MD on FI/RE

Mixing is a well known concept in physical chemistry. If you mix 2 ideal gases, what is the driving force that causes gases to mix, and what causes the mixing to become uniform? Ideal gases don’t react so there is no energy transfer due to chemical change in the constituents. So what is the driving force? The answer is entropy or something called the Gibbs free energy of mixing, in a formula dG = dH – TdS. dG is change in free energy, dH is change in enthalpy, T is temp and dS is change in entropy. In an ideal gas, dH=0 and T is constant, so the formula simplifies to dG = -TdS If dG is negative the mixing occurs spontaneously and it will mix until ALL of the molecules are thoroughly mixed. Once thoroughly mixed the potential to mix (dS) reaches zero, that is when entropy reaches it’s maximum and no further mixing will occur. There are plenty of youtube videos and wiki like sites to more fully describe this process.

The reason I bring this up is this is what drives the virus? Humans are like one ideal gas. Virus is like another ideal gas. The planet is the reaction vessel. The virus mixes by embedding itself into humanity in a manner that is a similar (but not the same) set to 2 ideal gases mixing. As the infection progresses the virus attains a bigger mole fraction further increasing the drive to entropy this would be like H in the above equation becoming a negative value and since H can be a function of time dH/dt as long as it stays negative it can grow exponentially. Thinking about this relationship we have to conclude there is not going to be any Hammer and Dance solution to the virus. The mixing will occur until the Gibbs free energy of mixing goes from negative to zero. If dG goes negative again mixing will again occur. That is precisely what we are seeing. When locked down dG effectively went to zero (Rt < 1). The lock down was cancelled Rt > 0 and means dG once again goes negative and mixing progresses. A vaccine since it interrupts the virus’s ability to mix effectively forces dG=<0 interrupting mixing.

So now you have a mathematical model upon which to base your judgments. If different states have different Rt’s it merely means they are at different places on the mixing surface. It does not mean they are handling things in a superior way, since the driving force is entropy. NY once had a Rt in the 0.8 range, today 1.05. This means dG has gone from zero back to negative and infection will continue until entropy is satisfied.

In anesthesia we measured drug effect in half lives. The curve to equilibrium was asymptotic and it took about 5 half lives to reach 90% of equilibrium (when entropy is satisfied). if we just divide the population into 1/5 ths and use that number as a half life, it means 1.4B people per half life. Herd immunity is about 80% of the population therefore 5.6B people is herd immunity. We are at about 12M worldwide infections.

A vaccine is not a cure. A vaccine is merely a substitute or competing infection. The virus or it’s competing substitute will continue until entropy is satisfied to a level of 80% herd immunity. Never in the history of humanity has a vaccine been created in a couple months so banking on that is like banking on the lotto. As old people die off, young people will take over. Much knowledge and critical productivity is contained in old people that is not contained in young people so a society of young people will be left to reinvent the wheel and reinventing the wheel kills productivity. Dead productivity = a dead market, so be careful when you glibly chop off the geezers. In addition if it’s geezers who are dying what about people who survive? There is significant morbidity associated with this disease. If you infarct 50% of your LV it stays infarcted and you become a cardiac cripple. Knock off 70% of your kidney function by micro infarcts and you’re on dialysis 3 days a week. There is a condition called pump brain where protracted bypass causes cognitive decline post bypass. It’s a soft sign kind of decline but something like this brain fog seems to be happening. Children seem to be showing neurological changes on brain scans. In Hong Kong I read a report that 25% of post infection survivers had long term lung problems and SOB. Do a quick thumbnail on the increased medical cost and lost productivity of this morbidity. Seems to me dying is the least of your problems if you get sick.

If nothing else Covid dumps a load of unmeasured volatility into the system likely long term. If you get the volatility wrong you are more likely to get the truth wrong. That’ll mean you’re long when you should have been short. The next time your Governor is up quacking about Covid and what a swell job he/she is doing you can think back to the Gibbs free energy of mixing and see if they really have a clue. My presentation is about similar sets not about perfect correlation. Certainly there are particular aspects of infection that deviate the model from ideal gases, but the model points you in the right direction. If you have N, S, E, W, to choose from and the model suggests N, go N.

I ran across this video. If you think this recovers like the flu think again.

As I explore the field of volatility, volatility has been traditionally accepted by me as the Markowitz defined Gaussian distribution aka standard deviation. It turns out the Gaussian only is predictable in a low volatility environment. The FED has manipulated the volatility over the past 30 or so years to a low vol back drop. Over the course of that time the act of investing has become trivial. The cost of investing today is virtually zero. I trade ETF’s and stocks, transactions often several hundred K in value at a single button press for free and I can do it several times a day getting in and out of a position. In the old days such a trade would have cost thousands of dollars for a one way trip. The ease of trading makes market participation more of a video game than serious finance.

In the past couple of years my understanding has changed from a statistical model to a game theory model. In a game theory model the actual wining and losing and the how of wining and losing matters. If the Gaussian model worked in all environments I would continue to subscribe to that, but it turns out in anything BUT what is called a “short vol” environment the Gaussian model looses its predictability. My favorite picture of the loss of predictability is this picture:

The column of hot gas up to the little circle is an area of Gaussian distribution. The movement is of low volatility and quite predictable and has a name, laminar flow. At the little circle is a phase transition from linear movement to angular movement. Like the eye of a hurricane the flow undergoes a phase transition, until turbulent flow is established and in turbulent flow anything BUT predictability is the rule.

I made my portfolio into what I thought was a diversified portfolio using stocks bonds gold and cash in a set of proportions, something like 58% stocks 10% cash 5% gold 2% BTC and 25% bonds. If you subdivided my portfolio according to risk, 58 + 2 + 25 = risk on assets called short vol and 5 + 10 represented long vol so from a traditional volatility risk perspective I had an 85/15 short/long portfolio, which means I had way too much risk. When the market crashed even the gold went from a long vol asset to a short vol asset leaving me with a net 90/10 risk on v risk off portfolio. What we think we own is often far from what we actually own. When I saw ALL of the risk indexes across ALL asset classes balloon out 500%, I decided to go to the risk free asset aka CASH till I could better understand what the hell was going on. I’ve figured it out.

Left is a portfolio of so called incredible diversity. IT OUGHT TO BE BULLET PROOF. In reality the portfolio through a long vol lens is the portfolio on the right virtually undiversified. In the past I’ve written about the Harry Browne Permanent Portfolio

Through a long vol lens the PP has 50% “risk on” (VTI and EDV) and 50% “risk off” (BIL and GLD) assets, and has 1/4 of the assets devoted to economic cycles inflation, deflation, growth and recession (contraction). Recession and deflation are not the same. Growth- recession exist along a growth axis while inflation-deflation exists along an inflation axis so you can define. Growth quadrant assets are VTI/EDV. Recession assets Cash/GLD. Deflation assets Cash/GLD. Inflation assets GLD/VTI. This description is meant to show the true diversity nature of the PP. PP results need to be viewed in real terms, not nominal terms. Gaining 12% on your stocks if inflation is 15% means you had a 3% real loss. The PP for all of it’s simplicity has thrown off 4% (or so) inflation adjusted real money/yr to spend on the buying of hamburgers, and has done so at half the market risk.

Dalio add commodities and different proportions

GLD and DBC total 15%. This portfolio has 2 durations of bonds, 20 yr and about 7 years to total 55% bond exposure. If bonds weren’t hovering at going negative I’d be more interested. Hard to justify 55% of your assets being held in accounts that purposely loose money. It has been shown however with proper re-balancing techniques 2 loosing assets can yield a positive return based on the return that re-balancing alone adds to a portfolio. The Dalio portfolio can be made from low cost ETF’s

The Dragon portfolio is different in proportion, asset mix, and cost. The portfolio is more like the PP in terms of allocation. The money is spread across stocks bonds gold and 2 new asset classes commodity trend following and long vol (which is the same long vol as above in the “diversified portfolio’ picture. When analyzed over the economic regimens presented over the past about 100 years, this portfolio survived every scenario with minimal draw down net of expenses. The 60/40 had several 10 year periods when returns were negative on a real basis and when draw down was 40+%. The other problem is SORR. If you have sequential poor performance in several 10 year epochs, your perception of performance will be like the match picture above. Everything seems alright until rotation starts. There is much bla bla bla on recency bias and diversity but a portfolio is only as good as it’s anti-fragility. A 60/40 is a fragile portfolio. It’s success entirely rests on the next 40 years being a mirror of the previous 40. This is highly highly unlikely. We are in fact in a period where everything is unraveling and the FED and the Government is desperately trying to pretend things are OK. Things are not OK. The world 7.5b people owes 334 trillion in debt never happened before. 45M are unemployed, never happened before. A deadly man made virus has been released on the world with very unpredictable consequence, never happened before. Businesses are going out of business at record rates often by bankruptcy. The numbers are closing on 2008 levels (which happened over some years) but the rates are off the charts happening in only a few months. The boomers are retired so their contribution to economic productivity is over. They will consume but at a far reduced rate. Pensions are entirely underfunded so they won’t have the money they think they’ve been promised and the other 75% of society is unlikely to step up and make them whole. We viewed the Greatest gen kindly boomers will be viewed with scorn. These among many more are objections to tomorrow being a mirror of yesterday.

The Dragon has 2 active components not in the PP or Dalio. Long vol and commodity trend following. Long vol is a synthetic tail risk insurance made by using futures. An example in the futures market you can sell a call for a certain premium say $10 and buy 2 higher strike $5 calls with the premium. If the market does nothing or falls, you pocket the premium. If the market explodes beyond the higher strike, you sell your stock to the owner of the first contract you sold, but then you buy back the market at the new higher price, BUT you own 2 call options.

Market at $90 You sell $100 option and turn that cash into 2 $115 options. The market hits $100 and your stock gets sold and you pocket the money. The market hits 105 and you buy back the market with one option and have a second which grows along with your shares Market hits 120 and your stock is up 15 plus your option is up way more than 15 because its in the money. Sell the option put the money in the money in the market and sell another call and buy another 2 calls at a higher strike. Properly adjusted this technique automatically leverages your investment based on volatility. There is a short window between 100 and 105 where you are vulnerable to a small loss and there are ways to trade around that. Properly implemented you can cover the tail risk in either tail with a very small carry cost or even make a bit inflation adjusted. Artemis seems to yield a bout 1.8% in times of low volatility. So you get your tail insurance essentially for free on an inflation adjusted basis, and the risk reduction knocks the hell out of the volatility and draw down and therefore SORR risk.

Commodity trend following is somewhat similar in it’s counter cyclical implementation. Commodities tend to follow the economic cycle and are very sensitive to inflation. So if inflation spikes or crashes and you are long or short commodities you can protect your portfolio using a rules based algo. The algo would be set such that if inflation spikes you go long commodities and if deflation you go short commodities thereby protecting the purchasing power of your portfolio. Both long vol and tend following are active processes not just passive investing, but when added to stopping losses they pay for themselves. If you own a 60/40 and drop 50% you have to make back 100% to get even. That takes time, let’s say 4 years. If you drop 20% you only need recover 25% to break even. That takes only 1/4 as much time so in a year you are even and then have 3 more years to compound while the 60/40 is still under water. In addition the Dragon is quite open to the free money of re-balancing across assets. This free money is enhanced because the classes are diversified across risk on v risk off. The 60/40 has been uncorrelated for the 40 year bull bond market since 1981. Uncorrelated bonds and stocks are not the norm.

Over 30% of the time stocks and bonds are highly correlated and moderately correlated an additional 59% of the time.

So that’s a thumb nail of the Dragon. It fit’s my market prejudice and quant nature quite well. The only issue is you pretty much have to commit all your money to the strategy and once purchased you can’t really screw around with tweaking allocations or you will screw up the efficiency.

The model I use to think about this is that of a geodesic dome. A dome is made from triangles, which essentially are a strong planar surface. Somehow you need to make those planes into a volume, It turns out the maximum volume can be had with minimum surface by joining the triangles 6 to a vertex except you need 12 vertices with only 5 triangles connected. This makes a shape of exceeding strength using the smallest amount of material to enclose the volume. That has the highest efficiency. If you consider the value of your money to be what fills the volume the dome gives you the most efficient anti-fragile structure to contain and protect your money.

In the course of investing we tend to glom onto recency bias. Most recently (in the past 40 years) the bias has been “buy the dip” and “60/40 fixed ratio portfolios”. Over 100 years “buy the dip” and something like a 60/40 has gone COMPLETELY bankrupt 3 times. 40 years ago was 1980 and in 1980 bond yields were 15%. In 2000 bond yields were 7%, so back of the napkin your $1000 1980 bond became a $2140 bond in 2000. Rates are near zero now (say 1%) so your 2000 $2140 bond appreciated 7x to just under 15K. This is why people trade bonds and why if you scoff at bonds you might want to gain some insight. If your 40 year bond was a zero coupon bond you would have paid $1000 in 1980 and received 15K in 2020 guaranteed a 7% per year rate of return.

In the last 40 years bonds and equities have been uncorrelated or negatively correlated, meaning as stocks vary bonds are indifferent or do the opposite. So a crash in equities means bonds yawn or in fact bonds go up as the FED lowers interest rates. In a 60/40 environment that means bonds can save you. Let’s say stocks fall in half to 30 and bonds grow to 50 by appreciation instead of being down 30% overall you would be down only 20%. This is called ergodicity. Ergodicity is anti-fragile. It adds robustness to the system. Properly balanced an ergodic system won’t crash, where as a non ergodic system is absolutely destined to failure. Every system ultimately is non ergodic as every system will succumb to the red giant our sun will become, but barring that over the course of a single lifetime, you can design an investment system that is ergodic.

It turns out over 130 years 1885 to 2015 stocks and bonds we anti-correlated only 11% of the time, moderately correlated 59% of the time and highly correlated 30% of the time. It just so happens anti-correlation has been the rule for the past 23 years, the period when most of us got rich. In the period from 1965 or so to 1997 most of us did not get rich, but most of us were in kindergarten so we were oblivious.

In 68, I was 17 and my father had a building supply business that failed. In about 65 we had a recession especially in the mid west. I was savvy enough to understand what was happening. My father’s business was quite fragile based on economic conditions. I then lived through stagflation in the 70’s and the FED reaction of increasing interest rates in the 80’s. To me that meant my medical school tuition went from 6800 to 8600 in 2 months and then from 8600 to 16,000 in one year. By my 2nd year I was basically out of money. I had enough saved in 1981 to pay for the whole thing and by 83 it was all gone, frittered away by inflation. Color my plan fragile, so I went into the Navy because no way was I going to take out a student loan with 20% interest. The Navy plan was anti-fragile. I got paid $700/mo as an Ensign and all school expenses. They paid 2 years and I served 2 years. The government soon realized they could lever their position to a 1:2 or a 1:3 position but my commission was unlevered at 1:1.

So what about retirement? What is our future? Is a 60/40 fragile or anti-fragile (much less an 80/20 90/10 or whatever foolishness you can cook up.) What kind of portfolio has a chance of being ergodic over the course of 100 years?

The answer of course is to study diversity since independent degrees of freedom are the basis of an ergodic portfolio. What the hell does that mean?

In 2008 we tried to construct my portfolio using a long volume ETF called the VXX. The portfolio was long stocks, long bonds, long gold, long commodity, long EM, and long vol in the form of VXX. VXX and commodities and EM was the wrong choice, but the idea was the right idea, and is still the right idea.

Chris Cole at Atremis capital management has a portfolio made up of

long stocks 24%

long Bonds 18%

long Gold 19%

long Volatility 21%

long commodity trend following 18%

This is a radical portfolio but it is ergodic. It back tests over 100 years as never failing. despite its cost. It is not a cheap portfolio to own. Long vol and CRB trend require active management. Long vol means creating derivatives in combination when there is asymmetric risk reward, where you can afford the carry cost to have a portion of your portfolio that explodes to the upside in the face of explosive downside. CRB trend is a means to follow momentum in either direction. CRB is an asset the government does not manipulate, hence the reason oil futures went negative a couple months ago. The government had no bid on oil, so oil actually behaved in a free market non manipulated fashion. As we see commodity prices rise in the likely coming stagflation being long commodity trends will counter balance the fragility of the stock market fomo. If you bought Hertz because it was cheap, I guess you missed it’s also dead.

This kid of portfolio is like the Harry Browne Permanent Portfolio in that it requires life long adherence for it to pay off. You can’t screw around trying to be a real estate tycoon. It’s advantage is it’s long term risk because of its diversity is minimized and of you have a lower risk at a given return you can withdraw a slightly greater draw without suffering the increased SORR.

I’ve always been attracted to the PP as an investing strategy, but to date I’ve sought the feigned security of the crowd and recency bias even though I tend to be on the perimeter of that perspective. I believe the regimen has changed. Regimens do change which is why the 60/40 went bankrupt 3 times in 100 years. I think the future is quite bleak and won’t look like the past 40 years much at all. I think the political landscape is bleak and there is much damage to be done with the stroke of a pen. I do know I absolutely can’t afford to stay in cash.

As I work through this I’ll likely write more. The geodesic dome is a structure based on the distribution of triangles across a pattern of vertices sometimes hexagonal in pattern, sometimes pentagonal in pattern dispersed across the face of a sphere. What you get is a inherently strong thin walled structure capable of distributing stress across the perimeter of the sphere the structure encloses. A Geodesic dome encloses the greatest volume for the least surface area which can be viewed as a measure of efficiency. Conceptually this is along the lines of how I view this kind of portfolio. Light weight, strong, efficient, in a word anti-fragile in the face of multiple insults.

The DXY has crashed It peaked in march and now is down 6% from the high. This means it takes more dollars to buy the same value. More dollars for same value is called inflation. More dollars for same value means stock prices go up but the value contained does not. Effectively this is a buy high result and is the basis of FOMO. FOMO is a greater fool strategy. You buy now in the hopes a greater fool will buy from you later. Passive index investing is a greater fool strategy as well.

Hertz is a perfect example. DEAD company with DEAD stock being bid up to 5 bux a share in a greater fool strategy, because there is always some dumbass who will buy my dead stock at 7. There’s always a dumbass until there isn’t and your $5 stock is now worth $2. In the mean time the cost of bread goes from $2 to $5 because inflation. The dollar crashed so by definition a less valuable dollar buys a lower value of goods. The smart money would have bought wheat or grocery stores or bread companies. In a time of inflation Shell oil might look good also.

In a time when GDP is crashing AND DXY is crashing, bad juju.

In addition I was just on a call regarding the economy. It turns out we now need to take out $7.50 in credit for every $1 increase in GDP. Now that’s what I call diminishing returns.

Dow is down 5.16% as I write. I came across a video that explains some of how as investors we are manipulated by our government. We read a headline number like GDP or unemployment and think we understand what it means and may be use it as a way to judge risk. But do we really have a clue? You may not agree with George, but why did the government back in the 90’s change the way it did calculations?

In the late 90’s I was day trading options. The late 90’s were the lead up to the .com crash. In the early 90’s small caps exploded as tech blew up. I knew guys who made 10M on things like Compaq and Sysco and Sprint buying stock at 10 cents per share. Later they levered the hell out of it and we got Long Term Capital Management. LTCM blew up and the NY banks covered the leverage. The market narrowly missed catastrophe. Next cake .COM and stocks with no property and no earnings, not worth anything were trading in the stratosphere. This is when I was trading options. JDSU was typical. It would undergo a stock split every 90 days with the stock eventually reaching 150 bux so a single share might split 8 times in a year and the price soared to 150 bux a share. Eventually the party was over the musical chairs were filled and JDSU did not have a chair. The stock went to $2 and the stock did a 8:1 reverse split. I made money trading JDSU till I lost money. I still don’t have a clue exactly what I owned in the stock from a value perspective, but what I cared to own was access to cash flow. JDSU LMNOP QRSTUV whatever, all I was doing was trading cash flow and momentum. It’s like sky diving. The acceleration is breath taking and only ends once the ground is hit. By then you better have risk management in place. If you don’t you will bounce. That is what sky divers say happens to people who “go in”, that is suddenly decelerate without deploying their risk management. I’ve seen bounces, they are not pretty. Pretty much everything gets crushed.

I didn’t manage my risk very well in 1999 and managed to loose 1M. I made it back and managed to loose that same 1M in 2008. I made it back as well. In 1999 I did have what I thought of as risk management. I didn’t know much about bonds but I did own some muni zero coupon strips that were paying 7.5%. I had GE. GE got to 57 bux in Aug 2000 AND NEVER RECOVERED! It’s taken GE 20 years to die but dead it is. I owned Fidelity Countrafund It was 6.5 bux in 1999, went to 7.8 bux in 2007 and is about 14 bux today. I sold Contrafund around 2008 but had I held it over 20 years I basically would have doubled my money in that period. That’s a 3.5% rate of return over 20 years dividends reinvested. I did own some Fidelity tech mutual funds in 1999 that actually went out of business. I thought I owned diversity. The interesting thing about 2000 was everybody and their brother was a trader. My contractor who had dropped out of high school had 1M in the market and was filling me in on his book out on my driveway back then. Didn’t turn out so well for either of us, but my risk management was better than his.

In 2005 or so I was having coffee after Church talking to a welder. He owned 5 acres of scrub land out in the sticks near where I live. He was telling me how the 5 acres across the street from him had sold for 90K an acre. I said 90K an ACRE? SELLLLLL I said!! I had priced 10 acres a few years earlier for 4.5K an acre in a much better location and I couldn’t get myself to pull the trigger so no way was 90K an acre reasonable by any stretch. He just looked at me and said: what if it goes to 120? I live in rural FL out where I live there are no lights to pollute the night time sky. My neighbor to the east is the Atlantic ocean so when I get up to pee the eastern sky is magnificent. That same 5 acre plot today would fetch 9.5K/acre. If I was in the market I’d wait a year and could probably get it for7K.

This time feels very much to me like 1999 and 2005. High school dropout contractors and welders are all tycoons. Not to diss them at all. They are my patients neighbors and friends. They go to my Church and shop at my Walgreens. So the question is what does price actually measure these days?

I looked at the market today and saw this:

I’ve read that there are several million new brokerage accounts that have been opened since the crash in March. I’ve read that many peeps on unemployment ate making more on unemployment than they made working. I read that peeps are getting an extra $600/wk. How is it the NAS closes up .29% while the Dow closes down 1.09%? That’s a 1.4% spread! The answer is this is 1999. This is my contractor sitting at home trading QQQ waiting for the job to come back. This is JDSU. This is 90K/acre. This is where the 4T in stimulus went. This is living in a video game called “Stock Market”. This is every fund manager having to go “all in” or else be left behind and loose his job. The laws of gravity have not been repealed. I just reviewed a side deck of world wide demand and world wide production and world wide shipping (supply chain) on a region by region basis. This deck is what life is like outside the video game.

Here is an example Singapore. Singapore is a city state Island in south Malaysia. It is a wealthy country and has 6M people and had 25 Covid deaths with 38K infections. Here are a couple charts of what’s going on in Singapore

Recreation is down 65% and work is down 60%. This is common across the world. Nothing anywhere is gangbusters. The title of the report is “Slowly Recovering”. Is Singapore consistent with a NAS of 10K? What happens to QQQ when the stimulus rolls off in July and NAS has a down day? What does price measure? Rate of change or value?

Here is a shot of the S&P on Feb 19 when the market peaked at 3393 intraday.

Here is a shot of the local market low on 3/23 of 2191 intraday

Here is a shot of Friday’s chart with an intra day high of 3049

Indexes are designed to go up. Indexes because of their design do not represent some intrinsic value associated with some intrinsic risk. Instead they represent a market elevator of unknown value and unknown risk. Passive investing is simply a on off switch. You pay some money and turn risk on or you cash out and turn risk off. The buy and hold passive crowd neither knows the risk they hold, nor do they ever turn the risk off. It’s risk on all the time. The risk however does vary over time. At market peak on Feb 19 here was the VIX 10.20

On March 18 it topped out at 86.76 with the resulting market low 5 days later. That’s 8.5 times the Feb 19 level

On Friday it topped out at 27.51, 2.69 times the Feb 19 level.

Since risk is what you own. Is something 269% above the Feb 19 level a high level of risk?

I was listening to a podcast breaking down the makeup of the S&P in comparison to the MSCI. They broke down the S&P with and without FAANG plus MS in the comparison using the Friday 3044 level. The expected level of the S&P 500 minus the FAANG + MS was about 2400 meaning without the FAANG+MS the S&P is up only 209 points above the March low. Over 600 S&P points are due to 6 stocks, the FAANG+MS. Only 200 points are due to the remaining 494 stocks, and the volatility is still +269%.

40.77M jobs lost. Let’s say when all is said and done 15M go back to work leaving 25M unemployed. Do you think if you left a 100K/yr job you are going back to a 100K/yr job? What if some joker will do that job for 50K? What happens to market risk if the job you go back to pays 50K less, meaning you will be severely limited in your purchasing power. No brand new F-150’s for you. Maybe no college for Junior.

The FOMO machine s basing everything on 6 companies and every Robinhoodie out there is plowing his stimulus check in the 6 FAANGS. You can make money on the way up and you can make money on the way down. It’s buy low sell high or sell high buy low (short sale). Either one will make you a ton of money. If you buy higher and then hold, in a market with 269% excessive risk what could possibly go wrong?. You can’t short an IRA or a Roth. The algorithms live to make profit and they make it selling high buying low just as easily as they do buying low selling high. The whole time the talking heads are selling you on a V shaped recovery because they know you have sucker stamped on your forehead. Your very mantra has sucker stamped all over it “buy higher never sell”. What buy higher never sell means is you constantly accumulate more and more risk. Sometime you might ask the question how much risk is enough risk to own?

The usual Mantra is BUY and HOLD even if your ass falls off! Then they go into some story about not being able to time the market. Just because YOU can’t time the market doesn’t mean the market isn’t time-able. The story goes “Oh the market fell and then Billy Bob sold, and now the market “recovered” and now he’s at a loss!” This isn’t how you time a market. How you time a market is, the market is high and I’ve made a lot of money, so maybe I should book some profit before the profit is lost.

There is some asymmetry to a market cycle. Early in the cycle there is mostly upside, late in a cycle there is ever increasing potential big time downside. At the end of a 12 year hyper-expansion there is MAJOR downside and not much upside. One thing to understand is as an investor you are really wall street’s sucker. Wall street wants to do one thing, sell you shit no matter what. The world is totally under water and the boobs on CNBC are quacking about green shoots. THAT crowd is paid to sell you shit. The Wall Street Journal is paid to sell you shit. Vanguard is paid to sell you shit and YOU are expected to buy shit no matter the asymmetry of the investment cycle, and no matter whether it’s healthy for your portfolio.

No matter that the rate of change of GDP has been slowing since Q4 of 2018 because that was the quarter acceleration peaked and turned to slow deceleration. It means yes there will be a higher high but a slowing higher high that’s bound and determined to become a major draw down.

We do simple calculations on our money, compounding calculations like this:

Here is a typical retirement portfolio. It starts at 50K, adds 50K/yr compounds at 6% and yields 3M bucks after 25 years. And we think that’s the ticket! 56% of our money comes from compounding. But wait that 6% needs to be in excess of inflation. If inflation averages 3% over the 25 years

Our 3M is really only worth 2M and we made only 33% on our money.

When you have a draw down how you get back to zero follows a formula Y=X + X*A.

Y = back to zero amount

X = starting amount after loss

A = % growth needed to get back to the start

L= % loss

So lets say you loose 10% on $100 how much do you have to compound to get back to $100?

100 = 90 + 90*.111, .111 = L/X = 10/90

So you have to compound an excess of 11.1% total ABOVE INFLATION over some period of time to get back to zero.

Let’s say you loose 30%.

100 = 70 + 70 *.428 to get back even ABOVE INFLATION. To calculate the % increase needed simply divide the starting point (in this case 70) into the % loss in this case 30. In other words L/X = 30/70 = .428. So you have to grow your money almost 43% above inflation to break even. Here is the sad truth

If you have $70 and need to grow it to $100 to break even and you have 3% inflation which yields only 3% of growth, it takes 12 years to get back to zero. Bet you never saw that on buy and hold CNBC. Bet you never saw that on some bogglehead web site. This is what you get with the old “you can’t time the market” mantra. It takes 12 years to get back to zero, with zero drawdown on the principal (say for retirement income). Lets say you correctly exit at a market top, say at $99 and the market falls 30% how long does it take to get back to $100 presuming you can time the market bottom. So the market falls from 100 to 70 and then you stick your 99 back in the market. How long does it take to get back to 100?

In one year you’re already $2 ahead. In the buy and hold case you’re $28 behind in one year

There is a saying

“The enemy of long term compounding is short term draw down.”

This analysis is a variation on a system control called a bang bang control analysis, where you model and optimize abruptly bounded conditions, like what if you loose 30% vs what if you loose 1%, how do you optimize those possibilities, solving for length of time to get back to zero. It assumes a steady 3% over inflation return. But even with those constraints it’s illustrative when Wall Street is trying top sell you FOMO, quick quick buy high it might go higher! Never mind 34M unemployed, never mind several years of projected negative GDP. Remember when you can’t identify the sucker, you are the sucker.

Over the weekend I was looking at an app on TomTom called the world according to traffic. Here is the view I found most interesting. It’s a sampling of traffic across the world. You can also view the Full Ranking which allows you to deep dive into many many cities across a given region.

By looking at this data you get some idea of what’s happening apart from the media narrative. Here is an example:

Wuhan

The real time data is the bold line to the minute. The dashy line is the previous week, and the dotty line is the average for 2019. All you hear about i how CHINA is open. How they squashed the bug so well. If Wuhan is open why does the traffic indicate it’s closed? It was pretty open till last Thursday and now it seems to be closed again.

Guangzhou:

One of my kids comes from Guangzhou. I’ve been there a couple of times. It’s a big bustling city of 13M people. It is the most important financial hub in southern China, but also loaded with industry and manufacturing. Seems like Guangzhou was open till last Thursday and closed on Friday similar to Wuhan. There is a holiday going on in China so maybe that’s the deal.

Hong Kong:

Hong Kong doesn’t have a holiday. It did have a holiday on May 1 so we see a 4 day weekend. On the Covid-19 map China doesn’t report individual data else wise I could look at Hong Kong infection rates vs traffic. So I will look at a city that has both infection data and traffic data NYC

You can see NYC is locked down tight. What about infections using the Johns Hopkins map?

You can see locked down NYC has dramatic improvement in new cases implying NYC has good success in driving down the R0.

This is where I live. It’s pretty closed down but not as closed down as NYC. The Johns Hopkins case map shows only the infection rate for FL so I can track that and it does show individual data for my specific county so I can track that

This is what FL as a state looks like and this is waht Orlando looks like as a data point.

Today FL is supposed to at least partially open up. GA opened up over the weekend. These maps give a way to gauge increased traffic vs increasing or decreasing infection rates and the likelihood of re-quarantine as a function of economic behavior apart from the media spin machine.

Regarding FOMO if the world is shut down as demonstrated by traffic, and the virus is still growing at an exponential clip world wide, I’ll let you complete that thought on your own.

So I’m looking at the COVID map after seeing the FEDS just ordered 100K more body bags. Today we stand at 62K dead. Yesterdays infection rate added 27K. At 27K/d at the end of May we will have added nearly 837K more to the case total therefore giving a expected total of 1.891M and if the death rate is stable @ 5.8% we can expect 109K dead by June 1st and 1/3 of those body bags to be consumed with 2/3 in reserve. This is under a social distancing society closed regimen. If the regimen goes away why would anyone think things get better?

Deflation is not the same as recession. In recession the fed cuts rates and a stimulus impulse surges through the economy. In recession things get cheap but it looks like tomorrow things will be more expensive i.e. things will reinflate. So the motive is to buy low before things go high. Deflation is an entirely different psychology. The deflationary psychology says “yes things are cheap, but tomorrow they will be cheaper so I will wait”.

CNBC wants you to believe this is recession. They get paid to hawk stocks. Virtually ALL of FIREland is buying that narrative as well. I’ve seen several blogs doing post mortem’s on how passive investing has worked so well and now it’s on to new heights! 30 MILLION people are out of work and an economy that was supposed to be up +3.5% is down -4.8% for a net of 8.3% decline for the quarter and that data only includes 2 weeks of virus. The world is in depression. Commodities are in depression. OIL actually traded negative. Ford’s bonds turned to junk and the Ford CEO on the quarter call admitted there was no hope, yet the Nasdaq is down only 0.93% on the YTD.

In Quantum physics reality s governed by wave functions which give probabilities that describe where a particle, say an electron MAY exist. Those probabilities are described by the wave function raised to the second power. It works like the risk distribution in a model of prices. A stock may have a price of $15, but the likelihood of that price being the real price (the real price is the price at which a transaction occurs aka the price where the transaction becomes liquid) actually lays across a distribution, say between $7 and $22 (just an example). So if you bought yesterday at $15 what you bought is quite unlikely worth $15. It’s worth what the market says it’s worth most likely between 7 and 22. So what determines? If we are in a V shaped recession the price is $22, If we are in a deflation the price is $7.

109K projected dead on May 31 with no change in social distancing policy, worse if the policy is more lax. The whole world in deflation and Ford has no hope. Today Gold crashed so I bought more gold. I just read Shell Oil cut dividends for the first time since WW2. I did not buy Apple, because my bet is we are headed to 7 not 22 and people aren’t in the market for a new iPhone. They’ll wait and get it at a cheaper price.

In the end the zombie companies will fail there will be deflation and then recovery in the US but the future won’t look like the past. We no longer are an extension of 2019. The bond market will predict the future. I’m not sure the stock market is even a market any more. It’s more like a wind sock clown hooked up to a big money pump flopping around. Ford says there is no hope. Shell cut dividends. Some people are dealing with reality, some are watching CNBC.