. Later in the season, same rivers, same pools, same old guides but much fewer fish. Most are gone, moved upstream. People coming late will often strike out, wondering why this great river, these well-known pools, are not producing like they’re famous for.

They will get disillusioned, be sorry to have lost that money, finally understand who the suckers really are. This sport is not for them, better to leave it to the pros.

But even the pros get sucked in by the excitement. That’s their living. They thrive when the crowds are in and even when they know the end is near, they keep you in. They don’t want it to end. They got stories, new styles, new equipment, new approaches, anything to keep people in the game as long as possible. This time may be different. After all, the authorities have abundantly restocked the rivers, they even found ways to control the water levels. There are different breeds of fish now, fast growers, slow swimmers, quick takers, latecomers and all.

And the younger guides are even better. The game has changed. New technology, brilliant software, algos of all kinds. Today’s lures are much more efficient. “Yo, check out this Froot-Loop fly! By the way, we got new ways to spot the fish, even late in season. We use drones, even satellites. Everybody is much smarter now, and with climate changes, seasons don’t end anymore.”

And don’t worry, there is now robo-fishing. River too high, river too low, water to warm, whatever, for a small monthly fee, you will automatically get moved to another great spot if and when needed. “We manage your risk, the fun will never end. Excitement 24/7!”

The game has changed. The times, they are a-changing.

Really?

This is from a speech by Benjamin Graham in November 1963:

(…) At that time then, in May 1962, the concept of a one-way market, which go only upwards with very small reactions, seemed to be abandoned for good. However, Wall Street has a very short memory, and now the majority of financial authorities seem to be slipping back to the concepts of 1960 and 1961.

They are returning to the idea that for the smart investor the question of stock-market fluctuations does not have to be considered.

There is a two-fold emphasis here, which slurs over the reality of stock-market fluctuations.

The first is the general conviction that the market can be counted on to advance so emphatically through the years that whatever declines take place are comparatively unimportant; hence if you have the true investor’s attitude you don’t have to concern yourself with them.

The second claim is a denial that the “stock market” exists at all, meaning thereby that what the market averages do is of no real importance to the intelligent, well-advised investor or speculator. It seems to be a ruling tenet of Wall Street that if you practice the proper kind of selectivity in investments you don’t have to worry about what the stock market does as a whole, as shown by the averages, for at all times the good stocks will be going up and the bad ones will be going down and all you need to do is pick the good stocks and forget about the stock-market averages.

How valid are these two arguments?

The first one – the argument that common stocks are and always be attractive, including the present time, because of their excellent record since 1949 – involves in those terms a very fundamental and dangerous fallacy.

This is the idea that the better the past record of the stock market as such, the more certain it is that common stocks are sound investments for the future. (…)

As I see it, the real truth is exactly the opposite, for the higher the stock market advances the more reason there is to mistrust its future action if you are going to consider only the market’s internal behavior. We all know that for many decades the typical history of the stock market has been a succession of large rises, in good part speculative, followed inevitably by substantial falls. Consequently, the substantial upsweeps of the past have always carried with them warning signals of unhappy consequences to come. (…)

Hence a large advance in the stock market is basically a sign for caution and not a reason for confidence.

(…) the nature of the market has not changed from its earliest times, as shown in our records that go back at least to the South Sea Bubble in 1720, practically 300 years. We have also very detailed data on stock prices in the United States since 1871, which were incorporated in the Cowles and the Standard & Poor’s records. It may well be that we shall still have the all-too-familiar alternations of excessive optimism and excessive pessimism. (…)

It is not in the nature of economic reality to permit net gains at the shown rates from 1949 to 1963 – something like 14% per annum including the dividend returns – to continue indefinitely in the future.

We just don’t have a financial and economic system that can operate on that basis. If that were true nobody would have to work for a living. (…)

My basic conclusion is that investors as well as speculators must be prepared in their thinking and in their policy for wide price movements in either direction. They should not be taken in by soothing statements that a real investor doesn’t have to worry about the fluctuations of the stock market.

In the end, it’s all confidence. High price fishing generally means good rivers, good pools, good dates, good guides, good food, good fun. Better odds to perform. You are willing to pay up because you have confidence that the river, the pools and the camp will deliver.

High price equities generally mean a good economy, good profits, buoyant markets. You may be willing to pay up if you have confidence that central banks, governments and corporate CEOs will deliver. This is a shakier type of confidence; it is on shakier grounds and black swans can be everywhere.

Just back from my annual Atlantic salmon fishing trip, my confidence was well deserved. The river, the pools and the camp delivered.

As I look at the investment landscape, looking for confidence in the economy, central banks and governments…Hmmm…And I am not talking of all the non-financial stuff…Yes, the times they are a-changing. (sigh)

Indeed, the river will get quiet again. Eventually. Until the next cycle. The eternal life cycles.

Curious to know how things really looked like around 1963?

By November 1963, the S&P 500 had recovered 33% from its June 1962 recession low. Profits were rising nicely and inflation was stable between 1.0% and 1.4%. Equities rose another 24% for a total bull market advance of 69% lasting 3.5 year, peaking at 93 in January 1966. During that period, profits rose 51%.

The economy kept rising for another 4 years which did not prevent the S&P 500 to correct 16% in early 1966 as profits stalled and inflation surprisingly jumped to 3.6%, forcing the Fed to hike rates aggressively.

Then the Nifty-Fifties took over and the S&P reached 108 in November 1968 when the market’s P/E was 19 and the Rule of 20 P/E 23.4.

The 1963-66 period is the only period since WWII when the Rule of 20 P/E did not quickly and meaningfully go through the “20” fair value P/E on the way up. In truth, investors got really spooked when the Index cratered 24% in the first half of 1962. There was a similar hesitation in 2014-16, potentially due to the very difficult memories of 2000-02 and 2007-08.

These memories now seem to have faded, giving way to optimism that the central banks will keep pumping, that the economy will keep humming, that inflation will stay quiet, that profits will keep rising and that President Trump will be delivering.

How rational is that?

Summertime, and the livin’ is easy
Fish are jumpin’ and the cotton is high  

BEARS ALSO ENJOY ATLANTIC SALMON

No catch and release with these guys. Nothing rational in that!