In his wonderful book, “The Wisdom of the Hive”, Cornell University biologist Thomas Seeley explains that the returning honey bee forages, do a little dance to tell their colony mates where the food is. But what’s remarkable is that the duration of the dance reflects not only the richness of the foraging site the bees are advertising but also the colony’s need for the commodity in question. In other words, each bee’s communication dance considers both the colony’s opportunities and its needs. As a result, a bee colony’s overall allocation pattern is appropriate even though no one bee is in control.
 Ants also demonstrate remarkable collective behaviour. Leading ant researcher Deborah Gordon shows that ants place their cemeteries at the point furthest from the colony. But it gets better, because they place their trash heaps at the spot that maximises its distance from the cemetery and the colony. Without awareness, the ants solve a tricky spatial problem worthy of a standardized intelligence test.
What makes the behaviour of social insects like bees and ants so amazing is that there is no central authority, no one driving traffic. Yet the aggregation of simple individuals generates complex, adaptive, and robust results. Colonies forage efficienty, have life cycles and change behaviour as circumstances warrant. These decentralized individuals collectively solve very hard problems, and they do it in a way that is very counterintuitive to the human predilection to command-and-control situations.
Stock markets share many of the same features as social insect colonies and decision markets. Markets emerge from the interaction of many individual investors. While both colonies and markets work well, given certain parameters, the biggest difference etween them are incentives and the role of prices. In a colony, each bee acts not to maximise its own well-being but rather the well-being of the colony (evolution shaped this behaviour). In markets, each trader seeks to maximise his own utility. This difference may make colonies more robust than markets because colonies are not as susceptible to the positive feedback that creates market fragility.
Also, hives do not have prices. Prices are important in a free market economic system because they help individuals determine how to allocate resources. Upward price moves also trigger deep seated emotional responses forcing individuals to drive up prices further. Bees convey information through their dances, but prices in markets often go beyond informing investors to influencing them, spurring unhealthy imitative behaviour. For example, stock prices tend to be efficient when investors are varied, making independent judgements leading to unbiased decisions. But when heterogeneity does not prevail and investor errors become non-independent markets become subject to excesses. Stock markets are more prone to excesses than colonies.
Comsider the curious attempt by the regulator to tame toxic animal spirits currently alive and well in the local stock market. The action was poor by all measures. If the aim was to increase the “integrity of the market”, criminal prosecution of insider traders would be a far better approach. Globally, regulators can do little about day traders and small retail investors getting burnt by hyperactive stock markets, as all markets have a fundamental agency problem. Brokers are remunerated on turnover, which will prompt them to encourage increased trading by the most vulnerable investors who are least knowledgeable. Excessive trading is by far the most wealth destructive strategy for average investors in highly concentrated share markets, such as Colombo.
The most natural course of action to “protect investors” and prevent “speculation” is to remove the agency conflict and propose a remuneration model that is not dependent on transactions. Needless to say that such a system has been vehemently opposed globally given the political power of broker firms (and investment banks).
Benjamin Graham, the father of value investing, wrote that "the market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities." Rather, he added, "the market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion." Herding, Graham understood, is part of the human condition. Neuroscience and psychology are now firmly behind that claim. It is high time regulators and investors accept that fact and focus their efforts on investment literacy as opposed to ineffectual rules.
The pillars of stock investing success lie in the knowledgeable, patient and emotionally stable individuals being rewarded at the expense of uninformed, impatient and highly emotional personalities.
(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at kajangak@gmail.com). |
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