Children are trained to count linearly: one, two, three, four, five, etc. Long before mathematics was invented, however, a subjective process of estimation was used to quantify and make decisions. If the ability to appreciate quantities in linear terms confers fitness advantage, that edge appears to have eluded Darwinian selection. Studies of the Amazonian Mundurucu indigenous tribe and preschool American children all suggest that humans are innately wired to use a compressed scale to understand magnitude – not unlike those depicted by logarithmic, exponential, or power-law functions. A compressed scale is biased toward achieving higher resolution at the lower end of the spectrum where smaller numbers reside, where discriminating subtleties in degrees of scarcity can provide the greatest benefit. Psychophysical studies assessing the magnitude of subjective estimation of sensory inputs such as light intensity and sound intensity also reveal innate mapping of signals on compressed scales. From an adaptive perspective, a compressed scale of subjective estimation enables a wider dynamic range of sensory processing which is valuable in environmental signal interpretation. The hypothesis that selective pressures favored the cognitive adoption of a compressed scale for subjective estimation is consistent with the reality that natural phenomena generally unfold through iteration, yielding patterns of development that are best understood through the prism of compounding rather than the lens of linearity. Like an intellectual slide rule, modern mathematics reprograms children. It obligates them to abandon their natural cognitive tendencies, which rely on compressed scales and estimation and coerces them into adopting linear scales that provide uniform resolution along the entire scale. It resigns them to participate in a wholesale exercise of indiscriminate precision with respect to all things. This force-fed mental framework may help individuals thrive in the artificiality of our modern socio-cultural-economic landscape, replete with man-made straight lines and standardized tests. However, we believe that the conflict between our innate instinct to estimate on a compressed scale and our learned ability to quantify on a linear scale is a source of profound decision dysfunction in the modern world, particularly impairing the ability to assess the possibilities of outlier outcomes.
Milton Friedman famously claimed, “Inflation is always and everywhere a monetary phenomenon.” Does this relationship also hold in reverse?
Decades ago, when everything and everyone from unions to cartels were blamed for inflation, Friedman rejected the conventional wisdom and posited on the basis of empirical data that money supply drives price levels. He argued that prices increased not due to price and wage increases, but because the federal government made the supply of money grow faster than the real economy created value. This groundbreaking theory, while highly controversial and almost revolutionary at the time, appeared to be vindicated by the “Great Inflation” of the 1970’s, and has since become the core tenet of monetarism and modern policymaking. However, in a mark-to-market world, a price may act insidiously to drive money supply and amplify boom-bust cycles.
Warren Buffett once famously stated that “Berkshire [Hathaway] buys when the lemmings are headed the other way,” conjuring up visions of rodents blindly following one another off a cliff. But the idea that lemmings participate in mass suicide is a myth, propagated by a Disney documentary. The widespread misuse of the lemming metaphor by investors to illustrate herd behavior itself reveals the herdlike behavior of investors and the scarcity of original insight.
Original insight is also uncommon among doctors. Physicians are trained through rote memorization, and independent views are often ridiculed by peers and prosecuted by malpractice attorneys. The hiring of physicians as consultants by investment firms seeking unique perspectives has instead led to a greater tendency toward consensus thinking.
A doctor-turned-stockpicker says he’s bearish on stents.
By MARK VEVERKA
YOU DON’T HAVE TO BE A MEDICAL DOCTOR to pick healthcare and biotech stocks, but it doesn’t hurt.
Joon Yun has been managing money for only nine years, but his 12 years as a radiologist — mostly at Stanford University Medical Center — have served him well in his second career as a partner of Palo Alto Investors in Palo Alto, Calif., an 18-year-old hedge fund with about $1.5 billion under management, focused mostly on small-cap growth. “Radiology is sort of similar to investing,” he says. “You’re making decisions based on limited information and looking for patterns.”
The graduate of Harvard and of Duke Medical School hadn’t been looking to leave his day job. But when a colleague had to bail on an interview with Palo Alto, which was seeking a doctor to oversee healthcare investing, Yun filled in on a whim. The rest is history.
Since joining PAI, Yun has never had a down year. The three-year return of Palo Alto’s $250 million micro-cap fund, heavily weighted toward healthcare and biotech, is nearly 23%. Over five years, the return is close to 30%.