Category: Finance

When reading the news, keep in mind that it is trying to program your brain what to think about. Frequently it tries to program your mind how to think. Social media is a filter and amplifier of both of these effects.

In all of these instances, they do not give you any cues about what is not being discussed. As a result, the potential for availability bias is extreme if one does not have reasonably decent critical thinking skills.

I’ve written before about what it takes to outperform in the markets, and one variable is knowing where your thinking is standing in relation to the competition. Since a good amount of the competition is programmed by media what to think, there is a value in paying attention to the programming, but with keeping your full mental shields on.

Right now, apparently Covid-19 is no longer the scourge of the earth. Businesses are re-opening, a good chunk of the public is in silent defiance of social distancing, and life appears to be slowly getting back to normal, short of the annoying lineups you see to get into Costco.

A safe time to invest back in the markets again? Seemingly yes, but the process of transitioning from a very risky (Covid-19 is going to kill us all) to risky (riots in the name of racism is going to kill us all) to not so risky (normalization of the pre-Covid life) has more or less been priced into the market – the S&P 500 is sitting at about 8% less than the pre-Covid peak.

Short of these headlines (riots, normalization), what is not being discussed? I’ll leave this as an exercise to the reader. Being able to assemble ideas to answer the “not” question is valuable in that it allows you to take a good guess at what might be in future headlines (presumably after you’ve gone long on whatever it is that you’ve thought of).

After things re-open, there is a certain ‘novelty’ factor which will result in an initial boost, but reality will be setting in pretty soon – the Canada Emergency Response Benefit payments will end (the US parallel is the $600/week unemployment benefit enhancement), and then decisions will become tough. This will come with increased risk, which portends to choppy waters ahead.

I’m not saying we’re going to crash back down again, but I am saying that the ‘easy’ gains (at least if you recognized that March 23rd was indeed the bottom) have been made here and things going forward will be much more difficult than the past month. The past month you could throw you money into nearly anything and make profits, while going forward, the market is going to be much more discriminating. In particular, I’d be especially hesitant to be long on stocks that Robinhood investors are bullish on. With record amounts of retail account openings, it gives me caution (although the wisdom of the masses may be correct in that they want to be converting their cash into assets that aren’t going to depreciate rapidly like all world currencies are doing).

Today wraps up another month in the markets.

This quarterly report is going to shape up to be one of the most interesting since the 2008-2009 economic crisis. May was a very active trading month. Indeed, something very rare is that my usually very concentrated portfolio has been flattened like the COVID-19 curve – today I count 18 separate issuers that I own either equity or debt positions in (some more concentrated than others). There is an additional three separate positions in various futures contracts. There are more balls being juggled up in the air than ever in the history of my portfolio.

I was caught very badly with the onset of Covid-19, but just because you lose a bunch of money on the way down doesn’t mean you have to earn it back in the same manner. Things are going to be a bit more tricky in the next month – predicting correctly the nature of the post-Covid normalization is where the bulk of the money will be made.

An investor wins in the Covid-19 era by avoiding where there is less likely to be demand. Although I’m sure a few of my picks are going to be duds, the nature of what happened (culminating March 23, 2020) will result in winners that will, by the virtue of mathematics, become more concentrated, while the laggards will naturally reduce in proportion to the overall portfolio.

But overall, there is still an obvious tailwind for the market. This is taking the market sailboat that we are all on in a forward and upward direction. The wind is going to slow its gusting (i.e. central banks will soon start to normalize monetary policy), but just because the wind slows down doesn’t mean the ship stops sailing forward. There’s momentum and plenty of participants that want to convert their zero-yielding cash into assets at ever increasing prices. The winners and losers of Covid-19 are well known by this point, and institutions have their sales data to place their near-insider bets on various retail agencies. Headlines now are concerned about racism and police brutality, geopolitical and electoral politics, another sign of normalization.

Finally, here is an un-testable prediction – on Saturday at 12:22pm Pacific Time, you can watch Elon Musk’s SpaceX launch a couple astronauts into space. While this might not seem like anything special, if this launch is successful, the S&P will rise faster than the rocket that took them up into space. I’ve always thought that SpaceX and not Tesla, SolarCity, Boring or Paypal is the gem of Elon Musk, which would explain why it’s not publicly traded.

It has been an infinitely frustrating process when you place long orders and have them completely blown away (unfilled) by market action. Like we are not talking about missing by a dime or two, we are talking missing out by 5% gap up trades.

That said, the majority of the portfolio that has been invested in the market has caught a huge tailwind. I expect it to continue.

Remember during the 2008-2009 economic crisis where in retrospect you could just stick your fingers on a multi-year stock chart on those two years and pretty much where things ended in 2007 where were they were trading at 2011? That’s the sort of scenario I envision happening, except about as fast as it did coming down.

I always remember the cliche of that psychologically there is a feeling of regret when there is a winning trade that you always wish that more capital was deployed. Tempering that feeling is knowledge of hindsight bias – one usually never thinks about the scenario where the trade goes south.

I’m going to make an observation which may or may not come to fruition. During the CoronaCrisis, I noticed that Kitco and other physical gold vendors were having significant capacity issues which is a sign of very high retail activity. Most of the inventory was sold out or shipping delayed until well into June. My speculation is as the market and economy makes a recovery that gold will continue to lag again in favour of other commodities despite the extremely loose monetary policy. Once the S&P has peaked, it’ll probably be a better time to get into physical gold – chances are by then the Canadian dollar will also have appreciated.

I’ve never been asked which college/university major is best for being able to outperform in the markets, but I am guessing that those choosing to major in philosophy (specifically those specializing in epistemology) or psychology (specializing in cognition and perception) will do better than most others, especially finance and accounting (the limited academic exposure I’ve had to finance and accounting suggests to me that the education delivered in these fields still render people ill-equipped to the financial marketplace).

It is becoming increasingly difficult to separate reality and fiction with some of the media reports on various matters. It is like reading the news on the morning of April 1st, except you’re doing it every day. For example, on the trivial matter of Major League Baseball‘s planned re-opening parameters in the light of COVID-19:

Major League Baseball players will be prohibited from taking showers after games and there will be no fist-bump celebrations or spitting sunflower seeds in the dugout, according to a return-to-play guidelines drafted by league officials.

This is a clever article because it hits on what I believe is the “two realities” theme that we are seeing in COVID-19.

In markets, determining what the reality of the market is, the reality of the underlying company you’re looking at, and your own reality are essential elements to determining your standing. For example, if the market has a pessimistic reality, but the actual reality is neutral, you can ‘win’ by going long if you assuming your own read of reality is correct (coupled with a future change in perception of market reality). Knowing your own standing in regards to your perception of reality is the most difficult of these three.

The funny thing is that there is evidence that we do not need to see reality for how it actually is to survive (this is a difficult to understand lecture, but if you do understand it, you will be much better equipped to handle the financial markets than most).

Going back to Major League Baseball, the two realities that this article hits is:

1) Those that believe that the ever-tightening restrictions of activities due to COVID-19 are justified. Those reading this would be “Oh, OK. Makes sense. Showering creates aerosols, people shower in proximity with each other in stadium locker rooms, so it helps prevent the spread. We must all do our part, including Major League Baseball players.” This caters to the ‘acceptance’ crowd.

2) Another reality is “This is completely ridiculous. You expect to play outside in 35C summer heat for three hours, and not being able to shower after?? This is all about control of people through top-down bureaucratic decree, socialism, left-wing politics, etc.”. This caters to the ‘rejection’ crowd.

The ultimate irony is either reaction goes down a path of no return, where intellectually once you’ve committed the costs of reversal are high – the analogy is digging yourself deeper into a pit makes it more difficult to get out of it. Once somebody has bought into a narrative, the chances of that narrative being mentally confirmed with subsequent articles increases. Social media is very good at accelerating and filtering for these processes, which is one explanation for the increasing amount of polarization we are seeing – only for those that have bought into the ‘two reality’ trap.

Human brains are very well wired to analyze two options and make a decision. We have much less of an ability to consider scenarios with three or more options (the paradox of choice), although most of what we see before us are the consequences of multiple variables, and most of the decisions we face actually have more than two options.

Availability bias is something to always be remembered when dealing with reality sortation – are there alternative, not-before-your-eyes explanations of reality that is not being presented in front of you?

Put this into the context of the markets, where the reaction we are seeing to the markets jumping up roughly 30% from the March 23, 2020 lows is “The economy is shut down. Unemployment is well above 10%. Deficits and debts are massively increasing. Businesses are going bankrupt like never before. Why the hell is the market going up?”.

The market knows about the economy, unemployment, deficits, debt, and bankruptcies. What other variables is the market taking into consideration that people fixated on a certain number of variables cannot see?

It is nearly impossible to engage people on any basis than those of their own selected reality. It is very rare where presented evidence actually gets people to change their minds – usually such evidence ends up being reinforced into the present beliefs in a manner that is quite creative. You see this all the time in cults.

One reason why I choose to engage in the financial marketplace is because I have found no better forum that allows you to quantitatively determine the outcome of others’ perception of reality. If you get it wrong, you lose money. If you get it right, you win money. What makes it particularly challenging is in obvious certain cases reality is not at all close to what it actually is – you can still be “wrong” even when being right. A great example of this is if you shorted Tilray stock before September 19, 2018, it would have been a virtual guarantee you would have lost.

(FYI on Tilray – on September 19, 2018 it reached a high of $300 before crashing. If you had shorted the day before, the VWAP was $144, and if you had shorted just a week before the VWAP was $104 – there would have been no way you could have survived the short before September 19, 2018 except with a very small position.)

So my advice for superior performance is simple to write, but very difficult to execute in practice. Make sure not to embed yourself into a reality or narrative too deeply. Be willing to discard it, or shade it down in the face of contrary evidence. Question the veracity of the evidence. And finally, keep your sense of humour whenever you see retail cashiers behind a 2 inch thick bulletproof plexiglass wall, while seeing a fan blowing your potentially COVID-19 infected exhaled breath to the back counter.