Friday, August 19, 2016

Focusing On Our Economic Breath

I've noticed that I get far fewer blog hits and retweets on posts about monetary policy. I don't take that personally at all. Much of the purpose of this blog is to figure stuff out for myself, and writing helps that process. But it's an interesting observation all the same, and I have a few theories why it might be true:

1) I'm a better writer on investing.
2) The self-selecting group that reads my blog is generally less interested in monetary policy.
3) I mostly focus on US monetary policy. Perhaps European and Asian readers are still as engaged.
4) There's monetary policy fatigue. After 8 years of headline-grabbing central bank actions, people are finally getting bored of hearing about policy changes. It's way more entertaining to read about outrageous things Donald Trump has said than to scrutinize cautious central bankers.
5) People are less interested in reading about monetary policy today because they believe it's a less important driver of economic and financial outcomes.

The reality is probably a mixture of these five possibilities. If theories (4) and (5) are true, other bloggers who focus primarily on monetary policy may also be seeing similar trends. You might think that would be reassuring, because it wouldn't be about my failings as a writer; it would merely be an exogenous change in demand for commentary on monetary policy. But you'd be wrong. I'd be incredibly worried if those two were the major factors. Every time someone comments that monetary policy has lost its power to affect macro or financial conditions, I get nervous. It's precisely when monetary policy is working well that we fail to notice it. Complacency is natural as labour markets heal and US financial markets march steadily higher. But it is incredibly dangerous for investors and policy-makers to forget the role that money plays. 

If you've spent any time with mindfulness or meditation practices, you'll know that a common starting point is to focus on the breath. It's actually pretty remarkable to realize how little attention we pay to the mechanism that keeps us alive. Similarly, appropriate monetary policy is the oft-neglected factor that allows policy-makers and investors to focus on structural, rather than cyclical, change. But there's one huge problem with this analogy: when we have trouble breathing, we know immediately that we're short of breath. But when monetary factors are out of equilibrium, we see the effects but aren't always quite as adept at diagnosing the cause. Economic mindfulness requires focusing on money, our economic breath. I'm hoping that the events of the past 8 years have created new economic pulmonologists - but sometimes, I'm just not sure.

Monday, August 1, 2016

Cultural Appropriation (In Business) Is Great!

2015 was a challenging year for US universities. University administrators across the country were forced to grapple with accusations of insensitivity or even outright racism. In the public discourse that followed, I learned the phrase "cultural appropriation". According to Wikipedia, "Cultural appropriation is the adoption or use of elements of one culture by members of another culture." As I understand it, it's generally used to imply a majority culture adopting elements of a minority culture. 

Much of the commentary I saw last year was critical of cultural appropriation. Challenging prevailing sentiment, Noah Smith wrote a great blog post, simply titled "Cultural Appropriation Is Great!" (As a fan of appropriation, he surely won't mind that I latched on to his title for this post.) In it, he lists six reasons why cultural appropriation is a good thing. Commenter Harriet argued that Noah was missing the difference between cultural exchange and cultural appropriation. If there is a difference between the two, it's pretty slim. Unlike trade in goods and services, there is no explicit exchange in culture. No-one ever says, "Here, you take this bit of my culture, and I'll take that bit of yours." I think we can all agree that it's important for members of one racial/religious/ethnic group to be careful not to mock other cultures, or abuse sacred cultural artifacts. (For more on navigating this path, check out The Atlantic's Jenni Avins.) But the reality is that cultural exchange is a fluid process, and is generally a force for good. One of the best lectures I heard this year was Harvard evolutionary biologist Joseph Henrich explaining how constant cultural evolution is the basis of our collective intelligence, which in turn drives our species' evolution. If you agree with Henrich, demonizing cultural appropriation seems misguided.

It struck me recently how much cultural appropriation has benefited the business world. I just finished "Conscious Capitalism," written by Whole Foods Market co-founder John Mackey and Babson College professor Raj Sisodia. Whole Foods is a pretty remarkable story, given that Mackey co-founded it with zero business experience at the age of 22. One of the central tenets of Conscious Capitalism is to encourage a stakeholder orientation. Rather than only paying attention to investors, or even to customers, a stakeholder orientation seeks to find mutually beneficial outcomes for employees, suppliers and many other parties. Whole Foods has gone so far as to create a "Declaration of Interdependence" codifying this philosophy. It all sounds a little hokey and idealistic until you realize how much this sounds like Japanese businesses. Western analysts often find it hard to wrap their heads around Japanese companies' insistence on a stakeholder mentality. But clearly, Whole Foods has successfully adopted this philosophy. 

Ok, you might say. It worked for Whole Foods but that's just one company, and John Mackey is a self-professed student of Eastern philosophy and religion. Can mainstream Western businesses be trusted with cultural appropriation? Absolutely! Sam Walton may have called his autobiography "Made In America", but in it, he details how much he learned about building corporate culture from visiting companies in Korea and Japan (including the famous Wal-Mart company cheer). More recently, Amazon.com appropriated Toyota's "andon cord" philosophy, in which any worker on the line could stop a process that was deemed unsafe or unsatisfactory from a quality standpoint. There's a reason Wal-Mart and Amazon have been so successful: their founders are serial appropriators, relentlessly seeking out other company practices and absorbing them. But don't forget that this process happens constantly in both directions. After all, much of Japan's manufacturing success has been attributed to productivity improvements pioneered by American statistician W. Edwards Deming. 

So, my view is pretty simple. There are times when people are insensitive towards other cultures, and we shouldn't hesitate to educate those who don't understand or don't seem to care what they're doing. But cultural appropriation is a complex, unstoppable process that we should generally welcome. And who better to have the last word on this than a Hong Kong martial arts star (born in San Francisco) credited with changing the way Asians are portrayed in Hollywood? As Bruce Lee said, "Absorb what is useful, discard what is useless and add what is specifically your own." That, in a nutshell, is the best form of cultural appropriation.

Friday, July 15, 2016

Not So Predetermined

A recurring theme on this blog is the notion that events are often far less predictable than we come to believe after the fact. Our understanding of how history unfolds is deeply flawed, even with the benefit of hindsight. But this doesn't mean we need to take a nihilistic "nothing-is-predictable-so-why-bother" approach. Rather, it calls for rigorous documentation of our views at any given point, and a scathingly honest assessment of why the predictions go right or wrong. As Charlie Munger colourfully put it, "I like people admitting they were complete stupid horses' asses."

This ethos seems to underlie the work of superforecasters, highlighted by Tetlock and Gardner. In my last post, I argued that superinvestors like George Soros and Warren Buffett share the characteristics of superforecasters, despite vastly different investing styles. Speaking about his well-known bet against the British pound, Soros insisted that his success in that particular trade was "not so predetermined."

The same interview raises an interesting question: was Soros's broader success "predetermined"? Curiously, his early career offers little suggestion of the brilliance investing tenure that was to follow (details from Soros on Soros).

1953 (aged 23): "I became a traveling salesman selling [fancy goods] to retailers in Welsh seaside resorts, and that was a low point in my career."

1953-56 (aged 23-26): Singer & Friedlander. "I was made to do some very boring, humdrum jobs, which I did very badly." Moved on the arbitrage department: "Again, I didn't shine." The managing director "told me he didn't get terribly encouraging reports about my performance." "I was a fifth wheel in whichever department I was placed."

1956-61 (aged 26-31): Wertheim & Co. "I put out memoranda that you would find heartbreaking if you read them today because they were so amateurish." Benefited from a boom in European stocks and was able to produce original research. "It was the first big breakthrough in my career." When President Kennedy placed a 15% tax on foreign investments, Soros's business trading global equities was destroyed, forcing him to leave Wertheim.

1961-66 (aged 31-36): Arnhold & S. Bleichroder, part 1. "Business became scarcer and scarcer, and I retired to philosophy." "I stayed employed, but my mind was on philosophy and not on business."

1966-73 (aged 36-43): Arnhold & S. Bleichroder, part 2. "Since I didn't know much about American securities, I wanted to find a way to educate myself." He set up a model account with the firm's money and used it as a tool to develop business with institutional investors. "This was a very successful format." In 1968-69, he helped set up investment funds, First Eagle Fund and Double Eagle Fund. As potential conflicts arose, he left the firm in 1973 to set up his own hedge fund, Quantum Fund, with $12 million of mainly outside money (roughly $65 million in 2016 terms).

My point is simple: Soros's stunning track record post-Quantum Fund is widely known, but at least from the history he sketches, there are relatively few harbingers of this success until he turned 36. But the desire to continue educating himself in US equities proved to be the platform he needed. There was also probably some luck involved in his decision to set up a model account in 1966, as US markets went on a nice little run (note that these figures are for the S&P 500, not Soros's fund). 

Year S&P 500 Return Value of $1000
1966 -9.97% 900.30
1967 23.80% 1114.57
1968 10.81% 1235.06
1969 -8.24% 1133.29
1970 3.56% 1173.63
1971 14.22% 1340.52
1972 18.76% 1592.01
CAGR 8.06%

However, starting business in the teeth of the brutal 1973-74 bear market can hardly have been easy, and must have required the same persistence that kept Soros going through the relatively lean years before 1966. The combination of a growth mindset and some luck set the stage for a track record that most investors can only dream of. But it's worthwhile to remember that, perhaps, that track record too was not so predetermined as we often believe today.

Thursday, July 7, 2016

Superinvestors, Superforecasters

The strategist Byron Wien once remarked to George Soros that on the investing equivalent of Mount Rushmore, there were two faces - Soros himself, and Warren Buffett. Soros responded, "You couldn't find two more dissimilar figures." Others who know Soros well have echoed this sentiment. In Inside The House Of Money, Scott Bessent commented, "[Soros] is the opposite of Warren Buffett. Buffett has a high batting average. George has a terrible batting average - it's below 50 percent and possibly even below 30 percent - but when he wins it's a grand slam. He's like Babe Ruth in that respect. George used to say, "If you're right in a position, you can never be big enough.""

Yet, despite the sharp differences in their styles, the two share analytical and philosophical traits that have contributed to their success. In the same interview, Wien asked Soros if his successful shorting of the British pound in 1992 was predetermined. Surely, he asks, Soros was able to participate in size and thereby influence the outcome of the event? Soros demurs, "It was not so predetermined. In retrospect, it was predetermined, but not in prospect. Believe me, speculation is not without risk, and the outcome is far from assured." This philosophical outlook might ring a bell for those familiar with Philip Tetlock's excellent work on Superforecasters, summarized here by Michael Maubossin and Dan Callahan:


Soros's non-determinism shines through in the earlier quote, but it's remarkable how many of the other characteristics he exhibits. For example, the quote that forms the title of this blog marks him as being actively open-minded. His pragmatism is apparent from his trading style, and his forays into philosophy demonstrate his reflective nature. 

While Buffett may have used the term "superinvestor" to refer specifically to value investors, it seems clear that "superinvestors" more broadly are really "superforecasters." Regardless of investment style, the greatest investors are skilled analysts of probabilities, and are able to perceive when those odds are overwhelmingly in their favour. They also possess another rare quality - having the courage of their convictions to bet accordingly. 

It's hard to know whether superinvestors are just naturally endowed with these skills. But for those of us gazing up at Mount Rushmore awe-struck, it's worth paying attention to the last characteristics of superforecasters: believing it's possible to get better, and being determined to keep at it, however long it takes.

Tuesday, June 28, 2016

The Power of "Because"

Superior investment results are usually attributed to some combination of better information, better analysis, and better emotion management. The first of these, information, is central to any investing endeavour. Analysis is the synthesis of information; information is its foundation. Similarly, no amount of emotion management can overcome deficiencies in the original analysis. It's no wonder, then, that investors go to great extremes (occasionally crossing ethical lines) to obtain information that can provide them with a competitive advantage. In this age of continuous, real-time data, many investors satisfy their information cravings with a steady diet of business news on TV and the Internet. But this unceasing flow of news rarely provides the advantage that some investors think it does. If anything, it's probably harmful to the investment process.

T.S. Eliot had something to say on this subject, famously writing, "Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?" We are confronted today with a surfeit of information, but significantly less knowledge and wisdom. The financial press is always quick to construct facile narratives for market movements. "The market fell today on fears of a hard landing in China," we hear, or, "The market rallied today in anticipation of a more dovish Fed." It's much harder to admit that markets are both random and complex. 

Chalk it up to the power of "because." Harvard social psychologist Ellen Langer demonstrated this in a series of experiments asking a small favor of people waiting in line for a library copying machine. The first request was, "Excuse me, I have five pages. May I use the Xerox machine because I'm in a rush?" An impressive 94% of those in line allowed her to skip ahead. This fell to just 64% when participants were confronted with the request, "Excuse me, I have five pages. May I use the Xerox machine?" But the real kicker was the final experiment, where participants were asked, "Excuse me, I have five pages. May I use the Xerox machine because I have to make some copies?" Amazingly, 93% of those asked agreed, even though the request contained no new information. Some justification, no matter how flimsy, was enough to secure compliance. 

In the world of investing, we see this when investors get locked into a prevailing narrative. In his book "Common Stocks and Common Sense," value investor Edgar Wachenheim recounts a winning investment in Southwest Airlines. Other investors failed to realize that a tightening in airline capacity would lead to higher pricing for airline seats. But Wachenheim is most critical of sell-side analysts, who had become so focused on short-term developments that they ended up missing the bigger picture. The so-called experts, he writes, "had become reporters of recent news, not analysts."

I prefer to leave the reporting to reporters. Intelligent contrarianism, which Philip Fisher described as "correctly zigging when the financial community is zagging", is at the heart of fundamental investing. But this is hard to do when we confuse the news with information or knowledge. We all need to stop and think a little bit harder, especially when the news offers that most seductive of words: "Because."

Saturday, June 18, 2016

Triumph of the Optimists

When interviewing people, the venture capitalist and entrepreneur Peter Thiel has a go-to question: "Tell me something that's true that nobody else agrees with." As it turns out, this is a stunningly hard question. But one of my answers would be simply, "That the world is getting much better."

We are bombarded daily with news coverage of threats like terrorism, global pandemic and economic mayhem. It's hard to follow the news without getting depressed about the future of humanity and the planet we inhabit. And yet, the truth is, the world is getting much better. This is true broadly in human health, economic well-being and safety, as documented by writers like Matt Ridley, Charles Kenny and Steven Pinker. On Twitter, I'm constantly impressed by the data visualizations compiled by Max Roser and HumanProgress.org, which highlight remarkable improvements in our world. This is not to deny that major suffering still exists, or that pockets of society in the US have seen only modest progress over the last 50 years. But looking at the big picture, I find it hard not to be awed by the strides we have made over several generations, and to therefore be optimistic about future developments.

Still, this appears to be a relatively unusual opinion. Even if it is something people agree with on an intellectual level, they often cannot help but feel differently at the visceral level. Why exactly this is the case is the cause of much debate. Personally, I'm always interested in trying to figure out how to apply contrarian opinions for practical purposes. It struck me that I use this particular unpopular stance all the time: I invest in equities for the long term. 

Contrarian optimism is hardly an unusual strategy when it comes to investing.  There are two quotes that every investing aficionado knows: (1) "Be fearful when others are greedy, and be greedy when others are fearful" (Warren Buffett), and (2) "The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." (John Templeton). But I'm thinking here of a longer term phenomenon instead of a cyclical one. Equity investors are generally rewarded for tolerating short-term volatility and long-term uncertainty. In fact, this is one of the many findings of Dimson, Marsh and Staunton's book that produced the title of this post. I wrote a few months ago that the point of a bear market is to return risky assets to their rightful owners. Most people seem ill-equipped for a combination of volatility and uncertainty, but this prevents them from enjoying the benefits of compounding, which only accumulate over time. Looking back at long periods of history is helpful for grasping the gigantic advantage available to those who can truly invest for the long term.

Obviously, it's possible to take this optimism too far. Investors often overestimate a company's long-term prospects. And the great bubbles in history have been the unfortunate byproduct of excessive optimism, greed and a pernicious fear of missing out. There's no doubt that we all need a healthy dose of skepticism to counter the inherent bullishness of the Wall Street machine. So an optimistic outlook needs to be combined with a finely-tuned malarkey detector. But while the pessimists sit on their hands, predicting the next financial collapse or outbreak of hyperinflation, positive change continues to happen all around us. As Ben Carlson notes, "Investors now spend 90% of their time planning for events that happen 5% of the time." This hardly seems like the best way to plan for the future. Instead, the best financial strategies focus on the powerful improvements unfolding over the long term while acknowledging the short-term challenges that always exist.

Of course, only time will tell if I'm right. But I'm relatively confident in betting that the next 50 years will prove to be yet another triumph of the optimists. 

Tuesday, June 7, 2016

Four Goals Good, Five Goals Bad

In my last post, I argued that despite talk of the Fed's dual mandate, it is targeting at least four goals:

1) Price stability
2) Full employment
3) International stability, seeking to implement monetary policy in a way that (a) harmonizes internal and external realities, and (b) recognizes the Fed's influence on global economic, monetary and financial conditions
4) Financial stability, avoiding both unwarranted booms and busts in asset prices.

Tim Duy has two theories (again, see previous post) for why the Fed seems surprisingly keen on raising rates. I think the Fed's recent actions appear much more understandable in light of their unstated financial stability goal.

One narrative of the cause of the financial crisis is that the Fed was directly responsible for the financial crisis of 2007-2009 by keeping interest rates too low for too long. A more generous view is that, as Hyman Minsky warned, stability breeds instability, and the success of "the Great Moderation" unfortunately encouraged high leverage and complex financial instruments at fragile institutions. 

Despite the Fed's best efforts to insulate itself from political pressure, it's unthinkable that it can have remained impervious to the two views above. In this sense, "normalization" can be seen as an attempt to head off any reprise of the financial crisis. Two more concerns are extant:

1) The notion that market participants have somehow become "addicted" to monetary stimulus. (Side note: If there's one thing that automatically sets my teeth on edge, it's references to the economy or financial markets as an alcoholic or drug addict, and to the Fed as a shameless enabler.) The problem is that this bias leads observers to see the 2013 taper tantrum and the 2016 Jan/Feb sell-off as evidence that financial markets are relying on low rates indefinitely. 
2) The notion that Fed actions have pushed all asset markets to overvalued levels. 

Part of the financial stability goal is clearly aimed at keeping unbridled speculation at bay. In Paul Blustein's "The Chastening", he recounts how Larry Summers famously told his bailout negotiating team, "We want to keep markets calm and the Russians scared." The Fed is playing an even more difficult game where it wants to keep markets calm and the speculators scared. This is already attempting to thread the needle, but even more difficult given the Fed's other three goals. 

I've been endlessly critical of hard money types, but it's worth acknowledging that they're not the only ones who may find this expanded array of goals troubling. Those who advocate different types of rules-based monetary policy, such as nominal GDP level targeting, may also consider the monetary policy Apocrypha too hard to achieve. Their concerns are understandable. In its attempt to fulfil its Apocryphal financial stability mandate, the Fed is failing to meet its Canonical dual mandate. Furthermore, in doing so, as Narayana Kocherlakota points out, the Fed is jeopardizing its credibility to meet the Canonical Mandates. I was stunned to read the well-known economist (and former Fed vice-chair!) Alan Blinder lament the limits of monetary policy. "If there is a cyclical downturn in a year or in the next several months, there would be nothing in that shotgun," Blinder warns. If a former Fed vice-chair believes that the Fed is out of ammo (another image I don't care for), it's unlikely economic and financial markets fully believe the Fed can stabilize economy in future downturns.

As unwieldy as the quadruple mandate may be, it seems to be the right approach to central banking in the US. There's no doubt that it's incredibly challenging to manage these four goals, but I don't see any other way. If, for example, we're aware that our diet will affect our teeth, skin, weight and ability to build muscle, it's challenging to choose the right food - but we have no choice but to constantly manage the trade-offs between these effects. Why, you may argue, should the Fed restrict itself to four mandates? Why not five? Why not six? I don't have a great answer to that, and recognize the danger of over-reach: in fact, one of the problems here is that policy-makers do indeed seem to have taken on a fifth mandate, "Normalization", which is at odds with many of its more worthwhile goals.

One of my favourite books is John Kay's "Obliquity." In it, he writes, "Good decision making is pragmatic and eclectic. Oblique approaches rely on a tool kit of models and narratives rather than any simple or single account. To fit the world into a single model or narrative fails to acknowledge the universality of uncertainty and complexity." Yellen's Fed has presumably used a dashboard of indicators to guide its policy-making thus far. It would be a huge mistake to fixate on one or two of those, despite the political appeal and intellectual comfort of doing so. While financial stability is a perfectly valid goal for the Fed to consider, the balance of risks does not appear to require a hasty set of rate hikes. If anything, it is that new mandate, "Normalization", that should be abandoned in favour of the four mandates that have historically served the Fed.