What seductive lies are investors telling themselves today?

Much of what investors take for granted today is wrong. The way to get an edge in the markets, says John Stepek, is to imagine a radically different future.


Artificial intelligence is changing the game

The US Federal Reserve issued the most gutless statement it could last night, in the circumstances.

To paraphrase: "We're a bit more worried than we were at this time last month because stocks even American ones! are lower than they were back then, which can't be right. I mean, markets only go up, don't they?

"But we can't come out and do a full U-turn on interest-rate rises already, regardless of what Ray Dalio and Jeffrey Gundlach say, because that would look really stupid and you lot might freak out even more badly than you are right now."

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

So markets went into a sulk, because they're not getting any sweeties yet. But the Fed's resolve is clearly weakening. So expect more tantrums, which will be followed by the dishing out of sweeties later in the year.

As every parent knows, tantrums plus sweeties often end in projectile vomiting, but we can discuss that some other time.

Anyway, so that's your Fed roundup. Now I want to turn to something much more interesting.

Computer games

We're another step closer to genuine artificial intelligence

Google's artificial intelligence (AI) unit has created an AI that has just managed to beat a professional human player at the game of Go'.

Go is an ancient board game from the Far East. It involves two players one using black counters, the other white. The goal is to surround more territory than your opponent. It's fun and it's difficult. It's up there with chess as one of the classics'.

But here's why Go matters for AI research, and why it's been seen as a tough' problem. Chess is difficult. But you can win using "brute force'. A computer can calculate every potential combination of moves, then pick the best one given the current configuration of the board. So it's as much about processing power as intelligence' (however we define that). That's how the computer Deep Blue beat chess grandmaster Garry Kasparov in 1997.

But you can't use brute force with Go. "There's more configurations of the board than there are atoms in the universe",according to Demis Hassabis, who heads Google's DeepMind unit. (Wikipedia puts a more specific figure on it there are ten to the power of 761 possible games in Go, versus ten to the power of 120 for chess.)

So the AI needs to think differently. More intuitively. More like a human, maybe.

I'll not go into the details of how the AI thinks differently I find it quite interesting, but you may not, and it's not really the point.

The point, for me, is this: until very recently, this was an intractable problem in AI. Some people even considered it insoluble. Even in December (ie just last month), reports Quartz, one very experienced researcher in this field said "he believed someone would crack the game in the next ten years". Less than two months later, and it's been done.

Things change. What we consider impossible today is unlikely tomorrow, then commonplace the next day. And understanding that matters for investment.

People don't change, but stories do

Understanding this that markets reflect the same cycle of increasingly ardent belief in one story, shock and discomfort at learning that it's not true, and then excitement at finding a new story to believe in will help you to understand why markets are not rational.

But it also means that one way to get an "edge" in markets is to be capable of imagining a future that is radically different to today. That's the core of contrarian investment. Understanding what it is that everyone is taking for granted today that is utterly and completely wrong.

"Tech stocks will go up forever."

"House prices never fall."

"Opec will never let oil prices fall below $100 a barrel."

They're all belief systems that failed. And it really didn't take much imagination for an investor to visualise a very different potential world, and thus avoid or even profit from these bubbles bursting.

What other statements are being taken as articles of faith today? I can see a few floating around.

"Inflation is dead. We're heading for perpetual stagnation."

"Developed world sovereign debt is the safest asset in a very uncertain world."

"Central banks have ultimate control over asset prices."

Those are three sentiments that you often read in the papers these days (pretty much every time Larry Summers opens his mouth in the FT, for example).

And how can you tell that people basically believe these stories, rather than all the other possible stories that are around right now (like "tech can solve all our problems", for example)?

Well, all of the above help to explain or justify why bond prices are so remarkably low right now. Most markets look fully or overvalued today, but I think bonds have to take the prize as being the most expensive in historic terms.

We'll have a lot more on this in upcoming issues of MoneyWeek magazine. Meanwhile, perhaps the AI researchers should consider the global game of bluff and double bluff that is monetary policy as their next project.

John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.