A Few Things...

December 3, 2019

1. How to make 66% annualized over 17 years…..

A number of you are reading the Greg Zuckerman book - The Man Who Solved The Markets about Jim Simons Renaissance Technologies.

Firstly for the uninitiated, here’s why people care:

And even after Renaissance’s fees and carry, investors were left with 39% net return from 2002 to 2018. To put that into context, below are a few of the greats.

So what did I learn from the book?

- Simons was clearly not the lone genius, but much more like a coach who created a culture of very collaborative idea sharing and was able to assemble ultra high class talent. This was key.

- The idea of using exclusively scientists with no economic background allowed them to quickly move to pure quantitative methods without the need for any economic explanations and throw traditional knowledge over board. They didn’t know why they were making money, just that they were.

- They focused much earlier than anyone else on gathering as much historical data as possible and later, to gather intra-day data earlier than others and then built an automated system around this data.

- This system seems to be able to include any kind of information and test it against all the other factors in the model in order to determine unusual and complex correlations that can be traded.

- They focused early on on very short term (intra-day) strategies and on large numbers of trades to minimize the risk on any single risk factor. Risk was a big issue for them and they tried to minimize at every turn.

But what does that mean for you & me ?

We all have to understand what our edge is in any investment situation. I think broadly edge comes in three forms (what am I missing?):

1. Data - know something others don’t.

2. Analytical - figure out something that others don’t.

3. Behavioral - act in ways that others don’t (time edge is a specific form of behavioral, where you think longer term than others).

I personally try to focus 50% / 50% on the analytical and behavioral.

An investment that involves thinking more than a few months forward - most people don’t have the luxury of looking at how something will look like in six months.

An investment that involves buying when the headlines are flashing red and everyone is selling (like December 2018) or conversely selling when everything is green and you want to add risk.

What’s your edge in a few words ?

2. Getting The Odds On Your Side.

That’s the subtitle of Howard Marks new book - Mastering the Market Cycle.

A good quote from a podcast Howard Marks did with Tim Ferriss that gets to the heart of the book:

One of those most important things is knowing where we stand in the cycle. I don’t believe in forecasts. We always say, “We never know where we’re going, but we sure as hell ought to know where we are.” I can’t tell you what’s going to happen tomorrow, but I should be able to assess the current environment, and that’s the kind of thinking that helped us prepare for the crisis. I think that the two most important things are where we stand in the cycle and the broad subject of risk, and in fact, where we stand in the cycle is the primary determinant of risk.

Which is to say, Howard Marks believes that a) the market has cycles and b) it’s hard to know where we are in the cycles. To make it more complicated, human emotions like fear and greed can further create mini-cycles on top of (and often times amplifying) the economic and credit cycles.

There is value in knowing roughly where the cycle might be even if you can not make short term forecasts about where it is going, because as Marks explains:

 “Since market cycles vary from one to the next in terms of amplitude, pace and duration of their fluctuations, they’re not regular enough to enable us to be sure what’ll happen next on the basis of what has gone on before. Thus from a given point in the cycle, the market is capable of moving in any directions, up flat or down. But that does not mean that all tree are equally likely. Where we stand influences the tendencies or probabilities, even if it does not determine future developments with certainty…. Assessing our cycle position doesn’t tell is what will happen next, just what’s more or less likely. But that’s a lot.”

Graphic from page 216 of the book.

Going back to his earlier book, the Most Important Thing:

“Cycles will rise and fall, things will come and go, and our environment will change in ways beyond our control. Thus we must recognize, accept, cope and respond. Isn’t that the essence of investing?” “Processes in fields like history and economics involve people, and when people are involved, the results are variable and cyclical. The main reason for this, I think, is that people are emotional and inconsistent, not steady and clinical. Objective factors do play a large part in cycles, of course – factors such as quantitative relationships, world events, environmental changes, technological developments and corporate decisions. But it’s the application of psychology to these things that causes investors to overreact or under react, and thus determines the amplitude of the cyclical fluctuations.” “Investor psychology can cause a security to be priced just about anywhere in the short run, regardless of its fundamentals.” “In January 2000, Yahoo sold at $237. In April 2001 it was $11. Anyone who argues that the market was right both times has his or her head in the clouds; it has to have been wrong on at least one of those occasions. But that doesn’t mean many investors were able to detect and act on the market’s error.” “A high-quality asset can constitute a good or bad buy, and a low-quality asset can constitute a good or bad buy. The tendency to mistake objective merit for investment opportunity, and the failure to distinguish between good assets and good buys, gets most investors into trouble.” “It has been demonstrated time and time again that no asset is so good that it can’t become a bad investment if bought at too high a price. And there are few assets so bad that they can’t be a good investment when bought cheaply enough.”

Quoting one of the best parts of the book (page 306):

About 45 years ago - in the early 1970’s - I received one of the greatest gifts I was ever given, when an older and wiser investor introduced me to “the three stages of a bull market”:

- The first stage, when only a few unusually perceptive people believe things will get better

- The second stage, when most investors realize that improvement is actually taking place, and

- The third stage, when everyone concludes things will get better forever.

Where do you think we are in the cycle and what is the best way to position ?

3. A Few Things Worth Checking Out:

A. Here’s a BBC glimpse into the world of polymaths and a solid argument for pursuing a wide range of hobbies and interests. "Nobel Prize-winning scientists are about 25 times more likely to sing, dance or act than the average scientist."

B. The legendary Joel Greenblatt of Gotham Capital fame was on Columbia Business School’s Value Investing podcast discussing his career.

C. One of the people I’ve learned from the most on Twitter is Gavin Baker (he managed the Fidelity OTC fund from 2009 to 2017, compounding at 19.3%), he was just on the Invest Like the Best podcast.

D. Turns out that even with all the Data, it’s Still hard to predict the future…..here’s an amusing analysis of a group of hackers who had access to 150,000 earnings press releases before the market:

“The informed traders had “perfect foresight” from stolen earnings announcement press releases, but they were only able to enjoy mixed success in predicting next-day stock returns. Their poor performance implies that capital market participants have difficulty mapping earnings information to stock price reactions.”

Which is a good reminder of the Neils Bohr quote: “It is very difficult to predict — especially the future.”

E. I’m a Lux Capital / Josh Wolfe fan boy, and enjoyed this recent Annual Dinner Talk covering the intersection between Technology & Truth.

F. This disturbing article made me think about the discussion on the dating market from last time and the William Gibson quote: the future is already here, it’s just not evenly distributed……

Quotes I Am Thinking About (about Freedom):

“People demand freedom of speech as a compensation for the freedom of thought which they seldom use.”

- Søren Kierkegaard

“The most satisfying form of freedom is not a life without responsibilities, but a life where you are free to choose your responsibilities.”

- James Clear