I don’t know what the market’s going to do next.
But that’s fine – because you don’t either. Nobody does, no matter how many conspiracy theories or bold predictions get thrown around.
This is one of the most important lessons in investing: If you can’t accept that you don’t know the future, you’ll never make any money.
I don’t put my faith in analysts, economists, or even myself.
What I do trust is the collective wisdom of the market itself. Price action is the truth.
Everything else is just noise.
800 Guesses
In 1906, at a country fair in England, 800 people entered a contest to guess the weight of an ox.
Out of those 800 people, not one person guessed the weight correctly.
But the average of all 800 guesses? 1,197 pounds. Just one pound off from the Ox’s actual weight, 1,198 pounds.
Find Scorpion
In May of 1968, the Navy submarine Scorpion went missing.
The only information the Navy had on its whereabouts came from the final radio signal transmitted from the sub.
Cartographers mapped a 20-mile circle in the middle of the North Atlantic as a starting point for the search.
Submerged in thousands of feet of water, locating the vessel seemed like an impossible task.
Instead of consulting “search and rescue experts” to find Scorpion, the Navy assembled a team with a wide range of knowledge and expertise to guess where the submarine could be.
Yes, that’s right, literally just “guess.”
Not one person independently identified the actual location of the Scorpion.
But the average of the group’s guesses? Just 220 yards away from the wreckage.
Wisdom of Crowds
I pulled these two stories from the book “The Wisdom of Crowds” by James Surowiecki.
Matt Cerminaro inspired today’s note. He’s known as “Chart Kid Matt” on The Compound & Friends podcast hosted by my friends over at Ritholtz Wealth Management.
Matt makes a great point in his recent note that the market works in the same way. And he makes a great list:
Every trade reflects an opinion.
Every sale reflects a risk tolerance.
Every allocation reflects a time horizon.
Aggregate millions of these diverse, independent opinions and voila: a price is set.
You don’t have to like the price.
You don’t have to agree with the price.
But, you’d be foolish not to respect the price.
As Matt concludes, “When the price of an asset doesn’t make sense to me, I concede that the market knows something I don’t.”
What We Do Know
There’s one thing we do know about markets: Asset prices trend.
The collective wisdom of the crowd pushes prices in one direction, and, more often than not, that direction persists. Trends are far more likely to continue than to suddenly reverse on a dime.
Rather than pretend to be experts in the geopolitics of the Middle East or to understand what’s in the minds of monetary policymakers or to know what earnings might look like for the tech stock du jour, it’s much easier to just respect the price trend.
The collective wisdom of the crowds in markets is much more useful than any individual’s opinion – just like guessing the weight of an Ox or in the search for Scorpion.
The NYSE Composite Index consists of all the stocks that trade on the world’s most important stock exchange, the New York Stock Exchange.
This index just closed the month at its highest levels ever:
The collective wisdom of the crowds suggests stocks as an asset class are in the midst of a healthy bull market.
That’s despite any and all scary warnings of recession, a government debt crisis, World War III, or any other rumors you’ll find in glorified gossip columns parading as business journalism.
Remember how many times they told you it was only seven stocks driving the market? They lied to you.
Here is the S&P 500, on an equal-weight basis, closing August at the highest levels in its entire history:
Not only is it not “just seven stocks.” But this index essentially eliminates all seven of those stocks, or any seven stocks for that matter, from the equation altogether.
The Invesco S&P 500 Equal Weight ETF (RSP) treats all of them the same.
From Nvidia (NVDA) and Microsoft (MSFT) all the way down to Eastman Chemical (EMN) and Carmax (KMX), RSP weights all 500-plus stocks in the S&P 500 regardless of market capitalization.
The fact that the index is at the highest level ever is the ultimate arbiter here that it is in fact NOT just seven stocks.
Mathematically – obviously – it can’t be.
They’re all wrong.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs