19 Apr Quarterly Review Q1 2021
WHAT’S PRICED IN?
Investing is a complicated endeavor. Predicting the future is hard enough; understanding what markets have priced in is just as hard – and just as important. Nobel Laureate –and University of Chicago behavioral economics professor – Richard Thaler conducted an interesting study providing some insights on the matter. The Financial Times allowed him to publish a contest asking for a number from 0 to 100. The guess closest to two-thirds of the average of allentries was crowned winner. This clever contest forced entrants to consider all others’ views – as all investors must do to outperform the broader financial market. Three specific answers showed up most often. The “first–level thinker” gave the third most popular answer – 33. The thinking: Because the average random response is likely 50, the winning answer should be 33 (two-thirds of 50). Meanwhile, the “second-level thinker” reasoned – if all respondents are “first-level thinkers”– the winning answer should be 22 (two-thirds of 33). In fact, this was the most popular answer. But why stop there? The really “smart” contestants answered 1 (second most popular response). These entrants, Thaler concluded with humor, had “too much economics training.” Average contestants did not go that many levels deep. The winning answer was lucky number 13 (two-thirds of 20), closely approximating “third–level thinking” (fairly common across repeat experiments). What constitutes first/second/third-level thinking in financial markets is not so straightforward – and can be very fluid, as investors respond to each other in real time. Let’s give it a shot anyway. Read the full Quarterly Review Q1 2021.