Li Lu: The Stock Market is Not Created For You
Bitcoin 'Flip Flop' by Wall Street, 'Think Different' as an Investment Philosophy
Wall Street ‘Flip Flop’ on Bitcoin
In the latest round of comedic relief in finance, we have banks that formerly shunned Bitcoin now looking for ways to generate revenues out of it:
JPMorgan Chase & Co. is preparing to offer a Bitcoin fund to wealthy clients, the latest sign that Wall Street is warming to the largest cryptocurrency after it soared in recent months…
…Wall Street banks are grappling with whether to offer clients exposure to cyptocurrencies after staying mostly on the sidelines…JPMorgan has been taking some of the biggest strides, adding Bitcoin exchanges Coinbase Inc. and Gemini Trust Co. as banking clients last year.
Source: Bloomberg
Never count Wall Street out in finding new ways to make money, especially in markets like these where there’s a buyer for anything. Don’t buy the narrative everyone else is selling though: Wall Street is hardly a true believer in crypto.
The Street’s real religion? It’s all about the fees, baby.
Li Lu: Stock Market Ain’t Made for Business Owners
Buffett & Munger protégée Li Lu gave a talk back in ‘06 at Columbia B-School, transcript is over at Roiss Investment Insight’s substack:
If we see ourselves as business owners, do we actually need the stock market? The stock market was not created for value investors. It was set to minimize friction and allow people to trade. Does anyone have a guess how much of the assets are managed by value investors?
There is not a conclusive study, but there are a number of attempts including one from Professor Lowenstein, a law professor next door. He estimates that just under 5% are held by value investors. This is consistent with what we said, that value investors are not the majority, but the minority with the stock market not being catered towards you. It was created for the other 95% and this is where both your opportunity and challenge lies.
—Li Lu (2006), Source: Roiss Investment Insights
Of course this was back before passive, algos, and free stonk trading apps became all the rage they are today, so surely even less than 5% of market activity today is due to value investors who see themselves as long term business owners.
In fact, true value investors don’t trade that often, so it’s probably even smaller than that. Then you have to add in today’s market conditions where most participants have moved away from any semblance of value oriented thinking and…it’s even smaller.
This might be a little shocking considering how many folks in that “95%” have convinced themselves they are purchasing “value assets” these days, but really just buying hyped up assets…
Think Different From the ‘Other 95%’
One thing that will routinely be stressed in this newsletter is that if you want to succeed in investing over the long run, you truly have to think independently. And independent thought will lead to independent action which will sound crazy to the “Other 95%'“.
And why is this the right way? Think about investing like betting at the racetrack:
The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what's bet. That's what happens in the stock market.
Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it's not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it's very hard to beat the system.
—Charlie Munger, Art of Stock Picking
To a degree, prices in the stock market reflect the consensus view on each individual security’s odds and amount of future payoff versus risk. So a stock that everyone thinks is great—like a fast horse—is already priced with the expectation of good performance (high price to earnings, for example). In other words, there is often little reward left at the prices you’d have to pay to buy such a security (or bet on the fast horse).
So, think about a horse name Tesla (TSLA):
In mid-2019 you could have bet on the horse for only $40B (a horse that was the largest global EV producer, far ahead of competitors, with a very talented CEO)
Recently, bids on that same horse were priced at $700B two years later
Which one is the more enticing deal? This is what Buffett means when he says you should think like you are buying the underlying business when you purchase a stock.
Obviously this is not a perfect model for markets (the Efficient Market Hypothesis ain’t for real), but it’s a useful simplification of thinking how the stock market works.
So, if you can think independently—that is, look each horse in the mouth and perfect your skills in scouting horses, you’ll have an edge that over time will deliver outsized returns. You may one day stumble upon a horse that no one is interested in that pays out incredible odds…and then goes on to smash some races and become a crowd favorite.
It Ain’t Easy to ‘Think Different’ Today
These are times when it’s very hard to think independently because it seems everyone else is making so much money. And for now, folks who merely follow trends on social media or Reddit may enjoy profits, but time and time again we’ve seen that such a strategy eventually crumbles as the house of cards comes tumbling down. The herd eventually gets burned.
If you ever needed a chance to prove it to yourself, now is the time: Are you really capable of thinking independently? And you may be asking: is it worth it? Time will tell.