The Art of winning an unfair game

Note: This post leans heavily on the work of Morgan Housel, who's book "The Psychology of Money" should be required reading for high school students around the globe. If you have somehow found your way to me without having read his book, do yourself a favor: Close this tab, waste no time on me, and go get Morgan's book instead.

Moneyball, Michael Lewis' famous book about Billy Beane and the success enjoyed by the Oakland As despite having one of the lowest payrolls in baseball, was subtitled "The Art of Winning an Unfair Game." A million words have already been written trying to compare Beane's strategy as a general manager to investing. I won't add to that. But I often think of that subtitle when I think about investing.

Lewis was writing about how Beane had managed to succeed despite all of the odds being stacked against him. The As were at a structural disadvantage compared to the bigger spending teams in baseball. Based on resources available, they should have been last. Every year. Instead, they constantly competed for a title. They were winning an unfair game.

On paper, an individual investor should face a similar uphill climb. Highly-paid, well-educated professionals with access to powerful tools like $24,000 per year terminals should have a structural advantage over a dude with an e-Trade account. 

But in reality, we are the New York Yankees in this scenario. We are the ones with the unfair advantage. The game is stacked, but in our favor. And Wall Street spends billions annually to try to hide that fact from us. (More on that next time.)

We might not have Bloomberg terminals or years of training. But we have time. And in investing, time can outweigh any other structural advantage out there.

Turn on CNBC or Bloomberg or almost any market coverage, and the discussion is about the most recent number. It is almost always about the most recent quarter, or the current quarter, or the current day. Wall Street programs us to think in the NOW. Sometimes really forward-looking savants might talk about the full year. But financial talk is almost exclusively about the present, not the future. And investing is all about the future. The talking heads don't have the patience to appreciate the power of pendulums.

It isn't that the pros don't realize the future is what matters. It just isn't what they are paid to look at. Wall Street is full of analysts who are judged based on their ability to predict what a company will earn, down to the penny, during a three-month period. There are hedge funds and money managers who have to produce quarterly statements to justify the insane amounts they are charging for their wisdom. They are in no position to spend too much time thinking about what the world will look like five years from now. If they don't focus on the present, by then those fees will have dried up. The incentives are lined up to focus on the short-term. The NOW.

I've worked with a lot of these people. I used to be one of them. I can tell you that there are a lot of smart individuals with great ideas about long-term megatrends and how they will impact various companies who, despite that wisdom, still spend most of their time fixated on the next three months. (This is why family offices are so popular... Not having clients is very liberating, it just greatly reduces your fee income.) These professionals, despite all of their knowledge, are locked into a structural disadvantage. It is our job to exploit it.

The more heads on the screen, the faster you should run.

An example, one I've hinted at in a previous post. It has been a brutal 12 months for a lot of financial stocks. The rising interest rate environment means a resetting of pricing on both the deposit and lending sides of the business. For some big banks that is a net positive. Bank of America for example has a massive amount of non-interest paying deposits in the form of consumer checking accounts, and a huge consumer credit portfolio. As rates rise they can boost their credit rates without boosting what they are paying as interest on deposits, and pocket more money. 

But there are a lot of banks, especially smaller banks and business-focused ones, who don't have that same advantage. They don't have that huge base of non-interest bearing deposits. As rates start to rise competitive pressures move rates higher on deposits as fast, if not faster, than on loans. And with rates rising lending volumes can stall, meaning there is less new business coming in. The result is near-term pressure on profits, and banks stocks that are down more than 50% over the past year.

The selloff is fully justified if your focus is on the present. It is fully justified if your focus is on the next six months. It could be fully justified if we remain in this interest rate environment forever. 

But we are smart enough to know that this isn't a new normal. Rates are not going to continue to rise indefinitely. The pendulum will eventually swing the other way. The NOW is temporary.

The Wall Street pros know that too. But the pendulum isn't likely to swing the other way before the end of the quarter. The analysts judged by their ability to predict the next quarter, and not the next few years, are lowering estimates. The investing pros don't want to explain why these "loser" stocks are littering their portfolios. 

Morgan Housel puts it this way: We are playing a whole different game than those pros, with different rules, and different priorities. It isn't that the pros are wrong, it is just they are looking at the world in a way that is irrelevant to us. To the extent we can block out that noise, and focus on where we think the world is going over the next five years and not over the next three months, that is our advantage.

Billy Beane won an unfair game as an underdog by being the smartest guy in the room. We can win an equally unfair game by simply tuning those "smart" guys out.

Disclaimer: Fits and Starts DOES NOT provide financial advice. All content is for informational purposes only. Stocks mentioned are as reference only, and a mention should not be interpreted as a buy or sell recommendation. The author is not a registered advisor or a broker/dealer. DO YOUR OWN HOMEWORK.