Mr. Market: Genius or Fool?

In chapter 8 of The Intelligent Investor, Ben Graham introduces us to the idea of Mr. Market. Mr. Market is your business partner in the stock market, and he’ll offer to buy or sell a stake in the business for a price he quotes. Often the prices he will quote you are sensible. But occasionally, since he is crazy, his quotes will be crazy. All you have to do is sit back, be patient, and pick off Mr. Market when he quotes a ridiculous price. Easy, right?

This parable has led many astray. Mr. Market may be crazy, but since when is it a good idea to pick a fight with a crazy person? Plus, his investment record is pretty good.

Why is that? Mr. Market has many, many advantages over you.

Seventy percent of the market is institutional investors. The big mutual funds and hedge funds have better information than you. They have professional analysts who spend years becoming experts in just a handful of companies. The portfolio managers, if they want to last over time, have to be talented (or lucky).

These funds talk to competitors, suppliers, industry experts, and private companies. They are all over management teams and the sell-side. They meet the CFO so often, they can tell when he sounds more upbeat than usual. They have seen NPD data that suggests that sales are up compared to street estimates. They know that SG&A is supposed to spike in Q1 due to annual raises.

They may have size limitations, but they are often competing in many of the same stocks you are. They also have access to trades you never will. They can trade privates. They get IPO allocations. They can structure asymmetric trades.

In many trading shops, traders have better information flow. Portfolio managers can size positions aggressively. Their capital may be more long-term than you think. They are experts in managing risk.

What about the quants? You have genius PhD’s using supercomputers and way better data to invest with unmatched discipline. They are in every corner of the market, in every security, in every geography. They can trade efficiently. Just because you are in micro-caps doesn’t matter to these guys. Computer algos can scale endlessly to seek out alpha in the smallest nano-caps.

The high frequency traders and quant shops can front-run all your orders. Or take advantage of technicals and your biases because they know what you are going to do.

There are specialists everywhere. Special situation funds arb out market inefficiencies. Medical doctors run healthcare funds. Bankruptcy lawyers run distressed funds.

There are corporate & private equity buyers that know the industry better than you. They can lever up or get sweetheart deals. They can extract synergies or create change through M&A.

There are insider traders (legal and otherwise) that have better information than you. These trades are usually at the expense of the investing public.

Mr. Market is the sum total of all of this activity. Mr. Market works 24 hours a day to beat you. He is massively incentivized to win. Most funds can’t beat him, especially after fees and taxes. Not that this is of any help you.

Oh, and he’s getting better every day.

If you are a small individual investor, I suppose you do have some advantages. You have a wider investment set than most. You usually don’t have pesky clients. And you can try to be longer-term (the big secret!). But even then, it’s not easy to translate these advantages to success.

Since it’s so hard to beat Mr. Market, so why not join him? Vanguard has offered investors this choice. In a low-turnover, low-tax, low-fee way, you can just invest alongside Mr. Market through index funds. Over time, this should lead to decent results.

Are we gonna do that? Nah.

There are ways for the enterprising investor to win at this game (as Jack Schwager’s fantastic books highlight). But whichever strategy you choose seems to come down to one word: discipline. You have to have a plan and stick with it, even as you repeatedly get punched in the face.

Mr. Market is no fool. He is irrational and volatile, but the odds are stacked against us. He regularly beats most challengers. If we want to have a chance at winning this game, we should at least acknowledge that.