Natural Selection and the Stock Market

 

If there are other worlds elsewhere in the universe, I would conjecture they are governed by the same laws of natural selection — Richard Dawkins

Arun Kumar

Arun Kumar + AI

Three fundamental elements are essential for the emergence of natural selection and evolution: (i) a finite pool of resources, such as energy; (ii) a diverse population capable of replication, ranging from simple self-replicating molecules to complex organisms like humans, with variations in traits within the population affecting resource acquisition efficiency; and (iii) the passage of time.

If one possessed divine powers, simply introducing three core elements would suffice for a complex tapestry of biology on a planet like ours to evolve: limited resources; a replicating population with trait variance; and time. Starting from there, the divine power would sit back and observe the unfolding of evolution.

The relentless pursuit of resources, coupled with the instinct to replicate, would inevitably give rise to increasingly complex and efficient life forms. Over time, this pursuit for efficiency would also catalyze the emergence of consciousness, the development of language for improved communication, and the formation of agrarian societies to support growing resource demands, all aiding in the race to excel over others.

Even at a more fundamental level, the mere presence of finite energy and existence of a primordial chemical mixture sets the stage for the inevitable rise of self-replicating entities, paving the way for the inevitability for the process of natural selection and evolution to occur.

Natural selection, however, extends beyond biological arena. Whenever three specific conditions converge in any domain, the principles of natural selection and evolution will take hold. A contemporary illustration of this is the dynamics of the stock market.

To draw parallels, let us first identify the presence of three essential components in the stock market.

Within the stock market’s framework, the ‘resource’ equates to the discretionary capital held by investors. The ‘population’ consists of diverse companies, each vying for that capital with their unique characteristics (or traits). Time, as always, is plenty.

Similar to biological entities, the primary objective for companies is to ensure their continuity and expansion, which they achieve by securing capital. The biological selection mechanism determining which traits are advantageous is mirrored their effectiveness in drawing investors and their money.

Companies strive to highlight a range of traits to capture investors’ interest and secure funding. These traits include above-average profitability, effective management, promising growth prospects, and investment in innovation to develop new products or enhance existing ones.

It is crucial to understand that the process is self-driven and natural. Individuals have discretionary funds at their disposal, which companies aim to attract. The stock exchange serves as the meeting ground, and that is where the intricate dance of natural selection plays out.

Just as environmental pressures — such as resource scarcity, climatic shifts, the advent of new pathogens, geographical transformations, and alterations in predator-prey relationships — steer the evolution of biological organisms, external factors also influence the evolution of companies. Examples of such changes include the rise of disruptive technologies like Uber, political turmoil that heightens the stock appeal of defense-focused firms, and public sentiment, such as attributing responsibility for climate change to certain corporations. And thus, along the path of evolution, the environmental pressures also evolve and affect which traits will be preferred.

Remarkable parallels exist between the evolutionary processes of organisms and companies, with both driven by the imperative to acquire resources more efficiently, leading to greater complexity with time (I am sure you have heard about complex financial transactions like hedge funds and derivatives). Nonetheless, distinctions between the two also exist.

In the stock market, investors engage in deliberate decision-making (despite the debatable rationality and objectivity of their choices), contrasting with natural selection influencing living organisms, which is an instinctive process shaped entirely by environmental forces.

Another distinction lies in the role of central banks, which actively work to tinker with market conditions and do not let the process of natural selection play out to its full potential. While there may be a natural selection counterpart to this regulatory influence in the present era - human intervention is now a significant factor in the evolution of species - it did not used to be this way.

An additional contrast is the potential for resource (i.e., capital) availability to expand over time for stock markets. 

Despite these differences, there are striking resemblances in the evolution of companies and biological organisms within their respective domains. This is inherently due to the combination of three fundamental elements listed at the beginning, which necessitates such a parallel.

Ciao.

The economics of flying

 Arun Kumar

34,000 feet (about 10 km) up above in the air I am on my way to Geneva. To put the height of the aircraft in perspective, the peak of Mount Everest measures 29,029 feet. 

Dinner has been served, everyone has been given their plastic bottle of water, and in a few hours, we will land in Geneva where I will be in transit and board another flight on the way to Lisbon. 

If you are wondering whether I am on my way from Stockholm to Lisbon with a stopover in Geneva, you would be wrong in your guess. 

I am flying from Washington DC to Lisbon and my route to the destination flies me close to Lisbon while on the way to Geneva. I would then go backtrack from there and fly to Lisbon. The route taken is a quirk of the economics of the pricing of airline tickets and the premium that is put on the perceived value of our time.

When I was checking the flights to have a week of vacation in Lisbon, the fares for direct flights from Washington DC to Lisbon were the most expensive. The flight time was around seven hours. 

Then there were other flight options that first took me to different cities in Europe, had a layover, and then continued to Lisbon. These options were priced cheaper, but their flight time to Lisbon ranged from 14-24 hours. 

You can see the logic of the pricing model here. If you are willing to sacrifice your time, then you could fly cheaper. This is one down to earth example of the saying that time is money. 

Being conscious of my wallet, I picked up the cheaper option; I opted not to pay a premium on the value of my time. After all, what else have I got to do? It is not that I am CEO of some start up and must fly to Lisbon to talk to some venture capitalist in the afternoon and then have another meeting lined up in the morning the day after in some other part of the world.

In picking up the economically cheaper option there was collateral damage. The cheaper option had a larger (personal) carbon footprint. 

Physics is simple. The carbon released in the atmosphere, and attributed to me, is proportional to the flight time I have in the air. But even though being a proponent of reducing carbon emissions I still took the option of a longer route.

I wonder if we can live in a world where the economics of flight would be different. A world where instead of putting a premium on time, airlines will have a pricing model that will put a premium on the carbon footprint – the price of ticket would be proportional to the carbon footprint. 

It would be a world where longer route options to get to a destination will be more expensive than shorter routes. Flying from Washington DC directly to Lisbon would be cheaper than flying there via Geneva.

You could argue that some pricing model genius would turn the logic upside down – the lower the carbon footprint is, the higher will be the price of the ticket. This model, however, would only work in an ideal world where its citizens cared about their carbon footprint over their wallets. And if we did, we would not be in the current mess of the climate crisis anyway.

An irony is that in an indirect way, by owning the stock through some index fund I have invested in the airline, and it is in my interest to make profit and pay a dividend back to me. By doing that, I am also encouraging the current pricing model that puts a premium on our time.

We are getting close to Geneva and are about to land. The flight attendant is walking down the aisle one last time asking us if we would like to return the plastic bottle of water because they are passionate about recycling and saving the world. I dutifully deposit my plastic bottle in the trash bag and my conscience is that much lighter of guilt.

Ciao

Life lessons from the stock market

 Arun Kumar

Pixabay

“Some things are within our power, while others are not. Within our power are opinion, motivation, desire; not within our power are our body, our property, our reputation (Enchiridion 1, 125 CE)”

It was a brilliant day in Carlsbad, California, about a 30 minute drive north of San Diego. A day that is typical of California, a place where gods and goddesses like George Clooney and Natilie Portman live. It is also a place where democrats have an upper hand. What else can one wish for?

We had driven there to visit Legoland. It was the day that turned out to be my very first ride on a roller coaster. It was a thrill to experience. There were moments during the ride when I had my heart in my throat. A slow ride up to the crest, a moment of stillness to let me ponder and prepare for what is about to happen, and then a sudden plunge to the trough.

All in all, my first experience was pleasant enough that I remember it 25 years later. What is more  is that I took the ride willingly. 

Some rides are our choice, but not always. Life gives us roller coaster rides without asking all the time. As stoics tell us, the occurrences of these rides in life are beyond our control. These rides are stoic challenges; random tests from stoic gods of our resilience. The one thing I have in my control is how I react.

And so the serenity prayer also tells me - grant me the serenity to accept the things I cannot change, the courage to change the things I can (my reaction), and the wisdom to know the difference.

Wise words, if I can only remember to practice them in the moments of need. But back to taking roller coaster rides by choice. 

There is another roller coaster ride I have taken willingly, and a ride that I continue to take. 

At the beginning of the Covid I got a rude reminder of it, and then again, it happened recently. It is the ride of the stock market. The Ups and Downs of the S&P 500.

This ride started the day I decided to take real money, with the click of a button, purchased some stocks. I didn't quite know what I was doing but in retrospect, I now realize how transformative that moment was.

 

With one click, I converted something tangible into something virtual. I converted real money that I can use at the grocery store around the corner for something that exists in the ether. With one click, I got initiated into a different world. A world of virtual reality (VR) long before VR became a reality.

Not only did I enter VR, I handed myself to the whims of others. Watching S&P 500 drop by 35% at the beginning of Covid in March 2020, all that was in my control was to take it as a stoic challenge and not to react and click the sell button.

At the beginning I also did not quite comprehend that stocks are like a pond in which water level goes up and down and carries all boats with it, and further, how that pond got created out of nowhere in the first place. You may think that I am a bit low on comprehension, but I can challenge you into an old fashioned duel that is also the case for the majority of my fellow humans who have traded real money for virtual for the promise for a better future. 

Life in our times is full of things that are too big for us to understand and have the feel of magic. Take the internet. Although you are reading this in the comfort of your home, it is a safe bet that you have no idea how these words flashed on your screen.  A click on the keyboard? Well yes, but the answer goes a bit deeper than that. Enjoy the reading anyway. Understanding is not a prerequisite for enjoying something. It might even ruin the pleasure.

How was the pool created in which I now float, and occasionally, feel like someone left the plug open and I am going to drown in the whirlpool?

It all started on the day the Initial Public Offering (IPO) was issued and the bell on the floor of the stock market rang. That moment was equivalent to the moment of the big bang and the beginning of the universe. That IPO was the beginning of the pond that is the stock of a company. That is the pond in which our boats now float.

Someone wanted the money to grow their potential, convert their vision into reality, and created the virtual reality of stocks. 

The people with vision offered the virtual world of stocks in return for real money, and poof, the transformation happens. Now I am a proud owner of virtual money that goes up and down at the whims of others, or as the economist might say, at the vagaries of an invisible hand.

Going back to the universe, this transformation is like E= MC2. Buying stocks is like converting matter into energy and selling stocks like converting energy back into the matter. In between these points, energy floats through the ether, reaches new highs and lows, and manages to strain my emotions. 

In hopes of a better future, I will stay in the pond, and learn how to be stoic and remind myself that although the water level is not in my control, I can manage my reaction and be a better investor.

Will I take the roller coaster ride in Carlsbad again? Perhaps, but now I need to check with my cardiologist. Aging hearts (or perhaps more accurately, aging farts) can fail.

Ciao.