The anthropomorphic metaphor of the market is too relativist, the view of the market as a voting machine is too rationalist: to take either too seriously leads to error.
People in the City talk of “the view of the market” and “what the market thinks”. Of course, the market does not think; only people think. But the anthropomorphic metaphor, which personalises market opinion, influences behaviour. Benjamin Graham, doyen of the value investor, once wrote of the capricious, volatile “Mr Market”. Warren Buffett, Graham’s successor today, continues this fancy.
A different metaphor is common among students of finance. The market is a voting machine, which allows participants to record their diverse views. The market price is a continuously varying record of the average of informed opinions.
While these two modes of description are not completely contradictory, their implications differ. The anthropomorphic metaphor is hierarchical. “We might ask the market,” City folk will say, but only if they occupy very senior positions or are leading specialists in their field. Such individuals are privileged by direct access to Mr Market himself. The most discreetly influential figures in the City and on Wall Street display the style and mannerisms of Mr Market’s courtiers.
The voting metaphor is democratic. Everyone’s opinion counts although some opinions count for more than others. Views are weighted by the amount of money behind them.
For those who think of the market as a person, investment skill is understanding Mr Market’s psychology and anticipating, a little faster than others, his changing moods. Those who think of the market as opinion poll take a sceptical view of all investment skill: they believe that the result of the continuous referendum reflects collective wisdom. Everything that can be known is already in the price of securities. The voting machine metaphor underpins the efficient market hypothesis.
Both metaphors are instructive but neither is adequate to describe the world: to take either too seriously leads to error. The voting mechanism metaphor is indispensable to the interpretation of short-term responses. Market players vote their expectations of variables for which the range of outcomes, and the process by which the outcomes are revealed, are well defined. The market price reflects an average of prevailing opinions about events such as interest rate decisions and corporate earnings announcements, and market reaction will reflect the difference between that average and the outcome.
But the anthropomorphic metaphor helps explain longer-term trends. The uniformity of conventional wisdom determines the fads and fashions that routinely grip markets. Abrupt changes in the opinion of Mr Market are the only means of explaining extreme market movements such as the crash of October 1987.
But since there is no Mr Market, those who chase him pursue their own shadows. In this imagined world, there are no criteria of truth other than what is generally believed to be true. So, as during the New Economy bubble, common belief can become divorced from objective reality. The (first) Gulf war, Jean Baudrillard said, took place only on television. The New Economy, in much the same sense, was observed only on Wall Street. Today, the improbable belief that opaque financing arrangements can generate returns far in excess of those earned on underlying investments acquires validity only from being generally believed.
But if the anthropomorphic metaphor is too relativist, the alternative view is too rationalist. The metaphor of market as voting machine gives too much credence to the coherence of collective wisdom. As Mr Buffett has observed, the efficient market hypothesis is 90 per cent true but the difference between 90 per cent and 100 per cent is night and day.
The pragmatism that judges wisdom by results confirms the investment philosophy of the Sage of Omaha. Mr Market is a silly old fool who occasionally makes assets available to Berkshire Hathaway below their fundamental value. The voters in the market referendum are overpaid know-it-alls whose opinions count for little relative to the shrewd assessment of the wise observer, who is not swept up in the intrigues of Mr Market’s court.