The Tyranny of the Minority in 'Market Democracy'

No more peanuts... Majority rules – until it doesn't... The tyranny of the minority in 'market democracy'... Drinking kosher and not knowing it... How the 'Flash Crash' happened... What to do if you spot this trend today...

In the early 1970s, Southwest Airlines (LUV) called itself the 'peanuts airline'...

Tickets on the budget carrier cost just "peanuts," according to the company's marketing – and peanuts were all passengers could expect for in-flight nourishment.

Today – at least until the start of the COVID-19 pandemic – Southwest offers pretzels, cheese squares, and bagel chips... But since August 2018, it no longer serves complimentary peanuts. No other American airline does, either.

Why?

About one out of every 100 Americans is allergic to peanuts (and almost no one was allergic five decades ago). Reactions can range from a mild rash to a throat-tightening, potentially lethal anaphylaxis. Rather than risk it, airlines have done away with peanuts altogether.

As a corporate policy – especially in a hyper-litigious country like the U.S., and when a public relations nightmare is a cellphone video or Twitter post away – it makes sense to exile the peanut. And it's a measure that I (Kim Iskyan) personally appreciate, as peanut allergies run in my family.

But let's not forget that the other 99 out of every 100 passengers are fine with peanuts...

In the world of in-flight snacks, the special needs of the small minority who are allergic dictate the options of the vast and silent majority of passengers.

This Digest isn't about airline snacks... or the dangers of legumes. But what has happened to the humble peanut illustrates a much broader point about our culture and human nature today...

When a small number of people calls the shots for everyone else, it's what philosopher, investor, and writer Nassim Taleb calls "the dictatorship of the minority."

It's how a minority faction gets their way far more often than the math of democracy and by-the-numbers fairness would suggest... at the expense of the "silent majority."

As I'll explain today, this dynamic plays a far bigger role in your life than you might think...

It reaches into public policy... the ingredients of the beverages you drink... and the election of the president of the U.S., as we've just seen. And it carries big implications – and lessons – about markets and your portfolio, too.

Much of the time, 'majority rules'...

The rule of the majority is the backbone of democracy (which means, literally, "power of the people"). In everyday life, the majority often decides for the group – from what the family will watch on movie night... to the theme of the next neighborhood block party that happens... to who will represent your state in Congress.

When the majority has its way, the preferences of some members of the group – the minority – aren't reflected, like the little sister who wanted to watch Cinderella (again)... the guy next door who has a thing for vampire costumes... or the voters whose candidate lost.

The big challenge of democracy is ensuring that the interests of the minority – the losers when the majority gets its way – aren't completely ignored.

The defeated minority doesn't have a lot of options. These folks can take the loss and move on. They can break off to do their own thing with others who are like-minded – watch their own movie or hold an alternate block party. If it's an election, they can work to get more supporters for their candidate.

It's a system that's far from perfect. But as Winston Churchill noted in 1947, "Indeed, it has been said that democracy is the worst form of government except for all those other forms that have been tried from time to time."

More often than you might think, though, the majority doesn't get its way...

If the majority ruled all the time, we'd still have peanuts on planes.

The minority gets its way in a lot of arenas, too...

Take gun control, for example. We're not here today to take one side, the other, or somewhere in between, but we bring up this idea to make our point...

In 2018, a Gallup poll showed that nearly two-thirds of Americans supported more gun control... A year later, 70% of Americans were in favor of a ban on assault weapons and 90% of voters supported universal background checks for firearms transactions.

Again, we're not making a statement on the value of these ideas. They may be terrible ideas. The point is, they're popular. And yet, the U.S. hasn't seen real gun control for decades... thanks to the tyranny of the minority, the Second Amendment, and the founders' intent on giving the minority a role in the government's decision-making processes.

It's built into the Constitution. The majority must contend with the minority by design.

The key to the power of the minority is that it's made up of people who are highly motivated – by ideology, money, desire for power, or something else – in the face of a majority that's indifferent or disorganized or scared.

As the Financial Times explained in 2013, describing how the concerns of a community of around 1,400 vocal villagers nearby was holding up the expansion of London's Heathrow Airport...

Because most people have little time or energy to devote to politics, small groups with a strong commercial, personal or ideological motivation exert disproportionate influence. This gives free rein to paid lobbyists, and to individuals and organizations obsessed by a single issue.

Did you know that you're probably drinking kosher?...

The tyranny of the minority touches you in ways you probably never even considered.

The minority – a tiny one – gets its way in an arena that's easy to overlook and one that few people know of... Many common beverages, from Pepsi to Slush Puppies to many Tropicana juices, are kosher (which means that they comply with the dietary standards of Jewish law).

Check it out – there's a small "K" or a "U" with a circle around it under the nutrition information panel for a lot of common foods and drinks to mark approval by the Orthodox Union. As Taleb explains in his book Skin in the Game...

The Kosher population represents less than three tenth of a percent of the residents of the United States. Yet, it appears that almost all drinks are Kosher. Why? Simply because going full Kosher allows the producer, grocer, restaurant, to not have to distinguish between Kosher and nonkosher for liquids, with special markers, separate aisles, separate inventories, different stocking sub-facilities.

(It's worth noting that some drinks are kosher anyway – and they're no different for earning the kosher certification.)

It's similar to the peanuts example... a kosher person (or someone with peanut allergies) won't ever consume a non-kosher product (or something with any trace of peanuts) – while a non-kosher eater (or anyone who isn't allergic to peanuts) is perfectly fine with kosher foods (or anything containing peanuts).

Increasingly, it's a similar conversation for non-genetically modified foods ("GMOs") and gluten-free foods... Your diet is shaped in ways that you probably don't even realize because, to put it plainly, most people don't really care if their food or drink has peanuts, is kosher, or contains GMOs or gluten... but it matters a lot to those small, well-organized, vocal minorities.

Sometimes, we need to be protected from the 'tyranny of the majority,' too...

U.S. elections – and the way the entire electoral system is set up – sometimes allow the minority to call the shots.

In fact, in two of the past six U.S. presidential elections, the winning candidate received fewer votes than the loser (George W. Bush in 2000 and Donald Trump in 2016).

In some ways, that might look like the tyranny of the minority at work again. But as I said earlier, this is a result of a system devised specifically to protect the minority from the majority getting its way all the time.

That's because making rules – or governing – based on popular will isn't necessarily always a good idea...

The U.S. (and most other democracies) is a democratic republic, rather than a direct democracy. That means that we elect people who are in charge of making rules for us.

It's designed to guard against what Edmund Burke – an Irish philosopher from the 1700s who is widely viewed as the father of conservatism – warned about... the "most cruel oppressions" that the majority could impose upon the minority.

As Columbia University Professor of Law Tim Wu noted in a March 2019 opinion piece in the New York Times...

[The U.S. Constitution – and the structure of the Congress, for example, and the Electoral College –] was designed to modulate the extremes of majority rule. Majorities sometimes want things – like bans on books or crackdowns on minorities – that they should not be given... A thoughtful process of democratic deliberation and compromise can yield better policy outcomes than merely following the majority's will.

A feature – or others say, a bug – of this structure, though, is that sometimes it works the other way around...

The 'deciding vote' minority is a key player in markets...

The tyranny of the minority matters in markets, too.

It's easy to think of markets as a kind of "market democracy"... If there are more buyers, the price of an asset goes up – and if there are more sellers, it goes down.

Simple, right?

But the reality is different... And like with gun control or peanuts, what matters is just how eager a buyer or seller is, or how much he or she cares. As Taleb explains...

We can say that markets aren't the sum of market participants, but price changes reflect the activities of the most motivated buyer and seller. Yes, the most motivated rules. Indeed this is something that only traders seem to understand: why a price can drop by ten percent because of a single seller. All you need is a stubborn seller. Markets react in a way that is disproportional to the impetus.

As a way of thinking about how a single stubborn seller (or buyer) can have an outsized impact of the price of an asset – anything from share prices to real estate to commodities like oil (or milk) – imagine a world with a closed market of just 100 cow farmers.

Each farmer owns one milk-producing cow. And for our purposes, let's say that all the cows produce identical volumes and quality of milk... and that no one but milk farmers can own cows.

In this imaginary universe, there are just enough milk drinkers to consume the production of those 100 cows. There's sufficient milk for buyers... Cow farmers earn a reasonable profit through a transparent marketplace... And everyone is happy.

But one day, a greedy cow farmer decides to break the rules – and he gets another cow to produce milk. Now, 101 cows are making milk... but there's still only demand for 100 cows' worth of milk.

The greedy farmer wants to sell his extra milk, of course... He's a highly motivated seller. So he cuts the price of his milk (which, remember, accounts for just less than 2% of total milk production) by 10% to be sure he can sell all of his milk. (It could be 5%... or 10%... or 20%. He'll go as low as he needs to go, since he just needs to get rid of the milk – at any price.)

When Mr. Greedy Farmer prices his milk below the current market price – the price that, as of the day before, was the prevailing market price – it disrupts the entire milk market. No customer will buy milk above the market-clearing price (that is, the new equilibrium price – where demand and supply meet). And no farmer wants to be left with unsold milk.

So the price of milk falls – and every farmer has to sell at the new price, or else end the day with leftover milk on his books.

As a result of just 1% more supply, the market price of milk falls a lot more. Given the high motivation of the greedy farmer, the market price of milk will fall until someone hits his bid – that is, until someone buys.

This is the tyranny of the minority at work again... a single motivated seller who drives the price of milk down. A single farmer with new supply disrupted the equilibrium price.

This happens in (real life) markets all the time – like with the 'Flash Crash' of 2010...

Sharp share price movements happen all the time when a big holder of a stock (like Mr. Greedy Farmer) needs to sell, at any price...

Maybe his fund is facing redemptions, and he needs to liquidate some positions to raise cash quickly... or he might be hit with a margin call, which happens when he's buying securities on credit (that is, with borrowed money) and needs to add cash to the account to satisfy the loan terms.

The so-called Flash Crash that happened on May 6, 2010, is an extreme example of how a single motivated (would-be) seller – a minority of one – can have an outsized impact on markets... In this case, he caused the Dow Jones Industrial Average to fall by 9% in 30 minutes, temporarily erasing around $1 trillion from U.S. share prices.

The seller was a math prodigy trader named Navinder Singh Sarao, who was trading a kind of futures contract on his computer from his bedroom in his parents' house in suburban London. He wrote code into trading software that allowed him to rapidly place or cancel trading orders, and he hit the market with around $3.5 billion of fake sell orders... which, as Bloomberg explained...

... were never executed, or intended to be executed, but they tricked people into thinking that there was a lot more selling interest than there actually was. That combined with a collapse in buying interest... to create a collapse in prices. [Sarao, who made around $900,000 in the flash crash] profited from those collapsing prices by selling high and buying back lower.

In this case, it wasn't a real motivated seller who caused markets to crash... It was simply the appearance of one. But that was more than enough.

The total volume of fake selling was a small fraction of average daily stock exchange trading volume – like the additional milk that Mr. Greedy Farmer had to sell. But it was sudden, unexpected, and additional – and made all the difference.

Watching from their "farm" on that day, one Wall Street firm put in a single order to sell $4.1 billion of futures contracts, which kicked off a cascade of effects, like algorithmic high-frequency trades being triggered... and the sharp, quick drop in stock prices that we still talk about today.

So what can we learn from the 'tyranny of the minority'?...

If there's a big-picture life lesson in the tyranny of the minority, it's this...

If you really (really) feel strongly about an issue – something that the majority is either indifferent to or otherwise disorganized and diffuse in its potential resistance to – you have a decent chance of bringing about change.

It wasn't overnight – it took decades – but today, American airlines are peanut-free. And similarly, despite a majority of Americans being in favor of more measures to control firearms, it hasn't happened.

Where else might we see this dynamic? Though it's not a perfect comparison, the current composition of the U.S. Senate is almost custom-made for the tyranny of the minority.

Following the victories of two Democrats in last week's runoff election for the two Senate seats from Georgia, the upper house is now split down the middle by party, 50-50 – with Vice President-elect Kamala Harris holding the tie-breaking vote.

This means any one Democratic senator who wants to get his or her way – and who doesn't mind earning the eternal annoyance of the party – can hold legislation hostage.

And as our colleague and Stansberry NewsWire editor C. Scott Garliss reported this morning, President-elect Joe Biden's administration is pushing for big, new spending plans...

Biden wants to push through two stimulus packages in his first few months in office. They would come in the form of stimulus spending and an infrastructure package. According to website Axios, they would total more than $3 trillion...

Axios also noted Biden and his team want to capitalize on current momentum. They're "confident" they have the support to push the bills through Congress. This would put more money in people's pockets. Increased consumer spending would provide economic support.

The first bill would include adding $1,400 to existing stimulus payments. It would bring the total to the $2,000 suggested by President Donald Trump and the Democrats as negotiations ended before the new year.

It would also cover funding for state and local governments, as well as more funding for COVID-19 vaccine distribution.

The second package would focus on Biden's "Build Back Better" infrastructure plan, something he discussed while campaigning. This would include $2 trillion in infrastructure spending (specifically "green" infrastructure).

But here's where the minority comes in...

If Democratic Senator X wants (say) funding for a new bridge to nowhere in his district, he can threaten to withhold his vote for a measure (remember, the House of Representatives has a Democratic majority).

If he doesn't get his way, the measure doesn't pass... In essence, every single vote is a deciding vote. That's a perfect situation for pork barrel politics to an unprecedented degree, thanks to the tyranny of a minority – within a controlling majority.

And here's another important practical point about all of this...

In markets, the "minority" – the motivated seller – who pushes down the price of an asset is often indifferent to the underlying value of the asset. That creates opportunity for investors who understand the dynamic of indiscriminate selling and are confident in their assessment of value.

For instance, regular Digest readers know about the type of approach I'm talking about... like that of my colleagues Dan Ferris and Mike Barrett in their Extreme Value newsletter.

... or that of the team behind our flagship Stansberry's Investment Advisory newsletter. They love "capital efficient," high-quality companies that can make the most of the dollars that are floating around the economy.

Said another way, any time a big sell-off occurs without any fundamental reason... well, look twice. You might be the minority that benefits... from the tyranny of another minority who has ideas and motivations that aren't the same as yours.

New 52-week highs (as of 1/8/21): ABB (ABB), Analog Devices (ADI), ARK Fintech Innovation Fund (ARKF), Asana (ASAN), AutoZone (AZO), Booz Allen Hamilton (BAH), Bunge (BG), ProShares Ultra Nasdaq Biotechnology Fund (BIB), Siren Nasdaq NexGen Economy Fund (BLCN), Berkshire Hathaway (BRK-B), Cognex (CGNX), Corteva (CTVA), Editas Medicine (EDIT), ProShares Ultra MSCI Emerging Markets Fund (EET), Eagle Materials (EXP), Fidelity Select Medical Technology and Devices Portfolio (FSMEX), Futu Holdings (FUTU), KraneShares MSCI All China Health Care Index Fund (KURE), KraneShares CSI China Internet Fund (KWEB), Norilsk Nickel (NILSY), NetEase (NTES), Intellia Therapeutics (NTLA), OptimizeRx (OPRX), Southern Copper (SCCO), Sea Limited (SE), Scotts Miracle-Gro (SMG), Spotify Technology (SPOT), ProShares Ultra S&P 500 Fund (SSO), Constellation Brands (STZ), Trulieve Cannabis (TCNNF), TFI International (TFII), Take-Two Interactive Software (TTWO), U.S. Concrete (USCR), Vanguard S&P 500 Fund (VOO), ProShares Ultra FTSE China 50 Fund (XPP), Zendesk (ZEN), and Zymeworks (ZYME).

In today's mailbag, feedback on a subscriber comment and on Dan Ferris' Friday Digest. Do you have a comment or question? Send your notes to feedback@stansberryresearch.com.

"I really enjoyed reading Mark N's comment at the end of last Friday's Digest. It was amazing to read through the Adams vs. Jefferson struggles and realize how similar it is to our political infighting today. Thank you, Mark!" – Paid-up subscriber Barbara D.

"Dan, I write to you about the idea of a Crack-up Boom, an idea from Von Mises expressed by Erik Townsend, at MacroVoices.com...

"You can find Von Mises ideas on this at pages 427, 436 and 562 in Human Action by Von Mises, or probably just look in the index.

"Basically Von Mises describes the act of society finally realizing the money printing isn't going to stop and suddenly money velocity increases drastically, in a matter of days or possibly weeks where society tries to move to hard assets or out of fiat money.

"My suspicion is that we may be close to this time because:

"1. The Fed is the central bank for the world's reserve currency. There is no other significant competitor to the U.S. dollar for the reserve currency for military, capitalism, democracy as well as many other reasons such as SWIFT and general market dominance.

"2. Other central banks must follow the Fed in devaluing their money because they would otherwise their country's industry would not be competitive. Especially since the Fed is so dominant today.

"3. The Fed has stated its money printing objectives and extended time line so the result, inflation, is likely to come true.

"4. Any one studying money knows the Fed / US government has no choice but to create more dollars. They would essentially go bankrupt instantly if they stopped that policy. Society would be furious as a credit collapse would ensue and political leaders would lose their jobs in mass.

"5. We see commodity prices skyrocketing unabatedly lately and commodity prices are coming off an all-time low as I'm sure you have seen charts of commodity prices versus other assets.

"6. Chaos in the political environment will free society's thinking as to what could happen. In other words when times get so crazy as they [are] now then it seems more likely that there could be a change to inflation. It certainly seems realistic if not expected to those studying money and history.

"7. A debt jubilee is essentially a precipitation point for a crack-up boom or an inflation take-off because it would immediately start a rate climb as people with money would not want to lend.

"8. The Fed's irrational effort to increase financial asset prices to cause a "wealth effect" has carried on to the point of absurdity to all experienced financial professionals.

"9. According to Steve Sjuggerud, euphoria is here i.e. it's near the end of the financial asset bubble.

"10. I'm sure you can come up with more reasons.

"In a sense, a crack-up boom has already started with so many moving from cities and buying homes in suburbia or anywhere they can find a home and buying homes sight-un-seen. Cities have to be sitting with huge unforeseen problems of amounts of 'apartments' which can't be sold. Chicago had a four month's supply of residences before the [pandemic] and now they have a 4 year supply. In Jackson Hole the property market has gone berserk in the past summer and continues. People want hard assets. Sure the media presents this as a move from riots and pandemic but that may be to hide the fact that hard assets are the main driving force as these media dudes probably can't see anything but their own mantra.

"The Fed has poured dollars onto markets but as we experience time and again governments are always trying to buck the trend of society's desires and they will fail this time too. Suddenly it seems likely the government's efforts to stop the move toward hard assets could be realized more pervasively than by just those who have the most to lose.

"Finally the millennials are probably the furthest from recognizing what is happening because they believe in the media more than boomers. I cite climate change, fires in California caused by climate change, racism, bitcoin, iPhone preoccupation. Teslas, internet news, hate of Trump. Millennials are all about media's mantra. When David Portnoy starts saying sell, it might open their eyes to other views." – Paid-up subscriber Al M.

Good investing,

Kim Iskyan
Dublin, Ireland
January 11, 2021