In a bit of a paradox, you’ll find the following two titles on our recommended reading list:
● The Wisdom of Crowds, James Surowiecki (2005)
● Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay (1852)
So, which is it? Are crowds wise or delusional? It helps to understand why the answer is yes, to both, and why both have shaped our investment recommendations through the years.
When Crowds Are Wise
Surowiecki describes group intelligence, or the wisdom of crowds, as follows: “If you ask a large enough group of diverse, independent people to estimate a probability, and then average those estimates, the errors each of them makes will cancel themselves out.”
To illustrate, he shares a classic jelly bean experiment, where a group of 56 students guessed how many jelly beans were in a jar of 850 beans. The group average was strikingly close at 871. Only one individual guess came closer. Similar experiments have been repeated across time and distance, and have found group consensus is consistently among the most reliable counts.
But what about those “mad” crowds? Surowiecki does not suggest every group consensus produces remarkably accurate answers. The group must be diverse, possess “a particular kind of decentralization,” and, importantly, be free to think independently.
Fortunately, these characteristics usually exist in free markets. Each individual trade may be spot on or wildly off, but their average, representing all known information and lucky guesses alike, typically generates our closest estimate to a perfect price in an imperfect world.
Game Shows and the Crowd’s Advantage
A similar phenomenon can be seen on game shows such as “Who Wants To Be A Millionaire?” When contestants turn to the studio audience for help, the collective response often proves far more accurate than even the most confident individual in the room. In fact, audience polls have consistently landed on the correct answer the vast majority of the time, providing yet another real-world example of how a diverse, independent group can outperform the supposed experts.
Crowd Wisdom in the Housing Market
This dynamic of group wisdom also extends to the housing market. While high-profile “housing crash” forecasters may capture headlines, it is actually the collective behavior of countless individual buyers and sellers that forms the most meaningful barometer.
Consider the surge of buyers entering the market after months of uncertainty. Each person comes with their own needs, information, and perspectives—much like the jelly bean counters. When aggregated, their decisions reflect the best available knowledge about current values, risks, and opportunities.
Rather than relying solely on bold predictions from self-styled experts, paying attention to the actions of this diverse crowd often offers a more balanced and reliable insight into where the real estate market is headed.
Early Warning Signs: How the Bond Market Spots Trouble
Interestingly, the bond market often acts as an early warning system, hinting at brewing trouble before it’s clear to the average investor or even the broader financial news cycle. For example, ahead of both the 2008 financial crisis and the onset of COVID-19’s global shocks, unusual patterns emerged among government and corporate bonds. Yields began to fall sharply, and certain spreads widened—classic signals that bond investors were growing nervous well before headlines caught up.
These shifts reflected the collective assessment of countless independent participants, each factoring in economic risks and uncertainties. By watching those moves—the “wisdom” embedded in market prices—savvy investors and analysts could detect gathering storms long before they made landfall.
A Real-World Example: The Power of Prediction Markets
Take election forecasting, for instance. Time and again, prediction markets—such as betting sites—have demonstrated a remarkable knack for accuracy that often surpasses the projections of individual polling organizations. By aggregating the diverse, independent perspectives (and sometimes, intuitions) of countless participants, these markets distill the collective expectations about an election’s outcome into a single, highly reliable probability.
In effect, it’s another case of group smarts in action: the wisdom of crowds play out not just in jars of jelly beans, but on a much grander political stage.
When Crowds Are Delusional
Of course, history is also jam-packed with times when crowds have gone bonkers, stampeding toward outcomes no rational individual would choose.
Usually, a crowd’s rash behavior is a result of “groupthink,” or herd thinking. Surowiecki warned against this when he wrote: “Deliberation in a groupthink setting has the disturbing effect not of opening people’s minds but of closing them.”
Investors are exposed to the madness of crowds whenever a stock, bond, or any other tradeable asset goes on an overwrought run or perilous plummet. When fear of missing out (FOMO), or just plain fear overcomes a market’s usual efficiencies, a few lucky souls may profit wildly. But billionaire businessman Warren Buffett describes the most likely eventual outcome: “[T]he stock market serves as a relocation center at which money is moved from the active to the patient.”
Manic pricing is nothing new. When Mackay published Extraordinary Popular Delusions in 1852, he dissected several centuries-old speculative runs, including a 17th century “tulipomania,” when some tulip bulb trades were fetching values normally reserved for entire estates.
Until, abruptly, they weren’t. As Mackay wrote: “Enterprise, like Icarus, had soared too high, and melted the wax of her wings; like Icarus, she had fallen into a sea, and learned, while floundering in its waves, that her proper element was the solid ground.”
Crazy or Crafty?
Thanks to Mackay, Surowiecki, and many others, we know that group dynamics can yield magnificently wise as well as woefully foolish results. We also know that investor “crowds”— capital markets—can exhibit both conditions, depending on the factors at play.
Adding to the challenge, we usually only know in hindsight which type of pricing we are participating in. Predominantly, global markets provide the volume and diverse independence needed to generate highly efficient trades. But from tulipomania to the latest hot holdings, groupthink can blur the view by sending securities off their proverbial rails, for years at a stretch.
Is it a bubble or substantial growth? Only time will tell.
Market Signals and Major Global Events
So, what can we glean from the markets themselves when it comes to the likelihood of truly seismic events—say, the outbreak of a global war? Historically, markets have served as rather reliable barometers for collective sentiment around such risks. If a significant conflict, like World War III, truly seemed imminent, we would expect to see unmistakable signals flashing across financial instruments.
For instance:
Equity markets (like the S&P 500) would typically experience steep declines as investors anticipate widespread economic disruption.
Safe-haven assets—think gold—would likely see dramatic surges, as anxious capital flees toward perceived security.
Oil prices could spike sharply, given the potential for supply shocks and geopolitical turmoil.
Today, these markets are behaving in a relatively calm manner. Stock indices remain close to their highs, gold prices have not soared to extraordinary levels, and oil remains below the type of panic-driven spikes seen during prior crises. In other words, despite unsettling headlines, the collective judgment of global investors reveals little sign that markets are bracing for imminent catastrophe. The wisdom (or perhaps composure) of crowds prevails—for now.
What’s a Rational Investor To Do?
For your own investments, how do you apply the wisdom of crowds and avoid its madness? Whether you try to outpace a wise market or a delusional one, you’re far more likely to be beaten by the crowd than to outsmart it. Under these circumstances, your best bet is to:
Join the wise crowds: Invest as cost-effectively as possible in the market’s broad expected returns, according to your personal goals and risk tolerances.
Rise above the mania: In case market mania is the principal driver of a run, avoid trying to chase or flee individual securities, or time your entry into and out of hot and cold markets.
Reading the (Tea) Leaves: What the Market Is Telling Us
So, what clues are markets offering about where the economy—and interest rates—might be headed? Despite the headlines trumpeting deficits, trade disputes, and inflation concerns, key signals from the bond market point to a measured optimism.
Bond yields, often considered the market’s collective crystal ball, currently suggest that most participants expect the economic ship to stay on course rather than drift into stormier seas. In other words, while challenges exist, there’s little evidence in current pricing that investors are bracing for either runaway interest rates or imminent economic downturn.
Instead, it appears that, like cautious but contented Goldilocks, market consensus is betting rates will remain in a more “just right” zone for now—neither too hot nor too cold.
Would you like to know more? Reach out to us today for a personalized conversation about your investment portfolio.