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The Average in Humans and Stocks, by Victor Niederhoffer
The average is something that we all would like to know so that we can learn what makes the world go round. Since more people are near the average than anywhere else, knowing about them is a key to success in business whether considering who you're going to sell to, buy from or employ. I like to study average people by reading the magazines they read the most, such as the National Enquirer, or seeing them in representative settings such as ballgames, church, car dealerships, or homes. It's an article of faith to me that the more I know about the average, the better an investor I'll be.
Thus, it was with great eagerness that I read The Average American by Kevin O’ Keefe, a successful married intellectual Democrat fund raising executive, championship runner, and friend of Jimmy Rogers. The book describes his quest to find the one “most average” American through a series of interviews with people whose eponym or business is average or normal.
The book starts with a visit to the Census Bureau, where he interviews statistician Greg Robinson and finds source material for the communities that he will canvas to find his average American. He then interviews a magician named Myklar the Ordinary, a track steward of a Land Rover club who awards a prize for an average finish, smoke-gun owners in Elko, Nevada, a director of noxious weeds in Dickinson County, Kansas, a postman in Maui, Hawaii, a presidential candidate for the Average Joe Party in Pennsylvania, an alderman running for office on the Average American ticket, the pollster George Gallup pollster, the president of the Little League in Williamette, Oregon, a golfing husband and wife in Florida whose business is selling products to the average golfer, and a person whose last name is Average. Eventually he finds the average American based on a checklist of 140 of their characteristics such as age, charity, community, education, employment, faith, family, geography, health, income, hobbies, home, physical characteristics and political convictions. The average person has all 140 of the positive attributes of averageness and it's Bob Burns in Windham, Connecticut . In the only beautiful part of the book, O’Keefe tells Burns that the average American is unique and glorious, not mediocre, and that he's the Average American. Burns says "What an honor!" and invites Keefe to go fishing next year. "What an honor!", O’Keefe says and he means it.
The list of average American qualities is instructive and includes:
Regrettably, the book is marred by the author's complete ignorance of statistics. He uses community criteria to exclude individuals, then tries to find the average by including each of 140 criteria that he randomly picks up from interviews with people whose businesses or names have something to do with averageness, or sparked by reading of popular magazines, movies, and books about average things. It's interesting to see how many average things he discovers and how many matches different people might have to them. But there is no validity or even justification for the goal of the book, which is to find the most average person. Instead what he comes up with is a person unique in fulfilling each of 140 criteria that each have, say, a one-third probability of failure. That indeed is a unique person, not an average person. In addition the author's persona is displeasing. He's the typical intellectual who is unsure of his position and status in life, and tries to find himself through exposure to common people.
In an effort to find the average stock, I am brainstorming about different approaches. One such approach comes from ecology where they consider such things as plant hardiness zones where in each zone conditions are more similar than growing conditions across two zones; this reminds me of the industry classifications that one usually uses to divide up an average. A nice approach to this is contained here. What is the average stock? the most representative stock? The problem is that it is different based on which of the multiple variables that can be used. Should it be classified by market value, price, profit margins, kind of business, kind of CEO, or a distance measure based on combining all of these. Here are some names of companies that Mike Pomada and I came up with in preliminary efforts to find the representative stock:
ANR ALPHA NATURAL RESOURCES INC TGP TEEKAY LNG PARTNERS LP CLRK COLOR KINETICS INC BLC BELO CORP -SER A COM PBNY PROVIDENT NEW YORK BANCORP SMSI SMITH MICRO SOFTWARE INC EEFT EURONET WORLDWIDE INC WEYS WEYCO GROUP INC NCI NAVIGANT CONSULTING INC FFKT FARMERS CAPITAL BANK CORP PBY PEP BOYS-MANNY MOE & JACK PWER POWER-ONE INC RHAT RED HAT INC MIGP MERCER INSURANCE GROUP INC AIQ ALLIANCE IMAGING INC CBJ CAMBIOR INC NRF NORTHSTAR REALTY FINANCE CP PYX PLAYTEX PRODUCTS INC GROW US GLOBAL INVESTORS INC OPLK OPLINK COMMUNICATIONS INC CXR COX RADIO INC -CL A LMIA LMI AEROSPACE INC ELX EMULEX CORP
The above stocks are in the middle of the average rank (i.e., rank each category, then average the ranking -- on an equal weighted basis -- and then rank the average rank) of the following 4 categories:
Stefan Jovanovich adds:
"The typical intellectual who is unsure of his position and status in life, and tries to find himself through exposure to common people" is a beautiful expression of an important truth. It reminds me of what happened to Milovan Djilas had after was released from prison by Marshal Tito and allowed to came to the United States.
Dad had my brother Peter drive Djilas around the Northeast so he could meet American intellectuals. One excursion was to Princeton. Peter remembers overhearing a member of the faculty asking Djilas what the other prisoners were like. "Ordinary criminals," Djilas replied. "Not political prisoners." "But, they were good guys, right?" asked the intellectual. "No," replied Djilas, "ordinary criminals -- murderers and rapists and thieves."
Rick Foust offers:
I too enjoy watching the average man. And living in a state with no great claim to fame other than being in the center of the US gives me plenty of opportunities to do just that. And when I travel, I insist on passing through the poor areas (to my wife's discomfort). When others might go to the tourist traps, I go to a county fair, or an auction, or even a flea market. My favorite way to travel is to spend months away from home as part of a job. That gives me time to become immersed in and gain an appreciation for the locals.
As I revealed previously, my best stock market indicators are the average 401K feeding guys at work. When I take time off from work, it is like going blindfolded with regard to the stock market.
The average man is of value as an indicator because he is an outlier from the Wall Street community. He knows nothing of how the stock market works. He thinks the Dow represents all stocks except those in the Nasdaq. His only involvement with the stock market is what he puts in his 401K and what he hears on the news. Both of these activities are on automatic and largely ignored because his focus is in on his family and his hobbies. He puts money in his 401K because his company matches his contribution. He puts his 401K in stocks because he has been told that stocks are the best investment over the long term. The average man does not trade, but instead buys stocks because he has faith in the system. His environment that has taught him that it is easier to work within the system than without it. He stays with the herd.
So how could watching the average man be of any use in trading? He is a filter. He ignores the noise and alerts at the extremes. If you have ever watched a herd of animals you may have noticed that they are oblivious to random and regular noises about them. But try sneaking up on them. They will pick you out of the noise every time. It is an instinctive skill honed since the dawn of time.
Dr. William Rafter responds:
One of our strategies ranks about 1000 stocks and selects 40 at a given time for further review. We then apply some different ranking methods to build a portfolio with the sort of qualities most investors would choose, like lower volatility. But for the most part, the 40 are our "stars", and most investors would be relatively indifferent as to holding one over the other. When we run the statistics we find that over long periods of time (say 10 years), out of the 1000 stocks we wind up owning 950 of them. That is, almost every one is a star at some point. Or put another way, it's quite average to be a star.
The smaller you make the list, the more it occurs. We also rank and rotate 20 International Indices and the 24 S&P Industry Groups. We have even researched this on markets we cannot yet trade, like the 14 DJ Blue Chip China Sectors. And over long periods of time we find that we were at some point long every one of the above.
The ranking process is a fairly complicated combination of linear and non-linear methods, so there are a few "hoops" the assets have to jump through. That is, we have deliberately made it difficult for these assets to be the stars, but yet they manage to do so.
Wouldn't the law of ever changing cycles dictate this very outcome?
Steve Ellison replies:
This idea is congruent with my intuitive reaction to this discussion. There is no such thing as an average person. In our advanced economy in which specialization is the norm, just about everybody has some unique talents. A person is only average when viewed through somebody else's filter--usually based on one measure, or at most a few.
Russell Sears replies:
One of my first jobs was helping building an extension onto Fairview Hatchery in Remington, Indiana. At the hatchery, millions of chicks are hatched on trays stacked on top of trays. These are wheeled around on rack after rack in incubators to processing and then to shipping.
For the most part, the thousands of chicks looked exactly the same. If a chick looked different or showed weakness, the others would gang-up on it and peck it to death. The processors would then take the damaged defective chick and pitch into a bucket. There these damaged tortured chicks would continue to peck at each other. They were left in a hopeless, oppressed condition, where rage was the only thing left to give them hope. They would attack each other until they all died.
You look at the violence going on today, and you find the political oppressor, feeding the rage, rather than the benevolence. They do this by making the "average guy" see wealth and betterment as a closed system. The only way to get ahead is "steal theirs". It is "us" against "them".
Its not just that the average is good or benevolent. The average is powerful.
Here are some ways in which this power is turned to benevolence or the greatest good:
Some thoughts (most need testing) on how to apply this to stocks and investing: