Market Lemmings Unite

The farther you get from things you know...the more unknowns you discover. And the more you operate in a world of uncertainty, the more you need to follow rules and principles.

An investor may have a general rule - "I only buy stocks with P/E ratios under 10," for example.

He may, however, find a company...study it carefully...and come to the conclusion that it is well worth a P/E of 11. His study has reduced the unknowns...so he doesn't have to rely on his rules.

Likewise, a small family-owned company might have a rule - 'we never borrow to expand.' But after long study of its aging facilities...market realities...its accounts...its products and so on...it may decide to over-ride its rule.

In both cases, the decision may be a good one. But as an investor or a businessman gets farther away from the things he really knows, the more likely it becomes that departing from his rules will lead to disaster.

"Let's set up a plant in China," says an ambitious CEO. "I've heard it's a great place to manufacture."

"I'm going to buy Google. I know, it's trading at an incredible P/E. But it's a new era...gotta get with it before it's too late."

In neither case does it sound to us as though the speaker is making a wise decision.

Many people we know can drive a car without having accidents...or control their family finances without major mishap. They are smart people who get along in life perfectly well. But ask them about the national economy...the war in Iraq...global warming...prayers in the schools...the war on drugs...or any other issue of public interest and you will find all manner of absurd opinions. How was it possible, we often wondered, for such sensible people to have such senseless ideas?

The answer comes to us from science...or at least scientific speculation. The human brain evolved over millions of years in circumstances very different from those today. People lived and worked in small groups, probably no larger than a few dozen...maybe 50...maybe 150. They learned to communicate and to cooperate...in order to survive. Those who failed to master the techniques died out...eliminating the defective, uncooperative genes of the species from gene pool.

In times of famine, for example, a group would be much more likely to survive if it followed certain rules for the preservation of food. A certain amount of group planning and group thinking was necessary, too, to organize group movements and projects, conservation of resources, rituals, taboos and so forth. In short, there were times and conditions when it probably helped for them all to come to believe the same thing at the same time. And these beliefs...were probably not only useful, but well founded in direct experience.

This is, of course, just guesswork...but we've heard worse. Groups of people needed to be able to co-operate in order to hunt effectively. Primitive hunters had no telescopic sights on their rifles. They had no rifles. They had to work together, often in relays, to run down, approach, surround and bring down large beasts. And when they were attacked - either by animals, other humans, or perhaps even other near-human species - they had to work together to defend themselves. We can imagine that the threats were many and the comforts were few. We can also imagine where our high regard for military valor came from. A tribe whose men-folk did not rush to its defense - even at the price of their lives - was probably soon exterminated. It made sense, too - from an evolutionary biology point of view - for a man to fight to the death to defend his own tribe. The group was related by blood. Its children carried his genes.

But the attitudes and genetic conditioning that made him ready and able to work with a small group on a local scale turned him into a dunce when the numbers grew larger and the distances increased. Today, he can still use tools...drive a car...organize a family vacation...do a decent job. He can still cooperate with others at work. And he is still a member of many smallish collective undertakings - his work team, his church, his clubs, his family.

But put a newspaper in his hands and he goes a little soft in the head. The skills that worked in a small group are worthless in a large one. He is too far from the facts to form a decent judgment. Nor can he really tell if his leaders know what they are talking about; he's never been in the same room with them. He is ready to cooperate...even ready to sacrifice himself for the good of the group...but all his instincts and good intentions only mislead him and turn him into a chump.

He can spot a good business when he is in the middle of one himself...but put him in front of hundreds of them...with only the financial news to go by... and he will buy a stock about which he knows nothing. If it were a private business, he wouldn't want anything to do with it. He is still reminded, walking down a dark alley at night, that there are times he has to fight to protect his family. But put him in front of the TV and he is rooting for war with people he's never met, in places he's never been to, for reasons about which he has no clue. He goes along. He is willing and able to think what everyone else thinks. But in the middle of a nation the size of the United States...what everyone else thinks is likely to be the lowest common denominator among 300 million people.

In other words, it is likely to be idiotic, puerile and lame.

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