Attempting to drink from the financial information fire hydrant is more or less a necessity for investors at this point, despite the numerous counter-productive side effects the practice entails. One of the larger issues involved is one of prioritization in that the daily onslaught of noise-ridden details makes an assessment of yesterday’s opinion difficult. Wave after wave of advice and opinion keep coming at us, paradoxically leaving no time to learn anything from it. To paraphrase the great John Wooden, we are confusing activity with achievement.
In highlighting my favorite blog posts from 2011, I want to focus on those with persistent benefit rather than outline successful trading ideas or strategies that may or may not be useful in the next twelve months. (I will, for future reference, point out that Richard Bernstein again justified my ongoing adulation – see HERE.) The danger as always is to select articles because they reaffirm what I already believe, which would make this post merely an excellent example of confirmation bias. I hope I have avoided this pitfall, but look for readers to call me out.
Psy-Fi: The Proper Etiquette for Market Panics. The consistently-awesome Psy-Fi Blog more or less lays out exactly why investors do what they do, why its wrong, and how to fix it. In a market environment where returns are generated almost solely by arbing the market’s emotional overshoots, it is difficult to think of a more productive blog to read than this one. Thee were numerous candidates for applause among Psy-Fi content in 2011 but this one stood out for its “man bites dog” argument surrounding volatility. The key bit:
all the sensible indicators like whether economies are actually doing well or badly and whether companies are more or less profitable don’t always matter very much when markets go mad. Often it really does seem to be a matter of psychology rather than financial fundamentals.
However, a nice piece of research by Dion Harmon and colleagues entitled Predicting Economic Crises Using Measures of Collective Panics attempts to do exactly what it says on the label. Now, generally economists have studied volatility, the rate of change of stock price movements, as a way of investigating behaviour during market crashes. However, volatility doesn’t appear to predict crashes:
“Studies find that, on average, volatility increases following price declines, but do not show higher volatility is followed by price declines.”
The implications of the conclusion, essentially that volatility is a lagging indicator, are wide reaching, not least because we can now forget about the Vix as a predictor of anything. If the study is accurate, the phrase “I’m not buying until the Vix goes below 30” will become a historical artifact.
Felix Salmon: The growing crisis of institutional legitimacy . Reuters’ most visible online voice details a longer term issue that scares the bejeebers out of me:
on this side of the pond we have Rick Perry — harbinger and prime example of the way in which mistrust in federal institutions has moved from the fringe to the mainstream. Indeed, what we see with Perry is far more than mistrust — he actually denies most federal institutions their existential legitimacy, and has written a book explaining at length how everything from Social Security to federal bank regulation is in fact unconstitutional.
When Perry accuses Ben Bernanke of treachery and treason, his violent rhetoric (“we would treat him pretty ugly down in Texas”) is scary in itself. But we shouldn’t let that obscure Perry’s substantive message — that neither Bernanke nor the Fed really deserve to exist, to control the US money supply, and to work towards a dual mandate of price stability and full employment.
No matter what your political affiliation or financial caste, a complete breakdown in institutional trust will not be welcome. It should also be noted that anti-institution pressure is coming from both ends of the political spectrum – OWS hates big banks, Ron Paul wants to get rid of the Fed. It is certainly not my contention that every institution that currently exists should be maintained, but this urge this urge to tear everything down, as an extension of the ongoing infantilization of public discourse, is a process that can run out of control. (I attempted to cover the technology aspect of this, and the echoes of the violent Protestant Reformation HERE. Warning: its among my most disjointed performances).
Interfluidity: Why is finance so complex?: Some essays are so good they represent an intellectual punch to the face, necessitating the equivalent of a “standing eight count” of ponderation. One of the undercurrents of Interloper to date has been an effort to illustrate the ways in which the industry subtly misleads its clients, with the intention that more transparency will allow for more investor wealth creation. Waldman turn this on its head by suggesting that hiding risk from investors is one of the primary, and overall economically
productive functions of financial services:
If only everyone would invest, there’s a pretty good chance that we’d all be better off, on average our investments would succeed. But if an individual invests while the rest of the world does not, the expected outcome is a loss. (Colored values wearing tilde hats represent stochastic payoffs whose expected value is the number shown.) There are two equilibria, a good one in the upper left corner where everyone invests and, on average, succeeds, and a bad one in the bottom right where everybody hoards and stays poor. If everyone is pessimistic, we can get stuck in the bad equilibrium. Animal spirits are game theory.
This is a core problem that finance in general and banks in particular have evolved to solve. A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs. It offers an alternative to risky direct investment and low return hoarding. Banks guarantee all investors a return better than hoarding, and they offer this return unconditionally, with certainty, without regard to whether other investors buy in or not.
Opacity is not something that can be reformed away, because it is essential to banks’ economic function of mobilizing the risk-bearing capacity of people who, if fully informed, wouldn’t bear the risk. Societies that lack opaque, faintly fraudulent, financial systems fail to develop and prosper. Insufficient economic risks are taken to sustain growth and development. You can have opacity and an industrial economy, or you can have transparency and herd goats.
There will be some time before I’m even able to deal with this with any degree of coherence. It basically argues that it is in all of our economic best interests to be misled by finance and, horrifyingly, it sounds right.
Assorted other amazing posts/articles from 2011:
Tyler Cowen on Stories – immediate, cautionary implications for traders
The Resentment Machine – The Internet as useless arbiter of quality
The buidling blocks of economic growth: Complexity matters – Brilliant reassessment of economic inputs.
Solitude and Leadership – William Deresiewicz speech to West Point. Hard to summarize but you have to read it.