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On our company conference call on Wednesday February 26th, Eugene noted that big changes were underway in Kiev, where he lives. Public transportation had been shut down and rivers of protesters were flowing into Maidan Square, a short walk from his apartment. That same day Alexey checked in with us well after midnight. He explained that he had been performing civic duties. Clad in a helmet and wielding a club, he had been protecting protestors marching in his eastern Ukrainian city (Kharkiv). Ukraine's President Viktor F. Yanukovych was voted out by parliament that night.
Throughout the Ukrainian unrest we've been checking the world maps on our website to gauge the intensity of the strife. According to our data, the Ukrainian government was clearly the most unstable in the world the week before the overthrow of President Yanukovych.
The global map above shows the intensity of Government Instability - one of the Thomson Reuters MarketPsych Indices - highlighted in red.
Alexey noted that the emotional fuel for the protests wasn't anger at any one person or political party. The protests were ultimately against unfairness - business cartels, political paralysis, and police corruption - and were stoked by a feeling that the people, all together, could make organic and lasting change. Alexey summed up the mood of the uprising as, "No more unfairness."
After the ouster of Yanukovych, the police stepped back. Per Eugene, "What amazed me a lot is how citizen themselves gathered to stop violence in Kyiv, because police was on side of the titushki [hired thugs]." Eugene noted, "in every district of Kyiv people organized to patrol city and keep peace."
Yanukovych's lavish house was entered by protestors, and Ukrainians were shocked to see video images of his personal zoo, greenhouses, golf course, and the wooden ship that served as his private restaurant. They could see how lavishly the President had been living, presumably at the cost of the country's development.
Now Crimea is poised to secede and join Russia. And given the installation of a new set of oligarchs (from the Ukrainian opposition), whether Ukraine's popular uprising will be sustained is an open question.
On a global scale, the Ukrainian events are evidence of an accelerating paradigm shift. Cartels, corrupt and rigid political systems, and ossified economic regulations are rapidly giving way to open, honest, and free association of people, ideas, and business -- but not without a fight. As investors, we must understand where this trend is heading next so we will not be left behind. Today's newsletter examines how investors can thrive as cartels fall, with an emphasis on finding your edge in increasingly open and efficient markets.
December's newsletter discussed exponential gains in investing, but truth be told, how we handle losing in life and the markets is more important to our long term prosperity than how we approach winning. This newsletter examines at the other half of the investing equation - minimizing your downside.
You might never fail on the scale I did,
but some failure in life is inevitable.
It is impossible to live without failing at something,
unless you live so cautiously that you might as well
not have lived at all – in which case, you fail by default.
~ J.K. Rowling
For most investors these two words - risk management - are a prelude to drooping eyelids and a suddenly urgent need to check one's phone. Yet risk management is ESSENTIAL to good investing. And risk management is all about minimizing the downside. As Warren Buffet - not an investing slouch - noted: Rule No.1: Never lose money. Rule No.2: Never forget rule No.1. And the best way to not lose money is to identify and prepare for potential losses in advance.
The first time our canoe capsized in the Congo river, I immediately called out for my traveling companion. He was a poor swimmer, and we were in the milky brown rapids just above Kisangani (formerly Stanleyville).
If you don't know where you are going, you'll end up someplace else.
The day before we hadn't prepared well for the canoe trip. We had needed to escape town in a hurry as the police shakedowns - common in Africa at that time, 1996 - were intensifying. My buddy elected to buy our dugout canoe himself while I changed money. We might have been OK through the rapids had my companion 1) had canoeing experience (I should have asked), 2) not been stoned when he bought the canoe (sadly he was always stoned, so I'm not sure if it would have made a difference), and 3) bought a larger canoe.
The morning of our launch we tried to escape police detection by arising early and fleeing our hotel at 4am. We loaded our petite canoe on the bank of the Congo at 5am, and set out into the Congo River above the town.
Kisangani is built just below the famous rapids that block further navigation of large boats from Kinshasa. As we watched the lights of the still-sleeping city come into view around a bend, the roaring sound that I thought was insects in the night continued to grow louder. I recalled with dread a few lines from Heart of Darkness: "There were rapids in the river here, and the sound of rushing water drowned out everything else." We tried to turn towards shore, but it was too late. We floated into the rapids, ascended up the crest of a massive surge of whitewater, and slid down into a minor whirlpool, swamping the canoe.
We were lucky after capsizing. I'm a good swimmer, and my buddy managed to haul himself onto our sack of money. (Due to hyperinflation, Zaire's largest bill was worth about $0.20, so we had piles of money stored in a waterproofed bag that floated high and dry. That bag was also a favorite target of the police).
Some events in life make you swear to never repeat them. For me, crossing Zaire in 1996 was one. After surviving that trip, I tried to understand what I could have done differently. I started learning more about political risk, I gained a greater understanding of failed economies, and I looked to better manage the risk of those who make decisions around me. In hindsight, we should have prepared better. And at its core it was a learning experience, which is what all worthy goals are, as we'll discuss later in the newsletter.
Navigating the financial markets is like canoeing across a river. Markets experience periods of calm. Investing in calm markets requires little skill or practice or even awareness of what you're doing. Markets also experience periods of crisis just as there are rapids in rivers. We cannot control the river, and so we must prepare. Within our control is how we learn about and train for contingencies, how we maintain mental flexibility, and how we adapt to unforeseen circumstances. But the chaos of the water itself is completely out of our control.
In 2013 the average hedge fund returned just over 8% according to Hedge Fund Research, while the U.S. equity market (S&P 500) returned over 26% and the Nasdaq over 38%. The stated expected return of most hedge funds is 10 to 20% annually, so with returns of 8% in an extremely positive year for equities, they are sorely lagging expectations. Why?
Every year at this time professional investors set goals and prepare for the new year, and every year they tend to make the same two mistakes. Their recent experiences color their risk forecasts, and they do not prepare appropriate goals. This month's newsletter examines how to set proper goals for 2014, looks at last year's U.S. equities rally, China, and lays out a vision for the year ahead. As you'll see (and hopefully experience) in the next sections, setting effective investment goals involves maintaining a big picture perspective, relying on internal goals, staying mentally flexible, and most importantly, creating a vision.
Optionality is the property of asymmetric upside (preferably unlimited) with correspondingly limited downside (preferably tiny).
~ Nassim Taleb, Antifragile
Most investors have a story of "the one that got away" - a good investments that would have made them a fortune, but alas... Such investments usually possesed the property of optionality, so that the missed return is often several times the initial investment. Like most, I've had a few big misses. For one the President of Dell Computer taught an undergraduate class of mine in Austin, Texas in 1992 and repeatedly told me, "if you want to get rich, buy Dell stock and hold on," but alas the stock's P/E ratio was too high for my valuation models and I was a dogmatic value investor, and alas ... (Dell stock was up 100x over the next 6 years). Even worse, I initially dismissed the internet. I had dinner with my college electrical engineering professors who explained the internet would change everything (this was 1994). At the time I reflected on the painfully slow Mosaic browser and the limited availability of web content, and I vocally disagreed (the memory of my limited vision still hurts). I remember these events because the professors outlined their visions with such wonder. The professors were truly in awe of the world's upcoming transformations.
If you 'have optionality’, you don't have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don't have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur.
~ Nassim Taleb, Antifragile
I learned a few things from these missed opportunities. Each opportunity had enormous - life changing - upside and limited downside. To take advantage of such optionality, we've got to first look for this property. We need the long-term vision to see over the horizon at the exponential changes coming our way. Moreover, we need both the aggressiveness to act on our vision and the prudence to avoid sabotaging ourselves as we pursue it.
Optionality is on my mind lately as Bitcoin and alternative cryptocurrencies (Litecoin, Feathercoin, etc...) continue their ascendance. We described the cryptocurrency bubble in March in this newsletter. In that newsletter you can see a chart of bitcoin as it was about to hit $100 per bitcoin. Today bitcoin is over $1,000 per bitcoin, driven in part by explicit acceptance of virtual currencies by the SEC and Federal Reserve and new Chinese exchanges catering to tech-savvy Chinese moving their savings offshore. Many courageous investors have gained paper (and real) wealth by speculating on cryptocurrencies early, and so today I thought it pertinent to look at the fundamental drivers of wealth accumulation, which is, after all, why we invest.
Today's newsletter explores the creation of massive wealth and the mental biases that sabotage its pursuit.
Trader's Tap Twitter for Top Stock Tweets. Oct 11, 2013. James Macintosh. Financial Times.
Curtain Could Fall on Social Media ETF Party" Oct 8, 2013. Trang Ho. Investor's Business Daily.
What is it the good managers have? It's a kind of locked in concentration, an intuition, a feel, nothing that can be schooled. The first thing you have to know is yourself.
~ Edward Johnson, Founder of Fidelity Investments
In the quote above Johnson was not entirely correct about one thing. Bad investment managers do not have "locked in concentration, an intuition, a feel" due to the fact that they cannot be learned in school (e.g., in business classes, trainings, etc.). They can be learned, but the problem is that these characteristics have not been properly taught. Although self-knowledge cannot be memorized from a book, skills for developing self-knowledge can be learned.
The goal of today's newsletter is shed some light on the nature of investing intuition.
Feel for the market, trader's intuition, gut instinct, and acting from the zone refer to those times when our investing flows naturally, as if in tune with the market's rhythm. Our thinking is clear. Our reactions to market events are correct. Trading decisions are seamless.
While I'm an empiricist by temperament, intuition is notoriously difficult to study in the context of decision making. We often know when we have an intuitive insight, but when we try to define it specifically, it's an evasive concept. The circularity of intuitive feelings is parodied in this Dilbert comic strip and this one.
Famous intuitives include George Soros and Jack Welch (his 2000 book was titled: "Jack: Straight from the Gut"). Infamous intuitives include Alan Greenspan, who asserted in his 2007 book The Age of Turbulence, "To this day the bathtub is where I get many of my best ideas." Intuitive insights often arrive when we are relaxed, thinking about something completely different from the markets, or perhaps nothing at all. It is in these quiet moments that the collected inputs of the past days and weeks coalesce in our brains, patterns and relationships are recognized, and insights bubble up into our awareness.
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