Monthly Archives: June 2012

Outsider Investor Guide to the NYT Business Section

In “Interloper Adjusts to Investing as an Outsider” I outlined a strategy for the average investor who, dutifully employed outside the financial services industry, does not have time to follow every tick of the market. Conceptually, this involved have a loose, flexible view on the future course of markets and then constantly testing this thesis against new newsflow. With this post, we’ll apply the practice to the headlines from the NYT business section.

I picked the Times because it is the most general of business news sources, thus best  reflecting the inputs of the average, non-professional investor. I currently have 35 headlines in my NYT Business section feed, dating from Saturday morning.

Stage 1: Ruthless Culling

The first task is to get the headlines down to a manageable number by ruthlessly ditching every headline with no relevance to investing portfolios. The key thing here is to remain focused – headlines may be interesting in any number of ways but if they do not represent potentially useful investment information the need to be kicked to the trash bin immediately before they become distractions. Times editors are not idiots, they will write the headlines with Mad Men skill to attract our attention. We must be cruel.

The mostly self-serving Media Circle Jerk headlines are easiest to root out, so we can ignore:

-Aristotle and Intermarkets Aim for Cheaper Political Ads (after silently cursing the possibility of more broadcast lying come election time)
-First Graduates from Advertising High
-Huffington Magazine Continues Digital Incursion
-Newspaper Work, With Buffet as Boss (This one caused initial hesitation – are media co.s like NYT finally cheap enough to consider? –  but recent market volatility has left enough cheap stock opportunities than a voyage that deep into cigar butt investing territory is likely not necessary.)

The largest category of headlines headed to the digital landfill consists of lifestyle and self-help stories disguised as business news. It is also the source of the most annoyance, the home of patronizing CEOs who have completely repressed the random circumstance and luck that led to their success, the quirky fads that are both doomed and uninvestable, and the dreaded Leadership Consultants. In this category, we get rid of:

-Corner Office: Usher’s New Look Foundation on Leadership
-When Software Grades Your Essay
-The Boss: John Thompson on His Career
-Take Breaks Regularly to Stay On Schedule
-Forceps, Camera, Action
-Wearable Gadgets Upset FA Curb s On Devices
-Verifying Ages Online Daunting Task
-Taking Advantage of Low Rates
-So You Think You can Be a Hair Braider?

Next we have political stories in business story clothing:

-Drexel Hamilton Hiring Disabled Veterans (hugely admirable, not investable)
-Executive Pay Still Climbing (exec pay rarely, if ever affects stock value)
-Letters: Why Punish the Savers?

Too Obscure:

-Japan Reaches tax Deal That Could Help Shrink Debt
-The Quiet Giant of consumer Database Mining
-Hearst Plans to Bring Back Elle Accessories Second Chance

Stage 2: Interesting, but Reading the Headline is Enough

At this point we’ve whittled 35 stories down to 16. The next category are the articles where the headline tells us all we need to know:

-Greece Pro-Bailout Party Wins Election
-Broken [Institutional} Trust is Hard to Mend*
-European Leaders Present Plan to Quell Crisis
-Markets Signal Initial Relief At Greek Election Results
-China Stifles Debate on Economic Change

The most common response to constituents is either “Duh” or “Not New but thanks for the reminder”

Stage 3: “Make a Note to Request a Research Report on That Next Month” 

-Journey to the Center of the Video Game Universe (“Wait a minute, didn’t I read that COD:MW3 made more money, and quicker, than Avatar?”)
-Digital Radio Royalties Start to Add Up
-Apple Enters Mobile Map World, Stepping Up Rivalry With Google (“I could care less about Mobile Maps, but there does seem to be evidence of Google stumbling lately”)

Stage 4: Argh, I’m going to have to open up and scan these

-Economic Reports for the Week of June 18, 2012
-Treasury Auctions Set for This Week
-Worried Banks in Europe Resist a Fiscal Union

Stage 5: Clear Your Head, Grab a Coffee, Read Carefully and Take Notes

Stages 1 through 4 were designed to get us here, to the stories that most matter, where either invested assets are at stake, or where opportunity could potentially lie:

-Euro May Have a Painful Path, Whatever Greece Decides (“I am tired of getting blindsided by European headlines, maybe this story will tell me what to look for”)
-Investors Relief Confronts Net Euro Crisis (See above)
-Mergers of European Mobile Carriers Expected to Grow (“Oh, really? Please tell me more about who is yielding 9%, is reasonably financially healthy and is most likely to be taken out, kthx”)**
-Why European Stocks May Be Ripe For long-Term Gains (“Wow, look at those yields. They all can’t be going out of business”)

There you have it, Interloper’s tour of today’s NYT Business section for fellow Outsider investors. It is general purpose, and I’m fully aware that many will have specific interests that will result in significant changes. Hopefully though, I’ve succeeded in providing a rough, if much longer than I intended, template that will assist investors in navigating the financial news fire hose.

*I personally read more or less every word Professor Cowen publishes, but put the piece in this category in keeping with the exercise’s constraints.

** Disclosure: I am recently long a European telco

Routine Ground Balls and the Traits of Real Market Professionals

I played baseball for 14 seasons over 15 years and was competent enough to get scouting attention at a younger age. I had one great coach, “Skid”, who, although every second sentence he uttered would now get him arrested under hate speech statutes, also frequently provided baseball-related thoughts that carried well into everyday life. One of his tenets, usually brought up by someone getting cocky was that, “you could have season tickets in the front row at Yankee Stadium and still never understand how good those guys are”. This statement has multiple implications but I’ll focus on the one in particular that has most informed my trading and investing.

Almost everyone on my team had, at one point in a game or practice, made a play remarkable enough to be featured as a play of the night on SportsCenter . They just happen as a function of instinct and circumstance. Even though a selected few of them had the physical tools necessary – speed, arm strength, etc –  no one was consistent enough at routine plays to ever challenge for a major league spot. The point Skid was making was that major league players were virtual machines, never making a mistake on routine ground balls and making difficult plays look mundane. (If you’ve ever wondered why most Major League middle infielders are Latin American, remember that most of them grew up in shithole barrios where playing fields were more or less parking lots with rocks and random chucks of concrete. When they get to the pool table surfaces of the big time they find ground balls, no matter how much spin’s on them or how hard they’ve been hit, comically easy).

The average fan, then, believes that Major League players are determined by diving, flashy plays when nothing could be further from the truth. In addition to having hands that move like compressed lightning at the plate (something that can’t be taught unfortunately), it is machine-like reliability and mental discipline that separates the talented from the true pro.

The corollaries to trading and investing are clear. The media will be happy to feed us SportsCenter-like highlights of big trades. The story of the real pros, the constant, consistent grinding out of profits informed by decades of practice no matter what kind of bad hops the market generates will remain less newsworthy. Given the choice, like baseball scouts the market will reward participants that make fewer errors, not those that generate the flashiest, unrepeatable trades.

Why Intuition Can be Better Than Analysis

There is an investing Rule of Thumb formerly used by prominent strategists called “The Law of 20″ (sometimes 22) that assumed over time that the combined market PE ratio and primary interest rate would return to a sum of 20. The Fed having put its foot on the neck of rates since 2008, any investor depending too heavily on this rule is out of business. VaR was viewed as gospel in terms of measuring credit risk after being tested by brilliant minds with exponentially more grounding in statistics and applied math than I have. Energy traders, as recently as the early 2000s, made huge bets based on US gasoline consumption until Chinese imports became the dominant determinant of oil prices. The rule in each case is that things change, and  the practice of reducing market strategy to individual indicators or relationships is, no matter how well back tested, subject to a likely-painful best-before date.

The impetus for these thoughts is a recent post by economist Nick Rowe emphasizing the non-linearity of economic forecasting, a thought which I am extending to asset markets. Rowe writes (read the whole thing though):

students really really wanted a linear story of the monetary transmission mechanism. And when I gave them a linear story they thought they understood it. They didn’t. They misunderstood it. They misunderstood it just as badly as a student who thinks “an increase in supply causes a decrease in price causes an increase in demand causes an increase in quantity” misunderstands demand and supply.

My students were like the people from the concrete steppes. The people from the concrete steppes want a linear story of the monetary policy transmission mechanism. Sorry, but you can’t have it. If you think you understand monetary policy through a linear story, you don’t understand it. The true story is non-linear. There is simultaneous causation, so endogenous variables are co-determined in equilibrium. Expectations matter, so the story has flashforwards and flashbacks, where the future affects the present. Those expectations are self-referential, because the characters in the story know the author who works at the central bank, and can anticipate the future plot he plans to write, which affects their actions today. That means a loosening of monetary policy could mean that interest rates rise, not fall. You cannot reason from an interest rate change (Scott Sumner), because interest rates are endogenous variables.

What professor Rowe is suggesting is that every relationship is subject to its context and that reductive analysis into tidy equations, while psychologically satisfying, often results in a weaker understanding of economic conditions. Deeper understanding, according to this theory, is derived using holistic, “whole picture” thinking. Easy to say, but what does this actually mean?

A practitioner of scientific, Rationalist thought will, when faced with a complicated system, immediately begin dissecting and organizing into component parts and this process encompasses the majority of market and economic research. Balance sheets are “broken down”, multi-trillion economies are encompassed by five letters, C+I+G +(X-M). A holistic view would have no real starting point beyond observing the entire system as it functions, which doesn’t seem like productive work at all, certainly nothing worth paying someone who isn’t Jane Goodall for.

As it turns out, however, our brains are doing a ton of calculations and analysis that it doesn’t bother telling us about, as neuroscientist David Eagleman describes in his book Incognito (a Kedrosky suggestion I’m currently reading, slowly).The author’s general view is that our conscious minds, far from running the show, don’t have security clearance for much of what our brain does. The depiction of vision was particularly fascinating. Researchers initially could not figure out why the process of walking down the street used up so much brainpower, in particular the areas associated with memory. Experiments uncovered that the conscious mind was barely functioning during mundane visual tasks, what was actually occurring was that our subconscious was busily comparing visual stimulus to expectations (born of memory) and only alerting our conscious selves when something surprising happened. This explains the “zoned out” feeling during long drives where time seems to have disappeared – our conscious brains were shut down because our subconscious didn’t see anything worth alerting us about.

Taken together, professor Rowe’s post and Eagleman’s research have fascinating potential implications for investors. Situations where the intuition of an experienced trader, drawing on subconscious calculations based on memory that we usually term “intuition”, could trump the data-driven analysis of an Ivy League economics professor are easily envisioned.

This is a blog post and I am over-simplifying. Intuition alone will never be sufficient for investing success. Professor Rowe’s thoughts, for example, are the outgrowth of decades of rational calculation and entirely conscious “Thinking Slow” (in Kahneman terms) effort, underscoring the idiocy of suggesting disbanding the rigorous study of economics departments in favor of everyone just trading and “feeling their way around”.  The financial crisis did, however, uncover embarrassing weaknesses in previously-revered methods of financial modeling and economic forecasting. The pervasiveness of this failure casts understandable doubt on the entire reductionist process by which the theories were derived, leaving both room for new methods of thought and a new respect for the intuition of traders.

 

The Flaws in My Character are the Flaws in My Trading

I’ve done some things I’m not proud of during my unemployed walk in the desert, unseemly things for an allegedly mature, married man in his mid-40s. Video games, one called Dark Souls in particular, began as a distraction from alcoholic temptation (the most seductive of time-wasting options for obsessives) and became the cause of extended, hand-cramping fugue states of extended concentration. The resulting guilt from this adolescent fixation was exacerbated by the games added “feature” of showing the number of hours played with each developed character. I decline to provide those numbers.

I’m not an idiot and there’s no way I’m going to prescribe a couple hundred hours of virtual swordplay, but the point remains that the game did teach me a valuable investing lesson – that the primary weakness in my character was also the weakness in my investing.

To understand how this happened it is important to note that Dark Souls is an intentionally, soul-crushingly difficult game, even for long-term gaming enthusiasts which I am not. The more difficult sections of the game (check HERE if interested –NSFW voiceover language) are more or less impossible to get through without the help of online videos and other forms of help. Even then, you can expect these sections to take anywhere from 25-50 attempts before success.

Every time I had trouble and went for YouTube help, the issue was impatience. The fact that I should have known this, impatience having been an Achilles Heel since gestation, shows a remarkable lack of introspection, an embarrassing blind spot in self-analysis. It is telling, though, that it took hours upon hours of frustration to realize what should have been obvious – I actually needed to be bludgeoned over the head again and again to learn the lesson. The psychological effort we expend to avoid recognizing our faults is incredible.

I took a vague swipe at a market outlook for 2012 in November’s “Cop Logic” and despite the Q1 rally; the environment is broadly what I expected. (I am not patting myself on the back here, any more than if I had doubled down on 11 and got hit with a face card – you play probabilities knowing anything can happen). The second that Chinese markets started falling and Spanish bond yields hit 2012 highs, I was tempted to jump in on the long side as a contrarian rather than let things play out. In a hubris-enriched attempt to get three months ahead of the market again, I would have made a highly costly, impatient, stupid decision. I checked up, realizing my investing tragic flaw was apparent.

Video games are a shameful waste of time, at least to the extent I was involved over the winter. My point in documenting the experience is to suggest that the most destructive tendencies of traders are likely apparent elsewhere in their lives, and that unsuccessful trades can offer a window into personality limitations that we all broadly share. Moreover, accepting and confronting these weaknesses is intensely counter-intuitive and our own subconscious will have us squirming away from uncomfortable conclusions.  It is not necessary to fruitlessly commit to a video game using the tagline “Prepare to Die”, but a closer examination of our tendencies outside of the financial world could provide useful, corrective guidance on trading and investment styles.

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