finance

On Common Sense on Mutual Funds

I recently finished reading Common Sense on Mutual Funds – New Imperatives for the Intelligent Investor – by John C. Bogle.

Below are key excerpts from this book that I found to be insightful:

Investing is an act of faith. We entrust our capital to corporate stewards in the faith—at least with the hope—that their efforts will generate high rates of return on our investments. When we purchase corporate America’s stocks and bonds, we are professing our faith that the long-term success of the U.S. economy and the nation’s financial markets will continue in the future.

To state the obvious, the long-term investor who pays least has the greatest opportunity to earn most of the real return provided by the stock market.

In my view, market timing and rapid turnover—both by and for mutual fund investors—betray both a lack of understanding of the economics of investing and an infatuation with the process of investing.

My guidelines also respect what I call the four dimensions of investing: (1) return, (2) risk, (3) cost, and (4) time. When you select your portfolio’s long-term allocation to stocks and bonds, you must make a decision about the real returns you can expect to earn and the risks to which your portfolio will be exposed. You must also consider the costs of investing that you will incur. Costs will tend to reduce your return and/or increase the risks you must take. Think of return, risk, and cost as the three spatial dimensions—the length, breadth, and width—of a cube. Then think of time as the temporal fourth dimension that interplays with each of the other three. For instance, if your time horizon is long, you can afford to take more risk than if your horizon is short, and vice versa.

Rule 1: Select Low-Cost Funds…Rule 2: Consider Carefully the Added Costs of Advice…Rule 3: Do Not Overrate Past Fund Performance…Rule 4: Use Past Performance to Determine Consistency and Risk…Rule 5: Beware of Stars…Rule 6: Beware of Asset Size…Rule 7: Don’t Own Too Many Funds…Rule 8: Buy Your Fund Portfolio—And Hold It.

No matter what fund style you seek, you should emphasize low-cost funds and eschew high-cost funds. And, for the best bet of all, you should consider indexing in whichever style category you want to include.

There are three major reasons why large size inhibits the achievement of superior returns: the universe of stocks available for a fund’s portfolio declines; transaction costs increase; and portfolio management becomes increasingly structured, group-oriented, and less reliant on savvy individuals.

Four principal problems are created by this overemphasis on marketing. First, it costs mutual fund shareholders a great deal of money— billions of dollars of extra fund expenses—which reduces the returns received by shareholders. Second, these large expenditures not only offer no countervailing benefit in terms of shareholder returns, but, to the extent they succeed in bringing additional assets into the funds, have a powerful tendency to further reduce fund returns. Third, mutual funds are too often hyped and hawked, and trusting investors may be imperiled by the risks assumed by, and deluded about the potential returns of, the funds. Lastly, and perhaps most significant of all, the distribution drive alters the relationship between investors and funds. Rather than being perceived as an owner oi the fund, the shareholder is perceived as a mere customer of the adviser.

On a closing note, on leadership:

To wrap up this litany, I put before you—both tentatively and humbly—a final attribute of leadership: courage. Sometimes, an enterprise has to dig down deep and have the courage of its convictions—to “press on,” regardless of adversity or scorn. Vanguard has been a truly contrarian firm in its mutual structure, in its drive for low costs and a fair shake for investors, in its conservative investment philosophy, in market index funds, and in shunning hot products, marketing gimmicks, and the carpet-bombing approach to advertising so abundantly evident elsewhere in this industry today. Sometimes, it takes a lot of courage to stay the course when fickle taste is in the saddle, but we have stood by our conviction: In the long run, when there is a gap between perception and reality, it is only a matter of time until reality carries the day.

A recommended read in the areas of investing and leadership.

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On Lords Of Finance

I recently finished reading the Pulitzer Prize winning, Lords of Finance – The Bankers Who Broke The World by Liaquat Ahamed. This book aim, as best described by the author is: “The collapse of the world economy from 1929 to 1933—now justly called the Great Depression—was the seminal economic event of the twentieth century. No country escaped its clutches; for more than ten years the malaise that it brought in its wake hung over the world, poisoning every aspect of social and material life and crippling the future of a whole generation. From it flowed the turmoil of Europe in the “low dishonest decade” of the 1930s, the rise of Hitler and Nazism, and the eventual slide of much of the globe into a Second World War even more terrible than the First. The story of the descent from the roaring boom of the twenties into the Great Depression can be told in many different ways. In this book, I have chosen to tell it by looking over the shoulders of the men in charge of the four principal central banks of the world: the Bank of England, the Federal Reserve System, the Reichsbank, and the Banque de France…Governments then believed matters of finance were best left to bankers; and so the task of restoring the world’s finances fell into the hands of the central banks of the four major surviving powers: Britain, France, Germany, and the United States. ”

Below are key insights from the book that I wish to share:

On Central Banks:

To understand the role of central bankers during the Great Depression, it is first necessary to understand what a central bank is and a little about low it operates. Central banks are mysterious institutions, the full details of their inner workings so arcane that very few outsiders, even economists. fully understand them. Boiled down to its essentials, a central bank is a bank that has been granted a monopoly over the issuance of currency. This power gives it the ability to regulate the price of credit—interest rates—and hence to determine how much money flows through the economy. Despite their role as national institutions determining credit policy for their entire countries, in 1914 most central banks were still privately owned.

On the start of WW1:

As the lights started to go out over Europe that fateful first week of August, every banker and finance minister seemed to be fixated not on military preparations or the movements of armies but on the size and durability of his gold reserves. The obsession was almost medieval. This was, after all, 1914, not 1814. Paper money had been in wide use for more than two centuries, and merchants and traders had developed highly sophisticated systems of credit. The idea that the scope of the war might be limited by the amount of gold on hand seems anachronistic. Nevertheless, here was the London magazine United Empire declaring that it was “the amounts of coin and bullion in the hands of the Continental Great Powders at the outbreak of hostilities” that would largely determine “the intensity and probable duration of the war.”

On the effect of the war on the US:

More important, the war had irrevocably changed the economic and financial position of the United States in relation to the rest of the world. The Fed, which barely existed in 1914, now sat on the largest reservoir of gold bullion in the world, making it potentially the dominant player if and when the international gold standard was restored.

On the impact of reparations on Germany:

Behind all the divisions that were to wreck Germany for the next few years, the one single factor that united every class and every political party—democrats and royalists, liberals and Socialists, Catholics and Protestants, northerners and southerners, Prussians, Bavarians, Saxons, and Hessians—was the injustice of the peace treaty, or as it was called the Diktat. And of all the various penalties heaped on Germany by the treaty – disarmament, dismemberment, occupation, and reparations—it was reparations that would become the single most consuming obsession of German foreign policy.

On the US monetary policy and Keynes:

The hidden irony was that every one of Keynes’s main recommendations—that the link between gold balances and the creation of credit be severed, that the automatic mechanism of the gold standard be replaced with a system of managed money, that credit policy be geared toward domestic price stability—corresponded precisely to the policies Strong had instituted in the United States.

On the expanding role of the Central Banks:

This new set of principles, somewhat cobbled together on the fly, represented a quiet, indeed carefully unheralded, revolution in monetary policy. Until then central bankers had seen their primary task as protecting the currency and confined their responsibilities to ensuring that the gold standard was given free rein, only stepping in at times of crisis or panic. The credit policy of every industrial country had been driven by one factor alone: gold reserves. The United States was, however, now so flush with gold that the solidity of its currency was assured. Led by Strong, the Fed had undertaken a totally new responsibility—that of promoting internal economic stability.

On Churchill and the return to gold standard:

Though Churchill remained chancellor until 1929, by 1927 he had come to realize that the return to gold at the old prewar exchange rate had been a misjudgment. But by then there was little he could do about it except fulminate in private about the evil effects of the gold standard. In later life, he would claim that it was “the biggest blunder in his life.” He blamed it on the bad advice he had received.

On the opposable forces facing Central Banks:

The men in charge of central banks seem to face a similar unfortunate fate—although not for eternity—of watching their successes dissolve in failure. Their goal is a strong economy and stable prices. This is, however, the very environment that breeds the sort of over-optimism and speculation that eventually ends up destabilizing the economy. In the United States during the second half of the 1920s, the destabilizing force was to be the soaring stock market. In Germany it was to be foreign borrowing.

On the blame attributed to the US and France regarding their “hoarding of gold”:

The Sunday Chronicle of September 20 carried a profile of Montagu Norman by Winston Churchill, as part of a commissioned series on contemporary figures. Since leaving office in June 1929, Churchill had quarreled with his Conservative colleagues over Indian self-rule and, now isolated and out of favor, felt free to express his disillusionment with the gold standard orthodoxy openly. The problem was not so much the standard itself, he argued, but the way it had been allowed to operate. It was the hoarding of gold by the United States and France and the resulting shortage in the rest of the world that had brought on the Depression. He had begun to sound almost like Keynes—in a speech to Parliament the week before he had described how gold “is dug up out of a hole in Africa and put down in another hole that is even more inaccessible in Europe and America.”

On the steps taken by the US Government to alleviate the great depression:

In February 1932, he pressed Congress to pass legislation that would make government securities an eligible asset to back currency. At the stroke of a pen the gold shortage was lifted, allowing the Fed to embark on a massive program of open market operations, injecting a total of $1 billion of cash into banks. The two new measures combined—the infusion of additional capital into the banking system and the injection of reserves allowed the Fed finally to pump money into the system on the scale required. But Meyer had left it too late. A similar measure in late 1930 or in 1931 might have changed the course of history. In 1932 it was like pushing n a string. Banks, shaken by the previous two years, instead of lending It the money used the capital so injected to build up their own reserves. Total bank credit kept shrinking at a rate of 20 percent a year…By Thursday, March 9, the Emergency Banking Act was ready to be submitted to Congress. Most of it was based on the original Mills proposal. Banks in the country were to be gradually reopened, starting with those known to be sound, and progressively moving to the shakier institutions, which would need government support. A whole class of insolvent banks would never be permitted to reopen. The bill also granted the Fee the right to issue additional currency backed not by gold but by bank assets. And it gave the federal government the authority to direct the Fed to provide support to banks. The legislation was supplemented by a commitment from the Treasury to the Fed that the government would indemnify it for any losses incurred in bailing out the banking system. This unprecedented package finally forced the Fed to fulfill its role as lender of last resort to the banking system. But to achieve this, the government was in effect providing an implicit blanket guarantee of the deposits of every bank allowed to reopen.

On the US coming off of the Gold standard:

Roosevelt’s decision to take the dollar off gold rocked the financial world. But in the days after the Roosevelt decision, as the dollar fell against gold, the stock market soared by 15 percent. Financial markets gave the move an overwhelming vote of confidence. Even the Morgan bankers. historically among the most staunch defenders of the gold standard, could not resist cheering. “Your action in going off gold saved the country from complete collapse,” wrote Russell Leffingwell to the president.

On the IMF:

Much of the negotiating had been done prior to the conference between the Americans and the British. At Bretton Woods, the biggest controversy was over how much money each country would be eligible to borrow from what was now being called the International Monetary Fund. The Russians, who were there in strength though very few of them spoke English, demanded that the borrowing rights reflect not simply economic power but also military strength, and insisted on equality with the British; India wanted to be on a par with China; the Bolivians wanted parity with the Chileans and the Chileans with the Cubans. The United States, as the find’s prime financier, set these quotas in a series of backroom deals orchestrated by White. On July 22, the conference came to its formal close with a great banquet. Keynes gave a final address. He reminding the participants of the economic chaos that had afflicted the world for almost a generation and paid tribute to the spirit of cooperation that had informed the discussions: “If we can so continue, this nightmare, in which most of us present have spent too much of our lives, will be over. The brotherhood of man will have become more than a phrase.” As he left the room, the delegates sang “For He’s Jolly Good Fellow.”

On a Concluding Note:

For many years people believed—even today many continue to do so—that an economic cataclysm of the magnitude of the Great Depression could only have been the result of mysterious and inexorable tectonic forces that governments were somehow powerless to resist…To the contrary, in this book I maintain that the Great Depression was not some act of God or the result of some deep-rooted contradictions of capitalism but the direct result of a series of misjudgments by economic policy makers, some made back in the 1920s, others after the first crises set in—by any measure the most dramatic sequence of collective blunders ever made by financial officials. Who then was to blame? The first culprits were the politicians who presided over the Paris Peace Conference. They burdened a world economy still trying to recover from the effects of war with a gigantic overhang of international debts…The second group to blame were the leading central bankers of the era in particular the four principal characters of this book, Montagu Norman, Benjamin Strong, Hjalmar Schacht, and Emile Moreau. Even though they, especially Schacht and Norman, spent much of the decade struggling to mitigate some of the worst political blunders behind reparations and war debts, more than anyone else they were responsible for the second fundamental error of economic policy in the 1920s: the decision to take the world back onto the gold standard…More than anything else, therefore, the Great Depression was caused by a failure of intellectual will, a lack of understanding about how the economy operated. No one struggled harder in the lead-up to the Great Depression and during it to make sense of the forces at work than Maynard Keynes. He believed that if only we could eliminate “muddled” thinking—one of his favorite expressions—in economic matters, then society could allow the management of its material welfare to take a backseat to what he thought were the central questions of existence, to the “problems of life and of human relations, of creation, behavior and religion.” That is what he meant when in a speech toward the end of his life he declared that economists are the “trustees, not of civilization, but of the possibility of civilization.” There is no greater testament of his legacy to that trusteeship than that in the sixty-odd years since he spoke those words, armed with his insights, the world has avoided an economic catastrophe such as overtook it in the years from 1929-33.

A must read for anyone seeking to gain a deeper understanding of the global financial system.

On Fooled by Randomness

I recently finished reading Fooled by Randomness – The Hidden Role of Chance in Life and in the Markets – by Nassim Nicholas Taleb.

As stated by the author in the prologue, the main premise of the book is: “More generally, we underestimate the share of randomness in about everything, a point that may not merit a book – except when it is the specialist who is the fool of all fools…In my experience (and in the scientific literature), economic “risk takers” are rather the victims of delusions (leading to overoptimism and overconfidence with their underestimation of possible adverse outcomes) than the opposite. Their “risk taking” is frequently randomness foolishness.”

Below are key excerpts from the book that I found particularly insightful:

1- “I start with the platitude that one cannot judge a performance in any given field (war, politics, medicine, investments) by the results, but by the costs of the alternative (i.e., if history played out in a different way). Such substitute courses of events are called alternative histories. Clearly, the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voice only by people who fail (those who succeed attribute their success to the quality of their decision…And like many platitudes, this one, while being too obvious, is not easy to carry out in practice.”

2- “It is a fact that our brain tends to go for superficial clues when it comes to risk and probability, these clues being largely determined by what emotions they elicit or the ease with which they come to mind. In addition to such problems with the perception of risk, it is also a scientific fact, and a shocking one, that both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.”

3- “There is an important and nontrivial aspect of historical thinking, perhaps more applicable to the markets than anything else: Unlike many “hard” sciences, history cannot lend itself to experimentation. But somehow, overall, history is potent enough to deliver, on time, in the medium to long run, most of the possible scenarios, and to eventually bury the bad guy…Mathematicians of probability give that a fancy name: ergodicity. It means, roughly, that (under certain conditions) very long sample paths would end up resembling each other.”

4- “1) Over a short time increment, one observes the variability of the portfolio, not the returns. In other words, one sees the variance, little else…2) Our emotions are not designed to understand the point…3) When I see an investor monitoring his portfolio with live prices on his cellular telephone or his handheld, I smile and smile.”

5- “…It is not how likely an event is to happen that matters, it is how much is made when it happens that should be the consideration. How frequent the profit is irrelevant, it is the magnitude of the outcome that counts.”

6- “…Brian Arthur, an economist concerned with nonlinearities at the Santa Fe Institute, wrote that chance events coupled with positive feedback rather than technological superiority will determine economic superiority – not some abstrusely  defined edge in a given area of expertise.”

7- “Causality can be very complex. It is very difficult to isolate a single cause when there are plenty around. This is called multi-variate analysis…People might ask me: Why do I want everybody to learn some statistics? The answer is that too many people read explanations. We cannot instinctively understand the nonlinear aspect of probability.”

8- “I am just intelligent enough to understand  that I have a predisposition to be fooled by randomness – and to accept the fact that I am rather emotional. I am dominated by my emotions – but as an aesthete, I am happy about the fact. I am just like every single character who I ridiculed in this book…The difference between me and those I ridicule is that I try to be aware of it.”

9- “People confuse science and scientists. Science is great, but individual scientists are dangerous. They are human; they are marred by the biases human have. Perhaps even more. For most scientists are hard-headed, otherwise they would not derive the patience and energy to perform the Herculean tasks asked of them…It was said that science evolves from funeral to funeral. After the LTCM collapse, a new financial economist will emerge, who will integrate each knowledge into his science. He will be resisted by the older ones, but, again, they will be must closer to their funeral date than he.”

10- “It took me an entire lifetime to find out what my generator is. It is: We favor the visible, the embedded, the personal, the narrated, and the tangible; we scorn the abstract. Everything good (aesthetics, ethics) and wrong (Fooled by Randomness) with us seems to flow from it.”

Regards,

Omar Halabieh

Fooled by Randomness

On The Overspent American

I recently finished reading The Overspent American – Upscaling, Downshifting and the New Consumer – by Juliet B. Schor.

Below are key lessons in the form of excerpts that I found particularly insightful from this book in which Juliet “analyzes the crisis of the American consumer in a culture where spending has become the ultimate social act”:

1- “While I believe all Americans are deeply affected by consumerism, this book is directed to people…whose income afford comfortable lifestyle. I focus on more affluent consumers not because I believe that inequalities of consuming power are unimportant. Far from it. They are at the heart of the problem. But I believe that achieving an equitable standard of living for all Americans will require that those of us with more comfortable material lives transform our relationship to spending. I offer this book as a step in that direction.”

2- “This book is about why: About why so many middle-class Americans feel materially dissatisfied…How even a six-figure income can seem inadequate, and why this country saves less than virtually any other nation in the world. It is about the ways in which, for America’s middle classes, “spending becomes you,” about how it flatters, enhances, and defines people in often wonderful ways, but also how it takes over their lives…IT analyzes how standards of belonging socially have changes in recent decades, and how this change has introduced American to highly intensified spending pressures. And finally, it is about a growing backlash to the consumption culture, a movement of people who are downshifting – by working less, and living their consumer lives much more deliberately.”

3- “…Even though products carry well-recognized levels of prestige, are associated with particular kinds of people, or convey widely accepted messages, we cannot automatically infer the motivations of the consumers who buy them…There are other sources of meaning (beyond social inequalities). Gender, ethnicity, personal predisposition, and many other factors help structure the meanings and motivation attached to consuming.”

4- “First, for a significant number of branded and highly advertised products, there are no quality differences discernible to consumers when the labels are removed; and second, variation in prices typically exceeds variation in quality, with the difference being in part a status premium…The extra money we spend could arguably be better used in other ways – improving our public schools, boosting retirement savings, or providing drug treatment for the millions of people the country is locking up in an effort to protect commodities others have acquired. But unless we find a way to dissociate what we buy from who we think we are, redirecting those dollars will prove difficult indeed.”

5- “Today, in a world where being middle-class is not good enough for many people and indeed that social category seems like an endangered species, securing a place means going upscale. But when everyone is doing it, upscaling can mean simply keeping up. Even when we are aiming high, there’s a strong defensive component to our comparisons. We don’t want to fall behind or lose the place we’ve carved out for ourselves.”

6- “To maintain psychological comfort, most of us must transcend the strictures of the current consumption map…The first step is to decouple spending from our sense of worth, a connection basic to all hierarchical consumption maps. The second is to find a reference group for whom a low-cost lifestyle is socially acceptable.”

7- “I outline nine principles to help individuals, and the nation, get off the consumer escalator…1) Controlling desire…2) Creating a new consumer symbolism: making exclusivity uncool…3) Controlling ourselves: voluntary restraints on competitive consumption…4) Learning to share: both as a borrower and a lender be…5) Deconstruct the Commercial system: Becoming an Educated Consumer…6) Avoid “Retail Therapy”: Spending is Addictive…7) Decommercialize the Rituals…8) Making Time: Is work-and-spend working?…9) The need for a coordinate intervention.”

8- “It can hardly be possible that the dumbing-down of America has proceeded so far that it’s either consumerism or nothing. We remain a creative, resourceful, and caring nation. There’s still time left to find our way out of the mall.”

Regards,

Omar Halabieh

The OVerspent American

On The Money Game

I recently finished reading The Money Game by George Goodman (pseudonym Adam Smith).

This is a classic about the stock market and investing. George covers a breadth of topics in that area based on his insider experience. This includes the psychology of the investor (“you”), IT systems and their impact on the investing field, the professional money managers and their role in the Game etc. The concepts are introduced in an accessible, and often humorous style. While the author does not offer direct investing advice, he does expose what he calls “the biases” that exist in the market – that are essential to take into account to be successful together with good judgment.

George is very successful at immersing the reader into the culture, the psychology and way of thinking that dominates the financial markets and its participants. While this book is dated, most of the concepts discussed still apply to the financial industry today. A recommended read for anyone looking to gain more insight into the Stock Market.

Below are excerpts from the book that I found particularly insightful:

1) “If you are a successful Game player, it can be a fascinating, consuming, totally absorbing experience, in fact it has to be. It it is not totally absorbing, you are not likely to be among the most successful, because you are competing with those who do find it absorbing.”

2) “The irony is that this is a money game and money is the way we keep score. But the real object of the Game is not money, it is the playing of the Game itself. For the true players, you could take all the trophies away and substitute plastic beads or whale’s teeth; as long as there is a way to keep score, they will play.”

3) “In short, if you really know what’s going on, you don’t even have to know what’s going on to know what’s going on.”

4) “You must use your emotions in a useful way…Your emotions must support the goal you’re after…You must operate without anxiety.”

5) “The strongest emotions in the marketplace are greed and fear. In rising markets, you can almost feel the greed tide begin…the greed itch begins when you see stocks move that you don’t own.”

6) “If you know that the stock doesn’t know you own it, you are ahead of the game. You are ahead because you can change your mind and your actions without regard to what you did or thought yesterday.”

7) “Who makes the really big money? The inside stockholders of a company do, when the market capitalizes the earnings of that company.”

8) “What you want is the company which is about to do that (compounding earnings) over the next couple of years. And to do that, you not only have to know that the company is doing something right, but what it is doing right, and why these earnings are compounding.”

9) “What I have told you is a set of biases so you can make your own judgement.”

10) “It is an informal thesis of charting that there are roughly four stages of stock movement. These four are: 1) Accumulation: To make a perfect case, let us say the stock has been asleep for a long time, inactively trade. Then the volume picks up and probably so does the price. 2) Mark-up…Now the supply may be a bit thinner, and the stock is more pursued by buyers, so it moves up more steeply. 3) Distribution. The Smart People who bought the stock early are busy selling it to the Dumb People who are buying it late, and the result is more or less a standoff, depending on whose enthusiasm is greater. 4) Panic Liquidation. Everybody gets the hell out, Smart People, Dumb People, “everybody.” Since there is “no one” left to buy, the stock goes down.”

11) “Does this mean that charts can be ignored? Perhaps charts can be a useful tool even without inherent predictive qualities. A chart can give you an instant portrait of the character of a stock, whether it follows a minuet, a waltz, a twist, or the latest rock gyration. The chart can also sometimes tell you whether the character of the dancer seems to have changed.”

12) “The computer is going to sanctify charting. The Chartists are on their way.”

13) “The characteristics of performance are concentration and turnover. By concentration, as I said before, I mean limiting the number of issues. Limiting the number of issues means that attention is focused sharply on them, and the ones that do not perform well virtually beg to be dropped off…Furthermore, you are going to be scouting for the best six ideas, because if you find a really good one it may bump one of your other ones off the list. Turnover means how long you hold the stocks…All that turover has doubled the volume in the last couple of years, and the brokers are getting very rich.”

14) “The further we come along, the more apparent becomes the wisdom of the Master in describing the market as a game of musical chairs. The most brilliant and perceptive analysis you can do may sit there until someone else believes it too, for the object of the game is not to own some stock, like a faithful dog, which you have chosen, but to get to the piece of paper ahead of the crowd. Value is not only inherent in the stock, it has to be value that is appreciated by others…It follows that some sort of sense timing is necessary, and you either develop it, or you don’t.”

15) “The aspiration of the people are a noble thing and no one is against jobs. But it does seem easy to produce them with currency rather than productivity. Central governments soon learn the utility of a deficit. It is convenient to take the views of the economists who followed Keynes and spend money during recessions. There are even problems on that side of the equation, because even with the breadth of statistical reporting and with computer, speed, this kind of economics is still inexact, and the central government can find itself pressing the wrong lever at the wrong time.”

16) “The love of money as a possession – as distinguished from love of money as a means to the enjoyments and realities of life – will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease.”

Regards,

Omar Halabieh

The Money Game

The Money Game

On More Than You Know

I recently finished reading the book More Than You Know – Finding Financial Wisdom in Unconventional Places – by Michael J. Mauboussin.

The core premise of this book is best summarized by the author: “More Than You Know’s core premise is simple to explain but devilishly difficult to live: you will be better investor, executive, parent, friend – person – if you approach problems from a multidisciplinary perspectives”. He then details his approach: “While the essays cover a range of topics, I categorize them into four parts – investment philosophy, psychology of investing, innovation and competitive strategy, and science and complexity theory. Consider these compartments in a toolbox, each addressing a distinct facet of investing.”

Michael does an excellent job of explaining his multidisciplinary perspectives for investing in a very accessible and practical way – assuming very little prior knowledge. The separate essays are very focused and direct to the point, making this book very easy and relatively quick to ready. A refreshing and very interesting take on investing that can be extended to numerous other fields. A must read!

Below are key excerpts from the book that I found particularly insightful:

1- “Rubin – “It’s not that results don’t matter. They do. But judging solely on results is a serious deterrent to taking risks that may be necessary to making the right decision. Simply put, the way decisions are evaluated affects the way decisions are made.”

2- “I would argue that many of the performance challenges in the business stem from an unhealthy balance between the profession and the business. Many of the investment managers that do beat the market seem to have the profession at the core.”

3- “…The leading thinkers and practitioners from somewhat varied fields have converged on the same formula: focus not on the frequency of correctness but on the magnitude of correctness.”

4- “The lesson from the process of theory building is that sound theories reflect context. Too many investors cling to attribute-based approaches and wring their hands when the market doesn’t conform to what they think it should do.”

5- “Investors need to pay a great deal of attention to what influences their behavior. Three of Cialdini’s six tendencies are particularly relevant for investors: consistency and commitment, social validation, and scarcity.”

6- “A dominant idea in Western society is that we should separate emotion and rationality. Advances in science show that such a separation is not only impossible but also undesirable. Yet successful investing requires a clear sense of probabilities and payoffs. Investors who are aware of affect are likely to make better decisions over time.”

7- “In markets, a symbiotic relationship between positive and negative feedback generally prevails…But the evidence shows that positive feedback can dominate prices, if only for a short time.”

8- “So The issue is not whether individuals are irrational (they are) but whether they are irrational in the same way at the same time.”

9- “In effect, when the environment is uncertain, it helps to start with lots of alternatives (e.g., synaptic connections) and then select (via pruning) the ones that are best given the environment. The process is undoubtedly costly because lots of energy and resources necessarily go to waste, but it’s the best one going.”

10- “Chess master Bruce Pandolfini observes four behaviors that are consistent among chess champions and useful in thinking through the short-term/long-term debate. 1) Don’t look too far ahead…2) Develop options and continuously revise them based on the changing conditions…3) Know your competition…4) Seek small advantages.”

11- “Idea diversity allows you to find what Johnson calls “weak signals.” A weak signal may be the start of a trend away from the dominant path (such as new technology or development) or the right piece of information at the right time from an unexpected source.”

12- “In his 2001 letter to shareholders, Warren Buffett distinguishes between experience and exposure. Experience, of course, looks to the past and considers the probability of future outcomes based on occurrence of historical events. Exposure, on the other hand, considers the likelihood – and potential risk – of an event that history (especially recent history) may not reveal. Buffett argues that in 2001 the insurance industry assumed huge terrorism risk without commensurate premiums because it was focused on experience, not exposure.”

13- “If the stock market is a system that emerges from the interaction of many different investors, then reductionism – understanding individuals – does not give a good picture of how the market works. Investors and corporate executives who pay too much attention to individuals are trying to understand markets at the wrong level. An inappropriate perspective of the market can lead to poor judgments and value-destroying decisions.”

14- “The stock market has all of the characteristics of a complex adaptive system. Investors with different investment styles and time horizons (adaptive decision riles) trade with one another (aggregation), and we see fat-tail price distributions (nonlinearity) and imitation (feedback loops). An agent-based approach to understanding markets is gaining broader acceptance. But this better descriptive framework does not offer the neat solutions that the current economic models do.”

Regards,

Omar Halabieh

More Than You Know

More Than You Know

On The Great Crash 1929

I recently finished reading The Great Crash 1929 by John Kenneth Galbraith.

As John best summarizes it: “The task of this book, as suggested on an early page, is only to tell what happened in 1929. IT is not to tell whether or when the misfortunes of 1929 will recur. One of the pregnant lessons of that year will by now be plain: it is that very specific and personal misfortune awaits those who presume to believe that the future is revealed to them. Yet, without undue risk, it may be possible to gain from our view of this useful year some insights into the future. We can distinguish, in particular, between misfortunes that could happen again and others which events, many of them in the aftermath of 1929, less improbable. And we can perhaps see a little of the form and magnitude of the remaining peril. ”

A great book that captures the environment and culture that lead up to the market collapse in 1929. The learnings are timeless and can easily apply to the financial crash of 2008 as they did back in 1929. A highly recommended read for anyone interested in finance, economics, investing and/or regulation.

Below are excerpts from the books that summarize key learnings:

1- “No one can doubt that the American people remain susceptible to the speculative mood – to the conviction that enterprise can be attended by unlimited rewards in which they, individually, were meant to share. A rising market can still bring the reality of riches. This, in turn, can draw more and more people to participate. The government preventatives and controls are ready. In the hands of a determined government their efficacy cannot be doubted. There are, however, a hundred reasons why a government will determine not to use them.”

2- “It follows that the only reward to ownership in which the boomtime owner has an interest is the increase in values. Could the right to the increased value be somehow divorced from the other and now unimportant fruits of possession and also from as many as possible of the burdens of ownership, this would be much welcomed by the speculator. Such an arrangement would enable him to concentrate on speculation which after all, is the business of a speculator. Such is the genius of capitalism that where a real demand exists it does not go long unfilled. In all great speculative orgies devices have appeared to enable the speculator so to concentrate on his business.”

3- “One of the oldest puzzles of politics is who is to regulate the regulators. But an equally baffling problem, which has never received the attention it deserves, is who is to make wise those who are required to have wisdom…For these people, however, every proposal to act raised the same intractable problem. The consequences of successful action seemed almost as terrible as the consequences of inaction, and they could be more horrible for those who took the action.”

4- “Between human beings there is a type of intercourse which proceeds not from knowledge, or even fro lack of knowledge, but from failure to know what isn’t know… Wisdom, itself, is often an abstraction associated not with fact or reality but with the man who asserts it and the manner of its assertion.”

5- “Mark Twain – Don’t part with your illusions; when they are done you may still exist, but you have ceased to live.”

6- “Thus viewed, the stock market is but a mirror which, perhaps as in this instance, somewhat belatedly, provides an image of the underlying or fundamental economic situation. Cause and effect run from the economy to the stock market, never the reverse.”

7- “Bagehot – Every great crisis reveals the excessive speculations of many houses which no one before suspected.”

8- “Moreover, regulatory bodies, like the people who comprise them, have a marked life cycle. In youth they are vigorous, aggressive, evangelistic, and even intolerant. Later they mellow, and in old age – after a matter of ten or fifteen years – they become, with some exceptions, either an arm of the industry they are regulating or senile.”

9- “Far more important than rate of interest and the supply of credit is the mood. Speculation on a large scale require pervasive sense of confidence and optimism and conviction that ordinary people were meant to be rich. People must also have faith in the good intentions and even in the benevolence of others, for it is by the agency of others that they will get rich…Savings must also be plentiful. Speculation, however it may rely on borrowed funds, must be nourished in part by those who participate…Finally, a speculative outbreak has a greater or less immunizing effect. The ensuing collapse automatically destroys the very mood speculation requires. It follows that an outbreak of speculation provides a reasonable assurance that another outbreak will not immediately occur.”

10- “There seems little question that in 1929, modifying a famous cliche, the economy was fundamentally unsound…five weaknesses seem to have had an especially intimate bearing on the ensuing disaster. They are: 1) The bad distribution of income, 2) The bad corporate structure, 3) The bad banking structure, 4) The dubious state of the foreign balance, 5) The poor state of economic intelligence.”

11- “Here, at least equally with communism, lies the threat to capitalism. It is what causes men who know that things are going quite wrong to say that things are fundamentally sound.”

Regards,

Omar Halabieh

The Great Crash 1929

The Great Crash 1929

Review – The Big Short: Michael Lewis

This book should be rated 6 stars if such rating existed. Michael Lewis manages to top his masterpiece Liar’s Poker with an even more thrilling account of the events that led to the recent financial crisis. Although most of us are aware of the fundamental cause of the crisis being the sub-prime mortgages, this book sheds light on the pivotal role that the rating agencies played in creating it. Michael presents the events from both angles, the entities that were long and the shorts who were betting on the melt-down of the financial system. Through reading this book, one does not only learn the events, but learns how to analyze like the financial managers on Wall-Street. This book can be viewed as an investor’s guide to irrational market. Michael does a great job at the end to relate this piece of work to Liar’s Poker and to show how what he talked about then, came to life now in the form of a crisis. One quote I particularly enjoyed is:
“The line between gambling and investing is artificial and thin. The soundest investment has the defining trait of a bet (you loosing all of your money in hopes of making a bit more), and the wildest speculation has the salient characteristic of an investment (you might get your money back with interest). Maybe the best definition of “investing” is “gambling with the offs in your favor.”
In short, if you wanted to read one book to truly understand the financial crisis, this should definitely be the one. Highly recommended!

Regards,

Omar Halabieh

On Financial Regulations

The aftermath of the financial crisis, has seen nothing short of a veritable crusade against the financial institutions around the world. The primary weapon used: financial regulations. Looking back however, financial regulations are not new and have been extensively used in the past. Yet, every financial crisis, including the most recent one, has eclipsed the ones in the past (minus the interventions).   One item that is completely missed is that regulations tend to focus almost exclusively on the supply side of the supply/demand curve. What they fail to address is the inherent demand that exists in the investment/consumer community. In numerous other applications, addressing the supply side without curbing the demand side has not led the required outcomes (look at drugs for instance).

In short, as long as the demand exists, innovations in new supplies (financial instruments) will emerge to satisfy them. The major question is, how can the demand be better managed, through regulation or other methods. This is a questions I continuously think about. Further comments to follow.

Regards,

Omar Halabieh

Disclosure: Long C and NYB.