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Investing and Philosophy: understanding the three stages of truth

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By Phil  Osophy

5.15.2010

http://wp.me/pOhuI-gH

All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident.” – Arthur Schopenhauer

A short essay which equates secular market timing to the three stages of truth

“Investing” has to do with the psychology of human beings. Understanding the three stages of truth can help enormously in understanding the financial markets, or anything else for that matter.

This essay uses the term “investing”, very loosely because it’s meaning has become muddled.  Todays 24 hour global on line financial markets much more accurately depict a legalized on line gaming environment. If there was any truth in advertising, qualified participants (people who have money qualify) could click on buy, sell, on line poker, horse races or craps. There is no reason they shouldn’t all be on the same screen.

Baby boomers now beginning to think of retiring grew up watching Mutual of Omaha’s Wild kingdom and were sold on the idea that their mutual funds would provide for it by nice people with expensive desks. The idea was that if you “invested for the long term”, your real wealth would compound. Merrill Lynch was bullish on America. They never said if they were bullish on themselves.  It is now obvious that this was all a con job, but the idea is disputed. Similarly, the idea that the global financial markets have devolved into a legalized gaming casino is past the stage of denial, and now the obvious truth is being met with a lot of opposition, mostly by all the interests vested in it. So these are two examples where we are currently on the second phase of truth.

Back to the point…

The fields of advertising and public relations have grown more potent, omnipotent and omnipresent. Everyone in the world, market participant or not,  is subject to a 24 hour PR cycle. Markets are linked globally and trading on ninety something percent leverage amplify the “news”(PR). The markets routinely have exaggerated daily movements of several percentage points as market participants try to estimate relative values by buying and selling at the speed of light and up to 99 percent leverage. The whole thing is driven by perception, belief and confidence…and it’s amplified by a debt based fiat currency system.

using the three stages of truth for practical purposes…

The first stage of truth is always met with denial. Human psychology…”the crowd”, collectively never want to acknowledge what is right under their nose. The crowd is always herd like. George Orwell wrote “to see what is in front of one’s nose needs a constant struggle”.  To do that requires independent thinking. In order to operate in the first stage of truth, by definition this expresses an opinion that is counter to the collective opinion.

George Soros wrote, “markets influence events they anticipate”. That is certainly true, until it isn’t. In other words, the real estate bubble, in the second stage of truth, was still influencing the event (higher prices) they were anticipating. By the time the third stage of truth came along, the market was collapsing. So the market participants collectively had to go from anticipating higher prices, to anticipating lower prices, and that happened because of the third stage of truth, which was only achieved by the market beginning to collapse. The actual root cause of this particular collapse (rising interest rates and unpayable debts), are what finally tipped this unsustainable bubble from the second to the third stage of truth.

Some would argue it all comes down to the math, and ultimately you would expect math to dictate events, but because of the three stages of truth, the math can take a back seat for long periods in the interim.  For example, the debt and future obligations of the US government (as well as many other governments today running fiat currencies) are far too large to ever be repaid except in greatly inflated dollars. So this item is currently in the second stage of truth. In spite of the fact that this debt is an order of magnitude too large to be repaid, and despite the fact that this is staring everyone in the face, the value of the currency has yet to collapse against real things because the truth is being violently opposed.  So despite the fact it is obvious that this debt cannot be repaid, people with vested interests in it will defend it’s legitimacy here in the second stage of truth.

When Bernie Madoff’s NASDAQ was peaking out around 10 years ago, it was supposed to go on forever. This new dot com era changed the whole game. “It was different this time”. It always is in the first stage of truth. Then there was the real estate bubble where anyone with a pulse could get a zero down loan because it was obvious that real estate prices would go up forever and would never go down. Supposedly intelligent people at the time would come on TV and say that. So these are both examples of things that were all right under everyone’s nose. First the truths were met with denial and ridicule, then in the second stage of truth met with opposition. In other words, when the real estate market began to collapse, that idea was met with extreme skepticism. Following that, in the third stage of truth after the collapse, it is now obvious to everyone that it was an unsustainable bubble.

A key point is that only hindsight offers the actual truth and even then is subject to historical revision.  So that’s the problem with any trading system. At the first stage, is the truth being met with denial because it’s either the truth or is the hypothesis simply wrong. Things that are wrong will also be met with denial because they were not the truth.

By definition, the application of this idea requires you have to have the ability, conviction, confidence and correctness to see the truth when that truth is the subject of denial and ridicule. It it is not the subject of ridicule, then either it is not the truth or it is already in the second stage of truth.

Famed investor Jim Rogers was once quoted as saying “buy value sell hysteria”. This is another example of the stages of truth. Value occurs in the first stage of truth. When Gold was trading below $300, people buying gold and gold derivatives were the subject of ridicule from the herd. Hysteria occurs during the second stage of truth. The stage where it’s obvious that this cannot continue forever, and despite that, it is continuing, and being defended against criticism. When the hysteria peaks, when the hypocrisy of the defenders becomes too great then the hysteria ends, the bubble bursts, and the third stage of truth is achieved. The short seller would of course, also like to sell in the transition phase between the second and third stages of truth.

Summarizing this idea, financial markets are legalized casinos with credit up to 99 percent of the purchase price and available on demand. Psychology and herd behavior drive the markets. They operate on belief and confidence or lack thereof…. according to the three stages of truth. Market relationships are purely a product of perception, belief, and confidence. Those all follow the three stages of truth. The efficient market theory is wrong and only still used by ivory tower academics, not successful market participants.

Using the three stages of truth for practical purposes, ideally a position would be initiated in the first stage of truth and held through the second stage when it is being met by opposition. Then, the position is terminated or reversed at the transition to third stage of truth, when it is obvious to everyone what the truth is.

Notes:

I write to you from a disgraced profession « Real-World Economics Review Blog
[filed under: failed financial system, John Maynard Keynes, Fraud, flat earth Economics professors]
The following is the text of  James Galbraith‘s written statement to members of the Senate Judiciary Committee delivered a few days ago.
I write to you from a disgraced profession. Economic theory, as widely taught since the 1980s, failed miserably to understand the forces behind the financial crisis. Concepts including “rational expectations,” “market discipline,” and the “efficient markets hypothesis” led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.
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