The turkey paradox is the story in which one of these animals is fattened and cared for throughout its life by its owner, with the intention of eating it on Christmas Day. The paradox comes from the turkey's own subjective view of events, who is pampered, fed and cared for excellently throughout its existence. And nothing makes him think - if turkeys could think - on Christmas Eve that this magnificent owner is going to cut his throat and eat him the next day, after a lifetime of attention from the best friend. I say friend, the best father! Many of you are already familiar with this turkey paradox, but it will be interesting to think about the options for analysing the turkey's situation if we use it as a metaphor that can be extrapolated to any investor, with Christmas Day being the metaphor equivalent to the fall in share prices in the investor's portfolio.
If the turkey had been merely a gambling addict rather than an investor, on Christmas Eve he would have bet all his money that the next day his owner would have fed him as usual, cleaned his pen and given him his daily pampering and care, just as he always had ever since the turkey could remember. All in. Everything on the line.
If the turkey had been an investor guided by macro analysis, he would have been confident that he would be fed and looked after in the pen for many years. In fact, he would know of many farms where the owners rear all sorts of animals – cows, pigs, chickens, and so on – for a long time. On Christmas Eve, nothing would lead it to believe that the next day it would have its throat cut, because none of that is happening on most of the farms it knows of in the surrounding area. On the contrary, on many of them, the owners facilitate the rearing of the animals so that they can multiply. In fact, even if he were to look at the flow of money (that is, the movement of large sums of money shifting from one type of asset to another), that too would not warn him of the disaster, since Shortly before Christmas, the macro analyst turkey would be reassured to see that every day more and more neighbours were fattening up turkeys in the same, seemingly comfortable circumstances as himself. Their line of thinking might be: «If we’re all doing the same thing and in the same boat, what danger could there possibly be?». Perhaps they’d like to take advantage (along with the technical analyst we’ll discuss next) of the timing of their care, trying to visit a different home each day to make the most of the days when each owner offers their turkeys the best food or the most pampering. But that’s very difficult to get right consistently, and it would probably deprive them of enjoying their own owners’ best days too, whilst also causing them stress and affecting their proper development. In any case, the day would come when one of those owners would deem him plump enough and gobble him up straight away. Macro analysis, therefore, would hardly warn it of what lies in store the following day, unless it were aware of its owner’s culinary traditions for special occasions – which, moreover, would be as changeable as geopolitics and finance in this ‘New Normal’. And that is something which, unfortunately, virtually no macro analyst manages to achieve consistently over time.
If the turkey had been an investor guided by technical analysis, it too would have bet on this good treatment continuing indefinitely, putting on more and more weight, without ever wondering why its owner was treating it to such a luxurious life. If that’s how things have been up to now, it would see no reason why tomorrow should be any different. In fact, it would plot rising lines and channels on charts using all manner of statistics: its weight, height, the amount of food available, the care provided by its owner, the number of plump turkeys in the neighbourhood, and so on and so forth. All this technical analysis would confirm to him that there is no reason to stop being optimistic. He would only have begun to doubt his future if he’d seen the heads of a few neighbourhood turkeys roll, assuming he remained attentive to what was happening around him. But probably his Any reaction would come too late, by the time its owner was already wielding a bloodstained knife. Or perhaps he would have become suspicious far too soon, following the death – whether natural or not – of a neighbouring turkey, when he was still just a chick that the children in the house enjoyed playing with. That would have led him to run away and starve to death or freeze to death long ago, squandering the food, shelter and affection his owners have given him all this time. Who knows whether, had he run away at the first premature incident involving any neighbouring turkey, he might have ended up in the yard of some worse owner, who would have eaten him long before, without even feeding him for a while. Perhaps he would have chosen a home where he saw his owner eating nothing but vegetables, even if in reality it was simply because the owner had eaten too much turkey recently and was on a temporary diet. That’s the thing about being a reactive turkey. Without reasoning or asking fundamental questions, he can misinterpreting events, and consequently reacting in an inappropriate, absurd and/or reckless manner.
If the turkey had been an investor guided by fundamental analysis, it would have wondered why its owner was spending so much money and time on its welfare. When it was a chick, this might have made sense, as the children in the house played with it, treating it like a pet. It was, in a way, a quid pro quo. But in recent months, his weight, his plumage and his plump adult body had become nothing but a burden to the family. The children no longer enjoyed having such a large animal around, with all the associated parasites, odours, droppings and a growing need for ever-increasing amounts of food. These were the objective and fundamental facts. The turkey no longer contributed anything to the family, only costs and sacrifices. Consequently, the turkey – a true analyst – would have grown increasingly doubtful, day by day, about the sustainability of his situation. Its situation could not be sustained indefinitely because it would be entirely unreasonable. It would not have mattered to it that the other neighbouring turkeys were blindly confident, despite being in the same situation of unjustified opulence. Its situation would make no sense, unless its owner were on the verge of receiving radical compensation for so much sacrifice. Consequently, the fundamental analyst turkey would have begun to mistrust his owner more and more, preparing an escape despite enjoying the same placid life as always and more food and care than ever before. Once he considered himself strong and developed enough to leave, he would have done so without hesitation. –Let others eat the last morsel– I would think –I have already had sufficient and healthy development-. Most of the other turkeys in the neighbourhood would carry on with their hedonistic lives labelling the key figure an idiot. But what cannot be, cannot be, or at least it is unsustainable in the long term.
Metaphors aside, investors who do not want to run around the markets like a headless chicken (or turkey) must never lose sight of the the relationship between the share price and the return on the company’s investments. Technical or macroeconomic analysis counts for little or nothing when we are investing in businesses whose share price is trading at a level that far exceeds their annual profits. It makes no sense whatsoever to hold a company’s shares when they are trading at 18–20 or more years’ worth of profits (unless, of course, there are forecasts that these profits will skyrocket in the coming years), even if technical or macroeconomic analyses predict that the rise will continue. to infinity and beyond. Sooner or later, Christmas Day will come for the fattest and most lustful turkeys – that is to say, the most overvalued shares. And by then, the losses will be irrecoverable.
Similarly, investing in sound, stable businesses at price-to-earnings multiples of just 3, 5 or 7 years’ profits, whilst capitalising on any stock market panic (such as the 2008 crash or the current situation on the Russian stock market), is a sure-fire way to achieve good capital gains in the medium term. It does not matter what technical analysis or cash flow analysis says. Owning shares in stable businesses at bargain prices is, and always will be, a sound investment. This is a universal law, the one true guiding principle that should steer our investment strategy.
Some would say that the best investor is one who carries out a combined analysis – fundamental, macro and technical. It sounds good, and so this concept sells very well. But it’s very hard to believe that being swayed by the sight of more and more neighbours with plump pets drunk on optimism in the days leading up to Christmas, or hopping from house to house, could lead a turkey that correctly analyses the fundamentals to make a wiser decision. If anything, I’d say it can confuse him and distract him from the rigour needed to avoid becoming Mr Market’s main course on 25 December. And in the markets, Christmas usually arrives just when you least expect it.