Andrew Lo’s heuristic to understanding why markets are resistant to rules is that we can’t think about them as though they’re governed by physics or mechanics. He refers to markets as biological systems, which are highly susceptible to unpredictability, adaptation and evolution. I think that’s right, based on everything I’ve seen, read and experienced over the last twenty years. Or, I should say, this is the best explanation I’ve seen anyone make.
Attempts to understand why things happen are best done in hindsight, never before the fact or during. And even then, we have no way to prove we’re right because there’s no counterfactual – we don’t get to rerun the experiment, with changes to the millions of variables, over and over again. We can only pretend that what had just happened was obvious from the start.
And we certainly can’t say, with a straight face, why an impossible thing all of a sudden becomes possible at a given moment in time. Investors will never get the answer to “Why now?”
I was thinking about this after digesting the latest weekend note from Eric Peters…
She imagined the board. Sixty-four black and white squares. Her opponent did the same. Three moves ahead lay 9 million possible combinations. Four moves ahead, 288 billion. A typical game contains more possible combinations than atoms in the universe. Google’s DeepMind artificial intelligence taught herself to play chess in four hours, then unseated earth’s long-reigning computer. Feeling lucky, she quite naturally turned her attention to Bitcoin. Where in a single week, the price of discrete lines of computer code leapt from 11k to 12k, then 13k, 14k, 15k, 16k, 17k, 18k, and 19k, dropping to 14k and climbing to 16k. To understand the phenomenon, DeepMind examined the entirety of human history. Booms, busts, facts, fictions. She searched for patterns, progressions, mapping market prices onto each rise and fall along our inexorable advance.
And DeepMind examined every theory for these manias of our making; illusions, delusions. Most followed a parabolic path, ended abruptly. Our history books examined each example from every angle. Yet they reoccurred with regularity. Afterwards, such folly appeared obvious, to humans that is. But not to DeepMind. Tulips, South Sea Bubbles, the Nifty Fifty, Nikkei, Sock Puppets, McMansions too. Up, down, spectacularly. “But why and when?” asked DeepMind, unable to understand their origins and endings.
In her parallel processors, a Tunisian fruit merchant lit himself afire, sparking the Arab Spring. DeepMind deconstructed innumerable revolutionary flashpoints, unable to understand why any one specific spark ignites an inferno. “Why him, why her, why then?” she asked each time, perplexed. Following decades of rising inequality, US populism has erupted. “Why now?” she wondered. America’s #MeToo movement appeared overnight, while the harassment it exposes haunted women forever. “Why now?” And DeepMind considered a possibility, infinitely exciting; that in a universe governed by natural law, operating with perfect precision, human behavior is its only true mystery, its greatest gift.
Josh here – just because something is a permanent mystery, that doesn’t mean we ought to to let it lie and make no attempt to understand it. It is in the process of trying to solve the unsolvable that we discover important truths about the markets and become more greatly aware of our own limitations. Being reminded of how little we can ever really know should not lead to frustration or pessimism, it should leads to enlightenment about how we ought to go about putting money at risk.
The only true answer when people ask “Why did that happen now, out of the blue?” is to say “Because.”