Going by the spate of recent commentary on the stock market, we’re in the midst of silly season. People bought shares in a video game retail chain on the advice of anonymous Redditors. People are buying crypto because Elon Musk, the world’s richest man, tweets cryptic endorsements of it, or because his company has purchased $1.5 billion worth of it. This is all wild, irrational behavior, many pundits believe—amateur investors showing their amateurishness. “This is just the sort of silliness we need to get used to at this stage of the longest market bull run in history,” the Financial Times columnist Katie Martin wrote.
Investment gurus typically think of the rational retail investor as the kind of creature dreamed up by the economist Benjamin Graham. In his book “The Intelligent Investor,” Graham advised his readers to look closely at annual reports, earnings announcements, and other financials. And certainly the history of markets tells us that there’s plenty to be said for an approach based on such fundamental, careful scrutiny, even if it tends to be scorned during galloping bull runs like the present one.
It’s also safe to say, though, that Graham’s model is not the norm. Investors run short of time, or they know too little, or they listen to bad advice, or they’re over-confident, or they fall prey to biases. They exhibit, in other words, what the economist John Maynard Keynes called “animal spirits” and what another economist, Herbert Simon, called “bounded rationality.”
The type of rational investing in which day traders buy stocks purely because they’ve understood a company’s fundamentals was rare even before GameStop and Musk. In fact, it’s possible to argue that it’s rare even among institutional investors today, given how much trading happens second-to-second, driven by algorithms that crunch vast streams of often unrelated data.
But what if there are other ways to be rational?
To many people, the stock markets must have been pretty confusing last year. Economies were suffering through the pandemic, and yet indices kept climbing. Alarmed calls of “Bubble!” kept circulating, but nothing has, as yet, burst. The signals were difficult to interpret. In this mess of conflicting information, investors looked for clear signs of imminent movements in the prices of specific assets.
They found those signs on Reddit and Twitter. To be precise, they found signs of how other investors would behave in the short term. By now it’s clear that when Musk hollers about an asset on Twitter, its value will rise. It has happened with Signal and GameStop; it has happened with dogecoin and bitcoin. The relationship between the tweet and the crowd’s collective response may be irrational. But the individual investor’s decision to anticipate that response—and to anticipate at least a short-term rise in value—is rational.
Once again, Keynes rides to the rescue. His “beauty contest” thought experiment—which supplied a way to think about when investors would sell their GameStop shares—argues, in essence, that a smart investor will buy assets that others will also want to buy.
“The fact that a thesis is flawed does not mean that we should not invest in it as long as other people believe in it,” George Soros, a seasoned speculator who referred often to the Keynesian beauty contest, wrote in “The Alchemy of Finance.” In other words, seeking out any clear cue to the crowd’s behavior is also a rational thing to do, particularly in a perplexing market and amidst dizzying quantities of often-conflicting information.
The market is set up to reward that kind of approach as well, at least in the short term. That it does so even with Dogecoin, a joke cryptocurrency named after a meme dog, is a reflection not of the irrationality of the investor but of the caprice of the market itself.