Caution: Dangerous Platforms Ahead!

A few weeks ago I read an article authored by the staff of a prominent, well-funded fintech website. I'll purposefully leave their name out, that's not the point here. To quote:

You know that adage, "stocks are sold, not bought?" What often drives stocks are simple, plausible stories. In fact, Nobel-winning economist Robert Shiller has made the case for how both financial markets and economies are heavily influenced by stories. Investors often call these stories their "investment thesis." We at [XX] like to call them themes, ideas, trends or motifs. We believe it is far more intuitive for investors to think this way.

If you can't explain your investment story very simply in just a sentence or two, it probably isn't a very good story. Put another way, this is known as start-ups' "elevator pitch" in the venture capital world. As for plausibility, the investment story may not necessarily turn out to be true, at least in the longer run. The thesis only needs to be widely credible in the shorter run by having some basis in reality. [my boldface added]

To be honest, this brazen submission scared the bejeezus out of me. And made me angry. And might have been the final catalyst to actually build this website and start publishing some general market thoughts.

I also imagine that, had he read it, Professor Shiller would have also been outraged to have his name associated with these statements. To me, when you say that a Nobel laureate "made the case" for something you are about to describe, it connotes some ideologically implicit support for the statements that follow. I'm sure that Professor Shiller thinks the concept here is as faulty and dangerous as I do.

At best, the viewpoint here is a recipe for a poor investment strategy. More dramatically, it is the same blueprint for proffering a Ponzi scheme. A couple years back, in a paper I wrote as a basic introduction to asset allocation (re-posted to this blog), I stated:

Examples of this herd-like behavior are readily observed and documented. One of the most famous (and comical) was Holland’s Tulip Mania of 1637. And to the degree that these booms and busts repeat themselves, the market becomes preconditioned by past experience for expectations of bubbles. We tend to jump to conclusions that have very poor grounding in probability. This can be referred to as “extrapolation”, or what behavioralists call a “representativeness heuristic” in which predictions are made using the closest match to past patterns, regardless of the probability of that pattern asserting itself.

In the financial markets, these periods tend to be accompanied by new theories which try to provide underpinnings to the price action that make them different – a.k.a. sustainable – this time around. To be dramatic, keep in mind the dynamics of a Ponzi scheme: initial investors must be convinced of some superficially plausible, if somewhat unverifiable, thesis. It is the subsequent investors that allow the scheme to proliferate when they abdicate the responsibility to perform any due diligence, rather, gauging the integrity of the thesis by the sizable returns accruing to other investors.

I'm not trying to play investment police here. Sharing ideas can be enlightening, if not at least entertaining. For fun, I may throw in a blog post or two along those lines.

But investors need to be careful when they actually consider allocating assets to strategies like these. And the fact that we now have highly publicized sites that are geared towards just that type of behavior indicates that added caution signs need to be posted.