Welcome back.
Thanks again for being here.
Woodrow Wilson was the only US president who had a PhD in political science.
He came to office having thought more about how a government functions and how you should run it, then most people before him or since.
One of Wilson's big complaints was that too many people in government held the belief that a government was a big machine.
When he meant by that was the belief that once you set up a series of rules, you could take your hands off the wheel, so to speak, and let the government run on its own forever.
Too many people, he said, viewed the government like it was physics, with a set of laws that required no updating or second guessing because they were believed to be precise and perfect as they were.
Wilson, again he thought that was all wrong.
He wrote in 1908 that quote, The trouble with this theory is that government is not a machine, but a living thing.
It falls not under the theory of the universe, but under the theory of organic life.
It is accountable to Darwin, not to Newton.
It is modified by its environment, necessitated by its tasks, shaped to its functions by the sheer pressure of life.
I always thought, look, I'm honestly not interested in politics, but the phrase, it is accountable to Darwin and not to Newton.
Oh, the first time I heard that, I thought that is so brilliant, so ingenious.
And of course, what he's getting at here is that things that are accountable to Darwin, Charles Darwin, evolve.
They change, they adapt to their environment, to their circumstances.
Whereas things that are accountable to Newton, Isaac Newton, like Newtonian physics, are very precise.
There are laws of physics that cannot be broken, they have always existed, they will always exist.
And that idea, I think, accountable to Darwin or accountable to Newton is a very useful way to explain how a lot of things work and why a lot of people get things wrong.
Let me give you two examples, from finance and the economy.
Of times when Darwin was in action, but it seemed like Newton should have been in control and it threw people off.
Growing a population has rarely been a problem in human history.
Virtually every nation could count on a consistent flow of births exceeding deaths and the population grew.
Population growth fueled economies and it seemed like a law of nature.
It seemed like every year in every country there were more people who were buying more things, buying new homes, in modern times buying new cars and that drove the economy.
But Newton is not involved here, so to speak.
Darwin runs the show and things changed.
Living conditions improved, competition favored something new, and over the last 30 years or so in the United States and all over the world.
Countries have changed dramatically, the birth rates have plunged.
So much that most big nations will have fewer workers.
Workers between age 16 and 64, the working age population, will decline by 2050 relative to what it was in 2020.
For basically the first time in human history, outside of a few cases like maybe the plagues in the Black Deaths, you have a decline in populations in many big countries all over the world.
Now think if you are a student of economic history and every model, every forecasting guideline, every belief that you have is driven by the very long term history of how economies worked.
And you have this assumption that oh well there's population growth and that fuels the economy and we can count on the economy growing.
And that everything changed.
Everything adapted and evolved all over the world and now we live in a very different world that we used to live in.
And look, I'm an optimist, I think the economy is still going to grow.
And if you are a listener in the United States, we have some of the most favorable demographics across the developed world.
Even if those demographics were worse than they were over the last hundred years, I'm not pessimistic in this.
But the idea that something that was stable for so long, then adapted and changed is so important.
And you see it all over the place.
Let me give you an example from investing.
Like so many other young investors, I read Benjamin Graham's book, The Intelligent Investor when I was, I don't know, 19, 20, something years old.
It totally changed how I looked at investing.
Graham's book was more than just a theory of investing.
It wasn't just philosophies.
He gave directions. He provided actual formulas that investors could use to find cheap stocks that they should buy.
And those formulas were very simple and they made intuitive sense.
And that really appealed to me because I had no clue what I was doing.
But something became clear once I started actually trying to put these formulas to work.
And try to use a formulas and like back in modern data and see how I could actually pick stocks in the Ben Graham way.
What was clear is that none of these formulas worked.
Graham's book advocated buying stocks that traded for less than their working capital, which is basically cash in the bank minus all debts.
And that sounded great.
But virtually no stocks actually trade that cheaply anymore other than maybe say like a foreign pharmaceutical company accused of accounting fraud or a shell company run out of a garage somewhere.
Not the kind of stocks I wanted to buy.
One of Benjamin Graham's criteria suggested that defensive investors should avoid stocks that traded for more than one and a half times book value.
Following that rule in recent years would have led you to own like absolutely nothing other than maybe like poorly run banks and insurance companies.
In no world should that be the generalized advice that you should give investors.
Look, the intelligent investor is one of the greatest investing books ever written of all time.
But I don't know a single person who has invested successfully by implementing Graham's formulas exactly as they were printed in that book.
Now, yes, the book is chock full of wisdom more than any other investment book that's maybe ever been published.
But as a how-to guide for what to do today, success was kind of a looser here.
And then that bothered me.
Why is this book that is so revered by so many people?
Why is it so difficult to actually put it into use with these formulas that Graham provided?
And that bothered me for a long time.
And then many years ago I had lunch with Jason Zouag of the Wall Street Journal and he explained exactly what was happening here.
Benjamin Graham was as practical as he was brilliant.
That's what made him so great.
And this is because in addition to him being an academic, he was actually an actual fun manager.
He ran what we now know, what we would now call a hedge fund.
And he had no desire to stick with antiquated strategies that other investors had caught on to and became too competitive.
Zouag once wrote, he said, quote, in each revised edition of the Intelligent Investor, Graham discarded the formulas that he presented in the previous edition and replaced them with new ones.
Laring, in a sense, those do not work anymore or they do not work as well as they used to.
These new formulas seem to work better now.
The most recent edition of the Intelligent Investor was published over half a century ago.
So who knows what Graham's strategies would look like today if he was alive to update them?
I mean, think of how much the markets have changed over the last 50 years.
So again, the quarterstones of investing success are timeless.
Patients and contrarian thinking and tax efficiency, those things will be as important 50 years from now as they were 50 years ago.
But among specific investing strategies, things changed.
And just to show you how on board with that philosophy, Ben Graham was, just before Graham died in 1976, he was asked whether detailed analysis of individual stocks, which is the kind of stuff that he became famous for was still a strategy that he believed in.
And he answered, quote, in general, no, I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities.
This was a rewarding activity, say 40 years ago when our textbook, Graham and Dodd, was first published.
But the situation has changed a great deal since then.
What he believed he continued was that buying a portfolio of stocks based off of a few criteria, maybe like low valuation, high dividend yields would make sense.
But what matters here and what so many people overlook when they're studying someone like Graham was that he changes mind.
He adapted. He knew that markets reported to Darwin and not to Newton.
The hard thing here is reconciling two opposing ideas.
One is that reversion to the mean is a very powerful force.
And you should expect that most things that are disconnected from their long term averages will find their way back in due time.
The second idea is that things change and what used to reliably work in the past often becomes outdated or out competed or outlawed or just socially unacceptable.
If an equation existed to know which is which, which is reversion to the mean and when do things change, we would all be better off.
But for most things, I think it's only in hindsight that you realize whether Newton or Darwin was in control.
If there is a common theme to this puzzle, it's that Darwin is usually the boss, most of the time.
But anything that does not answer to Darwin and does answer to Newton is exceptionally important.
So for example, cop-out-interest reports to Newton.
New one is entitled to long-term compounding, but the math behind it will always stay the same.
The power of it will always be the same.
And I think it will always be underappreciated.
And we'll always play a very important role in successful outcomes.
So that reports to Newton and you should pay a lot of attention to it.
Something like incentives also report to Newton's.
The details of different incentives come and go, they change.
But the idea that rewards guide motivation and morals in good ways and bad, that's always been true.
Always will be true. Then there are things like, your customers want low prices.
People want to be connected to other people.
Cultures are different.
There are some behaviors that report to Newton because it is impossible to imagine a world where they don't exist anymore.
Again, Darwin is in control most of the time.
I once read two things about how to deal with Darwin.
One was from the late Charlie Munger, who said quote, If you fall in love with an idea, you won't see the merits of alternative approaches.
One of life's great pleasures is letting go of a previously cherished idea.
Then you are free to look for new ones.
The other idea I came across recently is from Aaron Brown of Bloomberg, who wrote quote, Ininvestment and in life, it is important to have principles.
Things that you believe and deeply are willing to stick to even when they are unpopular and costly.
But only fanatics make every decision a matter of principle.
The basics of quantum investing.
Rigerus and skeptical consideration of all evidence.
Plus insistence on logical theory.
Our sound principles in good times and bad.
But principles are only general guides.
Wise investors allow themselves flexibility in execution.
A great way to end this idea.
That's it for this episode.
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And thanks again for listening.
