Photo Credits: Jen and www.david baxendale.com with help from pinetools || The casino is exciting. The scale is honest and unrelenting.
I want to give an update to one of the major concepts of Ben Graham, in order to make it fit the modern era better. Ben Graham said:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
https://www.goodreads.com/quotes/831517-in-the-short-run-the-market-is-a-voting-machine quoted from The Intelligent Investor
So let me modify it: In the short run, the market is a casino, but in the long run, it is a scale. Is this an improvement? Probably not, but speculation has become so rampant that it may be a necessary modification to change voting machine to casino.
The voting machine makes sense, but typically we think of voting as being democratic. We only get one vote per person. Markets are different. Someone who brings a little money to the market will not have the same influence as the one who brings a lot of money to the market. Thus my analogy of the casino, though typically casinos will place limits on how much the casino will wager. They want to avoid random large losses so that they can live to extract money from rubes for many years to come. The winner can brag that he “broke the bank,” but the casino survived to play on.
Bill Hwang and his CFO were formally charged with fraud today. What did they do? They synthetically borrowed a lot of money from investment banks to own huge amounts of a few companies. Their buying pushed the prices of the stocks higher, allowing them to borrow more against the positions. But eventually as the stocks they owned had some bad results, the margin calls on his positions wiped him out as the stock prices fell. The scale trumped the casino.
The same is true of crypto and meme stocks. Cryptocurrencies require a continuing inflow of real cash (admittedly fiat money) in order to appreciate. If people stop buying crypto on net, and that may be happening now, cryptocurrencies will decline. The scale says crypto is a zero — no intrinsic value. The casino begs for more people to bring real money to buy fake money.
That applies to meme stocks as well. You can throw a lot of money at a stock and it will rise. But for it to stay there or rise further, it will need increasing free cash flows to validate the value of the firm.
Going back to crypto, it lacks any link to the real economy. Crypto will only become legitimate when you can buy groceries and gasoline at a fixed amount of bitcoin that varies less than the same price in US dollars.
As a final note on the Scale versus the Casino, I give you Elon Musk. He borrows against his shares of Tesla to buy Twitter.
He either did not realize or ignored the fact that he could lose his stake in Tesla if the price of Tesla falls enough. Do you really want the margin desk to control your fate? This may not totally impoverish Musk, but it is not impossible that he could the entirety of his holdings of Tesla in order to keep his holdings of the unprofitable Twitter. All it would take is for short sellers to push Tesla below $740, and then the margin desk starts selling his shares into a falling market. Momentum, aided by an agreement leading to forced selling.
The market abhors a vacuum. So it is for those who assume that things will continue to go right for them.
It sure feels as though it was a voting machine these past couple of years and now we’re firmly entering the weighing machine phase.
Casinos are a very bad analogy for the stock and bond markets. Casinos have strict rules and they do much more to enforce those rules than the stock and bond markets do. Casinos are very focused on having an even playing field with a relatively fixed probabilistic percentage built into the rules that leads to the house making a steady profit on the numerous transactions that occur. The last thing they want is front-running other customers, card-counting to increase a participant’s profits at the expense of other customers or the house, or fraudulent activities. They will severely limit how much credit a client can have while gambling and they will limit the stakes on any one bet. it is highly unlikely that Bill Hwang could have done an equivalent thing in a casino that he did in the markets. Individuals can go bankrupt due to gambling in casinos due to their own behavior but it is highly unlikely they would endanger the casino or other participants.
One other reason that casinos are a bad analogy to stocks. If you go to a casino regularly and “invest” $10,000 into it, you will walk away with $9,000 to $9,900 on average, depending what games you play if you know how to play them based on probabilities. This will compound downwards over time if you don’t put more money into that initial $10k kitty. https://www.news5cleveland.com/before-you-go-gambling-the-best-and-worst-casino-game-odds You would likely gradually lose all your seed money slowly over time but you would not be impacting anybody else in the process, other than your family.
In the stock market, over the long term, your $10,000 invested into a broadly diversified stock index will grow to $10,800 on average (assuming average 8% total return per year). This will compound over time if you simply leave it in because the stock market has a historic upward trend based on economic growth (future returns not guaranteed if your country is invaded etc.). Despite this, people will do crazier things in the stock market than they would do in a casino in the hopes of getting big gains quickly, including doing things with fraud and on massive leverage that can destabilize the entire system and bankrupt them and other participants participating with leverage with destabilizing impacts to the broader society as financial systems teeter on the brink of collapse
We would probably be better off if the Nevada Gaming Commission replaced the SEC because they have shown that they can keep a system stable that is designed to lose the participants’ money. They could likely do much better than the SEC in a system that probabilistically makes money for everybody over time since the SEC has demonstrated they can take a system virtually guaranteed to make money over time and let it collapse periodically.
If you do much short-term trading with stocks, and especially if you do it with options, you will learn that the stock market is very much like a casino. The bid-ask will eat away any advantage from corporate profitability. Buffett has been saying much the same.
If you invest long-term, that is the scale. Short-term, the casino. Use no leverage, the scale. Use a lot of leverage (real or synthetic), the casino.