The Secret Rules of Modern Living: Algorithms

We caught this 2015 BBC documentary on Netflix last night. Very well done, entertaining and educational.  At the moment at least, it is also available on Youtube at the link below.

Without us noticing, modern life has been taken over. Algorithms run everything from search engines on the internet to satnavs and credit card data security – they even help us travel the world, find love and save lives.

Mathematician Professor Marcus du Sautoy demystifies the hidden world of algorithms. By showing us some of the algorithms most essential to our lives, he reveals where these 2,000-year-old problem solvers came from, how they work, what they have achieved and how they are now so advanced they can even programme themselves.  Here is a direct video link.

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Investment results should be measured from market trough to trough

The news flow of the past decade (century+) confirms the truth about ‘trading’ financial markets. Unless one exploits some privileged advance or inside information (which is commonly done but generally illegal) or is using high frequency machines that allow them to take lightning speed advantage of slower moving capital (which should be illegal and no doubt will be eventually), then ‘traders’ are speculators that frequently go bust–sometimes repeatedly. Some get lucky and win on timing without unfair or illegal advantage, but they must also then exercise the discipline to cash out their chips and go home, or as with gamblers at the casino, luck (price) always turns, and all will be lost once more.

The thrill and danger of chance no doubt can appeal to those hoping to take shortcuts to riches, but the lure of easy money most often ends in a slippery slope to mental and financial hell.

We all take concentrated career risks in our chosen field or business to earn our living.  But this is very different from speculating with our savings once obtained.  Those who seek financial security and self-preservation realize that they must consistently make prudent, careful, financial choices in order to build and preserve capital over their lifetime.

For those that are sworn off gambling or illegal acts, and seek to make higher probability investments with their savings, then attention to a valuation discipline and longer term cyclical and secular trends, are the best tools we have to control risk and navigate through a future that is perpetually uncertain.

Financial propaganda aside, what matters is not how much assets ‘make’ in a given year, but rather what capital one retains over each full market cycle.  So we can only ever accurately measure investment success from market cycle trough to troughIn reality, most managers and do-it-yourself-ers attribute gains into market peaks as their investment acumen, and then give it all back and more in the down cycle, where they blame factors beyond their control.

The last troughs were in 2002-3 and 2008-9.  We cannot know where the next cyclical trough lies, but we can know that it is overdue and we should be expecting it any day now.  We also should know that because of record financial engineering and leverage over the past decade, the mean reversion back below trend this cycle, is likely to be at least -50% from current levels.

Lance Roberts offers an on point chart (below) and commentary this week in The Psychological Impact of Loss: 

Currently, while only slightly below the peak of the 2000 “” bubble, the deviation [from long term trend line dotted below] is at levels that have ALWAYS coincided with a negative mean reverting event or very poor, and highly volatile, forward returns.”


“Of course, like “crying wolf,” when these short-term patterns and long-term prognostications fail to immediately validate themselves, they are summarily dismissed as being wrong, or just “mumbo jumbo,” which often leads to unwanted outcomes.

The primary problem is the “duration mismatch” between most technical analysis, which is typically very short-term (minute, hourly, daily), and the outlook for investors which is in years.

We also must keep in mind that we are overdue today, not just for a cyclical end of the market expansion (that began in 2009), but also of the secular decline in valuations that began from the record peak in 2000.

Secular valuation bottoms historically take 15 to 20 years to complete, and another 10+ years before recovering the prior secular peak once more.  Many today are hoping (ignorantly or optimistically) that the 14 years between the US market price peak in 2000 and the recovery and break above that price in late 2014 marks an unprecedented quick end to the latest secular bear (see below).

But that is to confuse price with valuations. It is asset valuations that define the start and end of secular market periods, not price levels. This next chart (below) shows secular valuation cycles since 1900 and where we are today versus the secular peak in 2000.
Valuation cycles
Suffice to say:  there is no evidence that we are through this historic and necessary mean reversion episode yet.  And most importantly, once valuations do retrace below the historic mean (black zero line above), we should expect at least a decade+ before they venture back above mean once more.

Bob Farrell’s #4 Market Rule: “Exponentially rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”  “Excesses in one direction will lead to an opposite excess in the other direction.” (#2 Market Rule).

This secular bear period of valuation re-tracement has been distinguished by extreme highs and leverage. We should therefore be prepared for the fact that it is likely to end in extremes in the opposite direction. The question is how many of of the current asset holders will be willing or able to wait 10-20+years just to recover their principle back to present levels? (ie., just to break even).

Despite the natural human tendency to short-term assessments and interim math, investment results can only be accurately measured from market trough to market trough, however long that takes. And in real life, that is the only result that actually matters.

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Hayek warns on subversion of the Rule of Law

This is an important article to read and understand.  The warnings on Trump’s behavior to date are clear.  See A warning to Trump from Friedrich Hayek:

“One of Hayek’s most important arguments in his great classic, “The Road to Serfdom,” involves the Rule of Law, which he defined to mean “that government in all its actions is bound by rules fixed and announced beforehand.” Because of the Rule of Law, “the government is prevented from stultifying individual efforts by ad hoc action.”

In “The Road to Serfdom” and (at greater length) in “The Constitution of Liberty,” Hayek distinguished between formal rules, which are indispensable, and mere “commands,” which create a world of trouble, because they are a recipe for arbitrariness. When formal rules are in place, “the coercive power of the state can be used only for cases defined in advance by law and in such a way that it can be foreseen how it will be used.

…In sharp contrast, President-elect Trump prides himself on his skills as a dealmaker, and he wants to use those skills to “make good deals” for the American people. There is a real risk that in practice, presidential deals, deliberately done on an ad-hoc basis, will turn out to be Hayekian commands.

In a world of presidential deals, companies are going to have horrible incentives — to curry presidential favor in countless ways, to act strategically, and to make promises and threats of their own, so as to avoid unfavorable treatment from government and to obtain optimal concessions from it. That’s nothing to celebrate. On the contrary, it is a road to serfdom.

One of Hayek’s enduring achievements was to clarify the importance of government neutrality and forbearance, not through anything like laissez-faire, but by avoiding commands in favor of clear, general, stable, predictable rules on which the private sector can rely. A Dealmaker-in-Chief might turn out, in practice, to be a Commander-in-Chief in precisely the sense that Hayek deplored.”

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Fake news and false prophets/profits

I have to admit, all the recent attention on ‘fake news’ strikes me as naive.  Never mind all the completely made up information, what about the relentless deluge of official government and corporate financial data and press releases.  Did most people really not realize, until now, how manipulated, massaged and misleading most information has become?  A lifelong devotion to critical thinking is the only hope.

On this theme, The Credit Strategist’s Michael E. Lewitt has penned two of the most honest, cathartic paragraphs I have read in some time in his January missive Faking it (subscription only here).

Such true words are rarely spoken.  We must understand and govern ourselves accordingly, especially in the financial plans and choices we make.  Eyes wide open.

After years of watching American corporations lie to investors about earnings and Wall Street analysts pimp for them and keep their jobs, it amazes me that people are just coming to discover “fake news”. Wall Street has churned out “fake news” since printing the first stock certificate. Companies lie to analysts, analysts lie to investors, the financial press parrots these lies and then everybody sits around predicting the future like a bunch of dime -store palm readers. CNBC claims to be the leading financial news channel when, to borrow the words of its Washington reporter John Harwood, it is nothing more than a cartoon version of a television network creating false excitement about markets to lure unsophisticated investors today-trade stocks at the worst possible times. They used to say that if you want a friend on Wall Street, you should get a dog. What they meant was that if you were looking for the truth on Wall Street, you are dumber than a dog.

We live in an inauthentic world yet people perceived to be telling the truth are demonized and shunned by the establishment. The fact that it took everybody so long to figure out that mainstream media promoted “fake news” to support their own political agenda is testimony to the fact that we claim to seek authenticity but settle for insincerity, falsehood and duplicity in our personal, business and civic relationships. Those of us who refuse to settle are considered “difficult”.  We term experts people whose credentials consist of being consistently and wildly wrong about the subjects of their alleged expertise while exhibiting a stunning lack of self-doubt and humility about their failures. “Often wrong but never in doubt” is the mantra of the technocrats and bureaucrats who lead us into one disaster after another while dismissing dissenting voices.  The question I keep asking (because I am decidedly “difficult”) is whether they are wrong because they are stupid or because they are lying.  I’ve come to conclude that the two alternatives are not mutually exclusive though one of the worst sins our society commits against itself is confusing educational achievement and wealth for intelligence or good intentions.

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Electric cars save lives

A recent study by the American Lung Association suggests that electric cars (EVs) will help to save thousands of lives per year in the US by reducing air pollution. But there is another life-saving design advantage in electric cars.  The lack of an internal combustion engine in the front helps reduce injury and fatality to passengers in frontal collisions.

Tesla CEO Elon Musk uses the analogy of a pool to describe the effect of the massive, engine free, crumple zone during an impact:  “it’s just like jumping into a pool from a high diving board — you want a deep pool and one without rocks in it.”

Tesla and treeA high speed collision with a huge tree in Virginia this week, underlined this point yet again.

See:  Tesla owner credits safety features and lack of an engine for saving his life in a crash.

Here is a picture.  The driver walked out with only scratches.


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The round trip of higher oil prices

Promised cuts enabled OPEC to talk up oil prices over the past few months (intended to boost the value of their planned Aramaco IPO in 2018), but the downside is that higher prices encourage higher production and ultimately a round trip back to lower prices.  U.S. oil production is growing again as shale comes out of hibernation faster than OPEC had hoped.  See US Shale’s Great Reawakening:

It was always going to be a matter of when and not if OPEC would have to start grappling with the return of shale, and it looks like that time had already come even before it started supporting oil prices again. The big question is to what degree will the group and its members comply with what they said they’ll do, and how much extra boost that will give to the U.S. shale oil industry.


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