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Man Beats Machine

Written by Briton Ryle
Posted May 7, 2019 at 8:00PM

In 1973, Tuckahoe Elementary had three classrooms of third graders. One day, we all gathered in the auditorium to sing a song we'd just learned: “The Ballad of John Henry.”

Now, John Henry was a man — a steel-driving man. He dug tunnels for the railroads with nothing but a sledgehammer and a steel spike to break up the rock. (And while I'm sure they used dynamite, too, there's nothing in the song about that.) 

Anyway, one day, the crew foreman brought a steam drill to the site. Clearly, the steam drill was faster, more efficient...

John Henry told the foreman:

A man ain't nothin' but a man 
And before I let that steam drill beat me down 
I'll die with a hammer in my hand

That song was one of my earliest memories of the whole "man vs. machine" conflict. I still remember the insult to my humanity. And I remember a small sense of pride when John Henry beat the machine. 

Of course, it took every bit of his strength to do it. And after he wins, the song tells that John Henry "laid down his hammer and he died."

Our sense of self, of our humanity, is determined by the degree to which we impact the word we live in. That's why we feel so alive after something as simple as mowing the lawn. We've implemented a change for the better in the world; we've made sense of the chaos.

Let it be known that there is a limit to how long grass can grow unkempt before we bring our humanity (and John Deere mowers) to bear!!!

“The Ballad of John Henry” is proof that humans have been struggling against the machines for a long time. If we lose our humanity to a damn machine, well, death may not be the worst thing. And if you ask me, the loss of blue-collar jobs and the rise of the opioid crisis are not unrelated. 

But for my purposes, that song represents an indoctrination of sorts. It's my earliest memory of the idea that humans can overcome anything if we have enough willpower, if we want it badly enough... 

Man vs. Machine

There aren't too many areas where machines haven't proved to be worthy adversaries to humans. It's often no contest at all. Machines dominate manufacturing today. Machines are the primary reason drilling costs in the oil patch have been cut in half in about five years.  

We're likely to start seeing more machines in retail in the next few years, too. 

Thankfully, there are spots where I don't think we will ever see machines. On the athletic field, in the kitchen of a five-star restaurant, on the evening news...

Because there are places where the only thing that really matters is the actual human experience. A machine that can bat 1.000 is no fun at all...

The one I'm still having a hard time reconciling is the automation in investing. Maybe it's just hitting a little close to home, but I cringe at the thought that a machine can pick better stocks than I can.

Don't get me wrong; I fully appreciate the power of trading algorithms. They can sweep the market, pinpoint specific conditions, and strike faster than a human can. 

But long-term investing needs some imagination. It needs some historical perspective. And it needs some wisdom. In other words, it needs the human touch. 

And so, when I see an article like the one that ran on the Wall Street Journal the other day — “Making Monkeys Out of the Sohn Investing Gurus” — I get a little fired up. 

The Sohn Investment Conference is a charity event. Every top fund manager pays a small fortune to stand before their peers and pitch their top investment ideas. And every year, the majority of them don't do well at all. 

It's gotten to the point where these guys get openly mocked by articles like the one I just mentioned. In it, these editors literally threw darts at the stocks pages of the Journal. And the results literally beat the big shots at the Sohn Conference. 

Now, the idea of throwing darts for stock picks comes from an economist, Burton Malkiel. He wrote, “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.”

And as it happens, the anecdotal evidence is pretty solid. No fund manager beats the S&P 500 for more than a couple years in a row. Then there's Warren Buffett's famous million-dollar bet with hedge funds: that they couldn't beat an S&P 500 Index fund over 10 years. 

Flawed Concept, Flawed Result

First off, let's have a look at the results from the Sohn Conference...

monkey

So the picks from the Sohn Conference did terrible! -20%?? Sheesh. 

I gotta say, I love that Palo Alto (NYSE: PANW) pick. I recommended it to my Wealth Advisory subscribers in November 2017, and we have a nice 72% gain. 

But look at the rest of the Sohn picks, and you can see the flaw. These guys aren't investing. CVS is a "falling knife" kind of stock. Maybe it's turning a corner, and if you catch it right, you'll do great. If not, it will be bloody. And it was. 

Also, note the two short positions. Short positions are not investing. Short positions are trades. And really, much of what these Sohn guys are doing is trading, not investing. 

So before you assume that Malkiel and his stupid monkey are right, investment returns really are random. Take a look at the conditions of the test. If they are flawed, you're not going to get a good result. 

As it happens, I also know why most fund managers can't beat the S&P 500 for more than three years running. It's the same reason my Wealth Advisory has crushed it for the last 10. It has to do with size. And I've got a great Warren Buffett quote that sums it up nicely: 

If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.

The big funds have too much money and, more importantly, too many stocks. Check the holdings of any mutual fund. There are probably 200 stocks in there. Why in the world would you put money into your 200th best idea? I doubt I've had 200 good ideas in my whole life....

That's what Buffett is saying in that quote. Fortunately, I don't think any of us are dealing with too much money. So don't just give up and settle for weak index fund-type returns. Channel your inner John Henry, get that hammer in your hand, and start swinging it. 

We should all be killing it in the stock market. 

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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