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Happy Hour: Ed Thorp’s Version of Mr. Market

March 23, 2018

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Jon

Barron’s interviewed Ed Thorp this week. Thorp’s curiosity led him down a path to finding ways to game inefficiencies in markets. He’s a math genius who wrote the book on winning blackjack. He parlayed that into a successful quant fund that earned around 19% a year for 20 years, then rolled that success into a second fund.

The Q&A session was short but had some good answers around the Kelly Criterion, whether market efficiencies still exist (he said yes), the value of time, and more. Okay, two highlights (with the links below).

The first is Thorp’s version of Mr. Market. I find it interesting how different people explain Graham’s parable. This is how a mathematical mind explains it in relation to owning an index fund. The second is on lessons for readers of his book A Man for All Markets. Continue Reading…
Mean Reversion in Markets

March 21, 2018

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Jon

Mean reversion is the one thing we can, eventually, rely on to align price with value. It also runs counter to the collective thinking in markets.

Mean reversion is the idea that things – growth rates, earnings, prices, returns – eventually move toward an average. It’s what you get when short-term expectations conflict with long-term reality.

History is littered with companies once considered great, that have since fallen by the wayside. And the companies that were written off for dead often exceed their lowly expectations by briefly performing well.

It turns out, few companies are immune to the cycle of creative destruction (it’s a feature, not a bug, of capitalism). Mean reversion is what results. Tobias Carlisle explains why in his book Deep Value: Continue Reading…
Happy Hour: Lucky Streak

March 16, 2018

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Jon

Morgan Housel is out with a great post on the relationship between luck and risk that you really should read.

Luck is the flip side of risk. You cannot understand one without appreciating the other.

If risk is what happens when you make good decisions but end up with a bad outcome, luck is what happens when you make bad or mediocre decisions but end up with a great outcome. They both happen because the world is too complex to allow 100% of your actions dictate 100% of your outcomes.

One of the biggest mistakes investors can make is confusing luck for skill and good decisions. When you’re dealing with probabilities there’s always a chance that an unlikely possibility makes you money. Continue Reading…
Happy Hour: Innovation, Debt, and Euphoria

March 9, 2018

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Jon

Nothing is more mind-boggling than our ability to repeatedly fall prey to financial euphoria. Equally so, is our ability to recognize it only after the fact. Though a few recognize it sooner, nobody really knows until its over, after the crash.

What’s almost as mind-boggling is how each new generation of investors gets the opportunity to experience it first hand.

Innovation (financial or other) and/or debt, taken to an extreme, are behind all of the booms and busts. Investment trusts and excessive margin debt in the late ’20s. The explosion of mutual funds in the late ’60s. Junk bonds in the ’80s. Dotcoms in the late ’90s. Housing Bubble and mortgage blowup in ’08. Bitcoin most recently. What’s next? ETFs? Continue Reading…
Galbraith: Bubbles and the Bias Behind Speculation

March 7, 2018

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Jon

John Kenneth Galbraith sat before a Senate Committee Hearing to explain his version of the events that led to the ’29 crash. I’ve referred to this hearing before. A number of prominent financial minds were called to offer their view of the market in 1955.

Galbraith was there to offer some historical context. As it turns out, his statement to the Committee is one of the better explanations for stock market euphoria that I’ve read.

Greed and fear are only part of it. While explaining the lifecycle of a bubble, Galbraith, adds that investors end up “fooling themselves.” Confirmation bias kicks in after taking a position. They look for things that confirm their beliefs and shun anything that goes against it. Simply, they see what they want to see.

It reinforces the need to be openminded, avoid filter bubbles, and seek disconfirming evidence. Then ask one simple question: What could go wrong? If no answers come to mind, try harder. Continue Reading…
Happy Hour: Buffett on Investing vs. Gambling

March 2, 2018

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Jon

Buffett sat with CNBC for an interview this past Monday. The Q&A gives Buffett a chance to elaborate on topics he touched upon in the annual letter and answer other questions as well: healthcare, airlines, Apple, etc.

Almost all of his comments are things he’s said before. He offered a few details on the new healthcare partnership with Amazon and JP Morgan. The healthcare industry incentivizes advancing research and medical breakthroughs, not lowering costs. It’s in desperate need of cost improvements, so it will be interesting to see how that plays out.

Two other parts stood out as well.

The first is something Buffett learned from Graham decades ago. Stocks are pieces of businesses. Continue Reading…

Happy Hour: Ed Thorp’s Version of Mr. Market

Mean Reversion in Markets

Happy Hour: Lucky Streak

Happy Hour: Innovation, Debt, and Euphoria

Galbraith: Bubbles and the Bias Behind Speculation

Happy Hour: Buffett on Investing vs. Gambling