The most consequential truths are transcendent. Take, for example, the dynamics of personal consumption. The financial decisions we make today have consequences well beyond the present moment. The virtue of patience, and its alter ego, impatience, are central to the choices we make. As they determine our spending patterns, they are responsible for what options will be available to us in the future. These inter-temporal[1] choices are many, but a perennial truth is that by consuming less today, consumption levels could increase significantly in the future—and vice versa.[2]
Moving from individuals to social and economic systems, a proclivity toward patience has profound implications for the evolution of these human systems. In classical economics, patience generates savings by households, which, through financial intermediaries, finances investment by companies. In turn, capital accumulation by the same companies drives future output. To the extent that financial intermediation is efficient, it also encourages thrift and promotes growth, reinforcing a patient approach to both private and public decisions.
For example, when government regulation is relaxed—including financial liberalization—two alternative paths are likely. Down the first, liberalization may encourage patience, improve choices, and promote growth. Along the second, impatience could generate a self-reinforcing feedback loop of quick fixes that trump the virtues Adam Smith extols immediately below.
Adam Smith and Patience
The renowned author of The Wealth of Nations advocated for the virtue of patience in the Theory of Moral Sentiments (1759):
The qualities most useful to ourselves are, first of all, superior reasons and understanding, by which we are capable of discerning the remote consequences of all our actions; and, secondly, self-command, by which we are enabled to abstain from present pleasure or to endure present pain in order to obtain a greater pleasure in some future time.
If life only were that simple. Smith complexifies the situations by describing “two selves,” later interpreted by behavioral economists as the patient “planner” and the impatient “doer.” To confuse the matter further, human reason is not always mathematically logical. People have a tendency to avoid discounting evenly over time. Instead, gains in the short term are valued more highly than gains realized farther into the future.
Preferences Evolve over Time
In behavioral economics this tendency is called hyperbolic discounting—putting present, smaller rewards over distant, larger ones—and it has far-reaching negative consequences. If the virtue of patience is practiced, it can become self-reinforcing, avoiding such consequences. Because of feedback loops, its temporary dominance holds sway over the two propensities—that is, unless the other successfully reasserts itself and the narrative reverses.
Studies show that happier people save more and spend less. Contrary to many caught on the hedonistic treadmill, in classical philosophy it is not money that brings contentment but learning to love that which is good and being of service to others. Material goods do not generally fill that bill. Instead the virtues themselves, of which patience is a constituent member, are more likely to yield sustainable happiness. Deferred gratification is a paramount practice in the training of this faculty. Financially, if expecting a longer life, deferring gratification becomes habituated, resulting in greater stability, a useful condition for psychological health. This dynamic is quite similar to the effects of good exercise and diet.
Expanding to economic systems, their growth can itself be a self-reinforcing pattern. Industriousness, like dieting, promotes self-esteem and long-term productivity, whereas idling, like overeating, has the opposite outcome. Moreover, behavioral contagion has a multiplier effect. Our actions result in “three degrees of influence.”[3] It is not just those around us but often those at a considerable distance who may be changed by our choices and actions.
By contrast, addictions are a vivid example of a self-destructive, impatient doer. The compulsion for immediate gratification (drugs, alcohol, sex, food, work—to name five) overrides consideration for long-term consequences. For financial systems, the implications are no less dire and disturbing. Credit—consumer, corporate, or government—brings forward tomorrow’s spending to today, leaving the future bereft of adequate resources. The impulses behind systemic credit binges differ little from individual drug addictions.
Gresham’s Dilemma in Finance
For a primer, see our post, Gresham’s Law & Growing Weeds. Today, finance faces its own Gresham’s dilemma—whether to take the patient or impatient path, being generous in assuming there is still a choice. Liberalization has given rise to greater information and liquidity in financial markets. The digital age makes it possible for the long-term investor to better compare prices with fundamentals, but it also tests the will and temperament of managers subject to short-term-performance measurements.
Anecdotally, performance evaluation intervals have progressively shortened over time. While Berkshire Hathaway resolutely adheres to interacting with owners only once a year at its May shareholders meeting, the prevailing standard among the vast majority of publicly traded U.S. companies caters to the instant-gratification mandate. The quarterly-earnings conference calls, made even less relevant and more redundant because of earnings guidance, are the new norm. More information and market liquidity (see next paragraph) can be too much of a good thing.
Beyond its obvious benefits, liquidity can also be a double-edged sword. After all, it makes buying and selling easier: Bid-ask spreads are narrowing, and commissions are approaching zero. Very few investors remember the days when share ownership was represented by physical certificates held in bank safety-deposit boxes, a nearly insurmountable practical impediment to frequently changing horses. Despite the conveniences afforded, liquidity inclines investors toward the path of least resistance, liberating impatience and its antisocial progeny: the excesses of trading, credit, and volatility. Whatever tendency the capital markets may have toward equilibrium and presumed stability, deviations resulting from impatience can be dangerously counterproductive to the goals of long-term, all-in investors.
Of particular interest to us is the growing effect of impatience on misalignment between price and value. Research has shown that over the last century, U.S. stock prices have been three times more volatile than fundamentals. In part due to financial innovation, volatility has accelerated since 1990, with stock prices fluctuating at 6–10 times the rate of change in fundamentals. If we assume volatility is a shorter-term phenomenon, the longer-term measures of misalignment that we frequently reference are evident as we write. Until the 1960s, the average absolute deviation[4] of U.S. equity prices was roughly 20%. Since the 1990s, the average absolute deviation has been well over 100%. While, admittedly, volatility and, in particular, misalignment play to the strengths of value investors, it comes at a high price of promoting systemic instability, which, ultimately, offers little of enduring value to anyone.
Practicing Impatience
Our society as a whole is becoming increasingly less patient. This phenomenon is not limited to the likes of commentators on Squawk Box. The Internet age has been instrumental in this shift. The briefest of Google searches on patience and smartphones will highlight the mental tethers we have to our devices that have proven to degrade everything from workplace productivity to test scores. Without our phones, we experience phantom vibrations, reaching into our pocket for the device that isn’t there. These are real experiences, demonstrating significant changes in our brains.
Two-day shipping now seems a long time to wait. Retailers compete, increasing traffic in the process by clogging local streets with large delivery trucks, to get us our parcels within hours of clicking toward the purchase of an item that the sidebar in our Internet browsers or smartphone banners somehow knew we were craving before we did. We see more advertisements than ever before, but not through television, the use of which is declining. Who can sit through a commercial? Meanwhile, millions aimlessly surf on their devices, unsure of what they’re seeking but nonetheless incapable of settling down without the tactile stimulations of tap and swipe.
This is not merely a technology problem, though. Baseball has been declining in popularity since the 1980s. The great American pastime simply takes up too much time for the busy American life. Granted, baseball games have been trending longer in recent years, but it’s the slowness of the action, the plodding strategy of marking the count, not the actual length of the game, that seems out of step with contemporary life.
Or consider the increased popularity of gambling. These games are clearly not about statistics, or no one would ever engage in them, save the mathematically brilliant at the blackjack table. Whether it’s playing the lottery at the gas station or slot machines at the proliferating casinos that pad weak state budgets, gambling is the impatient therapeutic release from whatever financial pain one is currently experiencing.
Have humans changed? Is Solomon wrong? After all, he said, “There is nothing new under the sun.” Is there a new human nature with which to contend? Likely not. Humans have struggled with patience throughout history. The trait is a concern of every spiritual tradition from the ancients forward. Why are we demonstrably less patient today? Short answer: We’ve been practicing impatience.
Virtues are learned over time with consistent practice. Technology is just the latest means we’ve developed to atrophy the patience we have and distract us from training in its ways.
This affects financial markets because they’re moved by human investors. Just over half the country owns any stocks at all, and it’s safe to say that most know very little about what they do own. Their boss has outsourced their retirement to someone the employee probably will never meet. The vast majority are uninvolved with their holdings, and their own patience, or lack thereof, is likely more clearly demonstrated in their consumption habits than in their trading behavior. This simply highlights the outsized impact the disposition of those who truly do control the marketplace have on the behavior of equity markets.
Whether we’re talking about a short-tenured CEO who earns options based on per-share performance or a pension manager understandably anxious about shortfalls in this low-yield environment, impatience can move markets—and with violent volatility. High-frequency algorithmic trading is simply an accelerant to this truism, creating much greater deviations from value than historically has been the case.
To the extent that today’s managers have practiced reaction, hurriedness (even harriedness!), and impatience in their daily or professional lives, the markets in which they trade will mirror those inclinations. Let the impatient be forewarned. As too much debt is taken on to spur ever-slowing growth, or too much leverage is assumed to see returns increase more quickly, or as you follow the latest trend because you heard about it on Squawk Box and don’t want to miss out, impatience is being practiced.
The
cautious and temperate would do well to avoid the playground of impatience as
it, especially in the financial world, invariably leads to an unfortunate fate.
[1] Inter, between, temporal, in relation to time.
[2] In 2010 Andrew Haldane, current chief economist for the Bank of England, wrote on a similar theme for the China Business Forum. His remarks deal less with character formation as social proclivities, but aspects of these reflections draw from his material and inspiration. https://www.bis.org/review/r100909e.pdf
[3] Research has shown that our sphere of influence begins with friends (one degree), our friends’ friends (two degrees), and even our friends’ friends’ friends (three degrees). Our influence gradually dissipates and ceases to have a noticeable effect on people beyond the social frontier that lies at three degrees of separation.
[4] The mean absolute deviation measures the absolute dispersion of data by computing the distance of the data to its mean, whereas standard deviation is calculating the square of the difference.