Practicing Random Acts of Insanity
"Distilled information" culled from the wisdom of old, the lessons of history, and – when in doubt – the "systematic rejection of new ideas"…
This little meditation began as a speech. It was delivered on Saturday to the New Orleans investment conference. Then, it took a detour, as your editor read a book sent by a friend – "Fooled by Randomness," by Nassim Nicholas Taleb.
The book is a gem. Its author, a mathematician, coaxes out of numbers the same insights that we discover by intuition and accident.
Those of you who read the Daily Reckoning regularly will recognize our theme. A casual view of some of our articles might suggest a morbid fascination with the dead. We read the obituaries, dear reader, in the way others read the editorial pages – for information and enlightenment, for the distilled wisdom of saint and sinner alike. The editorial pages, by contrast, we read only for entertainment. The editorial pages – like the news pages – are the distracting random background noise of everyday life. It is like loud music at a bar, where you can hardly hear…and barely think. The headlines offer one urgent problem after another. An election contest…a financial calamity…a traffic accident – each headline crashes into your mind like a madman through the front door yelling, "FIRE!" How could you not pay attention?
But that is the trouble with the news. It is hard to know what is really going on…and impossible to know what is important…when you only have the judgment of people who happen to be breathing to rely upon. The living can imagine no problems more urgent than the ones they confront right here and now…and no opportunities greater than the ones right in front of them. We prefer the obituaries.
Nassim Nicholas Taleb: The Ghosts of the 1920s
Take investments, as another example. When you buy a stock today, the presumption you’re making is that you won’t be able to get a better deal on it tomorrow. You can ask investors what they think, and they’ll tell you that stocks could go down. And if we were to dig up some dead men and take a poll, you’d find that whenever stocks sell for more than 20 times earnings, the odds are pretty good that they’re going to be a lot cheaper in the future. If you asked the ghosts of investors who bought in the 1920s, they’d say they wished they had waited until the 1930s to buy stocks. Or if you asked the old folks who bought stocks in the late 60s…they’d say they wished they had waited until the late ’70s.
But if you ask people today – when stocks are once again over 20 times earnings – how many wait? Not many.
Fund managers have the lowest proportion of their funds in cash in many years. And individual investors and consumers can’t seem to wait, either. How many save their money to buy a car next year…or a stock 10 years from now? How many set real savings aside – or bury gold in their backyards – so their children and grandchildren can spend or invest it on better deals? Not many.
Last week, we read an interview with Sir Templeton. The great old man said he thought stocks were too expensive and that the U.S. was cruising for a bruising with its trade deficit and U.S. federal deficit. He said he anticipated a long bear market in stocks and a serious slump in the economy. Implicitly, he advised investors to hold cash.
The person who wrote the article then asked local analysts and stockbrokers what they thought of Templeton’s opinion. One challenged Templeton’s competence, saying that because of his advanced age, (Templeton is 92) he might be ‘out of touch’ with current thinking.
Nassim Nicholas Taleb: We Like Old Things
Templeton is not even dead yet, and already his views are being dismissed.
At the Daily Reckoning, we take the opposite view. We like old things. Old buildings. Old ideas. Old trees. Old rules. Old investors. The older the investor, the more confidence we have in him. He’s seen good times and bad times. He’s seen bulls and bears. Maybe the old fellow’s even heard enough absurdities to be able to recognize the voice.
Mr. Taleb explains it in a different way.
"For an idea to have survived so long across so many cycles is indicative of its relative fitness. Noise, at least some noise, was filtered out. Mathematically, progress means that some new information is better than past information, not that the average of new information will supplant past information, which means that it is optimal for someone, when in doubt, to systematically reject the new idea, information, or method…
"The Saturday newspaper lists dozens of new patents of such items that can revolutionize our lives. People tend to infer that because some inventions have revolutionized our lives that inventions are good to endorse and we should favor the new over the old. I take the opposite view. The opportunity cost of missing a ‘new new thing’ like the airplane and the automobile is minuscule compared to the toxicity of all the garbage one has to go through to get to these jewels (assuming these have brought some improvement to our lives, which I frequently doubt.)"
Mr. Taleb considers the wisdom of the old…and the lessons of history…as a sort of ‘distilled information.’ He notes that the information revolution has put more raw, undistilled, information in front of people…making them more susceptible to error.
"A preference for distilled thinking," he continues, "implies favoring old investors and traders, that is, investors who have been exposed to markets the longest, a matter that is counter to the Wall Street practice of preferring those that have been the most profitable and preferring the younger whenever possible…"
Nassim Nicholas Taleb: Survival of the Fittest
Testing the proposition using a mathematical model, Taleb "found a significant advantage in selecting aged traders, using, as a selection criterion, their cumulative years of experience rather than their absolute success (conditional on their having survived without blowing up)."
In investing, as in other things, it is "survival of the fittest," he explains. "Who will survive are not necessarily those who appear to be the fittest. Curiously, it will be the oldest, simply because older people have been exposed longer to the rare event and can be, convincingly, more resistant to it."
And then, he gives us all hope for the future with the insight: "Women prefer [on balance] to mate with healthy older men over healthy younger ones, everything else being equal, as the former provide some evidence of better genes. Gray hair signals an enhanced ability to survive – conditional on having reached the gray hair stage, he is likely to be more resistant to the vagaries of life."
We mentioned last week that on a recent trip back to France, we were seated next to a fellow from Heston, Kansas. We had never heard of Heston, Kansas…so asked what he did there. It turned out he was an engineer with Agco…the company that makes Massey Ferguson tractors.
What was he doing on a plane to Paris? Well, it turns out they don’t make their tractors in Heston, Kansas…they make them in Beauvais, France. American labor is cheaper. And America is supposed to be so much more hospitable to enterprises. But for some reason, Massey Ferguson makes its tractors in France. Go figure.
The subject of the war in Iraq came up.
Nassim Nicholas Taleb: Nothing but a Statistic
"I was sent to Vietnam right after my 21st birthday," he said. "They told me we were trying to protect the U.S. and make the world a better place. It took me exactly 2 weeks to realize that it was BS. If I got killed, I would be nothing more than a statistic. Nothing more."
Of course, in the "here and now" of 1970, the war in Vietnam seemed like the biggest, most urgent foreign policy challenge the U.S. faced. Later, Americans came to their senses, retreated…and Vietnam did fall to the communists. But was the world better, or worse? No one knew or cared. Eventually, a quarter century later, the Donald Rumsfeld of the era – Robert MacNamara – wrote that the war had been a mistake. But it certainly had seemed like a good idea at the time.
We mention Vietnam for another reason. Lyndon Johnson’s war in Vietnam was conducted at a time when he was also toting up the bill for the Great Society. If the old Eisenhower had been consulted before he died, he would have told Johnson that you have to choose – Guns or Butter, which will it be? Trying to do both at the same time was an invitation to trouble.
But Lyndon Johnson, a Texan, was the George Bush of his time. He figured he could get away with it. America was a great power back then, too. And the stock market boom of the late ’60s made everyone think that better things were coming not just tomorrow and the next day, but forever.
But then the war went bad…and stock market crashed…and the economy went sour, too…Johnson gave up and Richard Nixon took over at the White House. Richard Milhouse Nixon is remembered chiefly for the petty B&E job at the Watergate…but his greatest crime was committed in August of 1971. That was when the bills from Johnson’s Guns and Butter policies were coming in. And back then, other sovereign nations could take their dollar bills up to the ‘gold window’ at the U.S. Treasury and ask to have them redeemed in gold.
The French, as usual, were first in line. Years before, General de Gaulle had realized that an international monetary system with dollars as the reserve currency had a bit of a flaw.
"The Americans can pay off their debts in money of whatever value they choose," he had noticed. So Nixon had a major problem. He could do the right thing – honoring the commitment of generations of Americans…who had pledged to back their paper dollars at a fixed rate with hard gold. Or, he could renege on those solemn promises…essentially defaulting on U.S. foreign debt.
Faced with a such a moral dilemma, Nixon did the time- honored thing – the thing almost all politicians do – the thing calculated to get his derrière off the hot seat in the ‘here and now’…and make it someone else’s problem…sometime in the future. He closed the gold window at the Treasury department. Henceforth, anyone who wanted to trade his dollars in for something of value would have to take whatever the market gave them.
Well, now…the future is here. The system that replaced the Bretton Woods, gold-backed system might properly be called The Dollar Standard system. Where once there were gold bars, now there are paper dollars and paper Treasury bonds. And while once there were people lined up to trade their dollars for gold…now there are people lined up – or practically so – to buy more U.S. dollar assets.
Who are these people? Well, you will recall that once we were told not to worry about the federal debt because, as they said, "we owe it to ourselves." That little ditty may need to be updated. According to the Treasury department, a total of $41.2 billion in new money was raised in the month of August. Who were the buyers? A full 81% of them, according to the Treasury department, were foreigners, who now own a net of about $3 trillion in U.S. dollar assets, which is the equivalent of holding the mortgages on 30 million American houses, at an average of $100,000 each.
But don’t worry. The headlines tell us that the economy is growing faster than any time in the last 19 years…and productivity is reaching to the stars. That is the news that occupies our thoughts…and that most investors rely upon. The economy is so wonderful…it is almost too good to be true. Everyone is getting rich. We’d be a fool not to go along with it, the noise whispers.
We prefer the obituaries.
November 07, 2003 — Baltimore, Maryland
P.S. Thank God for all the noise.
Mr. Taleb explains: "I currently look at it [undistilled information…headline news…noise] with delight," he writes. "I am happy to see such mass-scale idiotic decision-making, prone to overreaction in their post- perusal investment orders – in other words I currently see in the fact that people read such material an insurance for my continuing in the entertaining business of option trading against the fools of randomness."
Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the Wall Street Journal best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).
The Dow rose again yesterday. Our souls squirmed.
Unemployment claims fell to their lowest point in 2 years. Cisco hit 2-year highs. Gold fell $2. Productivity rose at an 8% rate in the third quarter. And the economy is growing at its fastest pace since 1984, with real GDP rising at a 7.2% rate in the 3rd quarter and personal spending up 4.7%.
What a wonderful economy. It is almost too good to be true…even the dollar rose yesterday.
How could we be so wrong? Despite all of our warnings…our watching…waiting for the end of the world…The numbers from the last quarter clearly show we are in a boom!
How can it be, dear reader?
But wait…what’s this?
The productivity number is mostly fiction, of course…but it also turns out that nearly half the 3rd quarter’s magnificent gain can be traced to child tax credits. At least, that’s what Bridgewater Associates reports. The Treasury sent out $13.7 billion worth of child tax credits in the month of July, which produced an "orgy of spending."
Another big chunk of the increase in GDP could be traced to auto sales – which raced along, increasing at a 38.9% annual rate. Here in Baltimore, we see the evidence all around us – big, new SUVs fill every parking space.
But while auto sales move fast enough to bust the radar, personal incomes refused to start at all. The latest numbers show real compensation per hour rising at barely a 1% annual rate.
How people can increase spending 4 times faster than income is one of those mysteries we wait to have resolved. It is just one of the things that make us wonder how real this boom really is. Another thing that makes us wonder is the persistence of layoffs and the steady increase in debt. How people who are losing their jobs can continue spending so much money…buying so many cars and houses…is another puzzlement.
But what do we know?
What we do know is that the smart money doesn’t care much for this boom. For the first time in his life, Buffett is moving money to foreign currencies. Templeton warns investors to head for the hills. Soros says the whole thing is going to blow up…and so does his old sidekick Jim Rogers. What do the old-timers know? More below…
The insiders, too, are getting out while the getting’s good. They’re selling 34 shares for every one they buy. You might want to do the same, dear reader.
Here are more notes from Eric Fry…
Eric Fry, our man on the scene in New York…
– Stocks up, dollar up, bonds down, gold down…Details to follow…
– Your New York editor vacated his post on Tuesday and Wednesday to attend – and to help lead – a seminar in Baltimore about "good writing." Most of the attendees found it very useful and even the most accomplished writers among us seemed to benefit from the experience.
– After the seminar, 10 of us dined at a nearby Afghani restaurant. At the end of the meal, your Paris-based editor graciously picked up the tab…Many of us felt that his signature on the credit card draft was some of the best writing we’d ever seen.
– Yesterday afternoon found your New York editor speeding home from Baltimore on one of Amtrak’s spiffy new Acela trains. The high-speed trains rarely travel at high-speeds along the Washington-Boston corridor, but they are clean and comfortable nonetheless.
– Along the way, I chanced upon none of the sorts of colorful characters that seem to find your Paris correspondent wherever he travels – there were no gypsies or German archdukes or French prostitutes…nor even any New Jersey prostitutes. Instead, I found myself surrounded by 40-something businessmen blabbing continuously into cell phones.
– In the New Economy, the drone of inane cell phone conversations has replaced the deafening whir of big, heavy machines spitting out textiles and tractors and Tonka trucks. Our grime-free service economy continues to muscle- up, while the manufacturing economy atrophies.
– But the crowded trainful of cell-phone-yacking businesspeople attests to the resurgence of our service economy. Somebody, somewhere must be buying or selling something…or all of these folks would not be speeding toward New York and Boston with cell phones fused to their ears like space-age prosthetics.
– The stock market duly reflects the economy’s buoyancy, as well as the resulting investor optimism. The worst is passed and the best is straight ahead, or so the roaring stock market seems to imply. The overheating stock market frightens us, but we are delighted that it is doing so well. A bubbly stock market makes folks feel richer and happier, even if they aren’t, while making the economy seem stronger and more vibrant, even if it isn’t – all of which makes folks spend money they feel like they have, even if they don’t.
– Yesterday, the Dow Jones Industrial Average spent most of the day in the red, but rallied briskly in the afternoon to gain 36 points to 9,857. The Nasdaq Composite added 1% to 1,976, led by the tech sector icon, Cisco Systems. Shortly after Wednesday’s bell, the networking giant reported that its fiscal first-quarter net income nearly doubled…Cisco shares soared in after-market trading and held onto their gains during yesterday’s session. "CSCO" soared to its highest level since May 2001, and closed up more than 5%.
– A couple of upbeat economic reports also goaded investors to add to their stock holdings. The positive economic reports du jour featured a big drop in jobless claims and a big jump in third-quarter productivity. Jobless claims for the week ended Nov. 1 plunged by 43,000 to 348,000…the lowest number of weekly claims ever seen during the Bush Administration.
– Meanwhile, U.S. nonfarm business productivity surged at an 8.1% annual rate in the third quarter – the biggest increase in six quarters. We don’t understand exactly how the government can measure the productivity of cell phone talkers, but investors seemed delighted by the dubious data.
– The robust economic reports boosted stocks and the dollar, while deflating Treasury bonds and gold. As bond prices fell, the 10-year Treasury yield jumped above 4.40% for the first time in about two months. Gold also stumbled a bit, falling $2 to $380.70 an ounce. The yellow metal had climbed $5.60 in the past two sessions. But the net gain of $3.60 over the last three days has inspired very little buying of gold stocks. The XAU Index of gold shares has slipped about 1% over the last three days and sits at a two-week low.
– For the moment, most investors are enjoying the little burst of 1999 that has arrived on Wall Street…even if it is 2003.
Bill Bonner, back in Baltimore…
*** Gold fell $2 yesterday…landing at $380. That’s still $10 above our target buying price…and $30 above our previous target. Maybe we should raise our target?
*** China and Gold. Those were the two biggest stories at the New Orleans investment conference where your editor gave a short speech. Everyone seemed to want to own a piece of China and a piece of gold.
"Ivanhoe!" said a friend. "Here’s a way to kill two birds with one stone. This company has a goldfield the size of California. It’s in Mongolia. But that’s not all. It also has a huge deposit of copper. And if there’s one thing a growing economy needs – it’s copper. They use it in air conditioners, for example. Right now, most Chinese don’t have air conditioning. But in the south of the country – where more than half a billion people live – it gets awfully hot and humid in the summer. People are going to buy air conditioners like crazy as soon as they can afford them. And with the economy booming so much, they’ll be able to buy hundreds of millions of air conditioners and other things that take copper – by the way, did you know that copper is the essential metal of the whole modern world? It’s the critical component of all electric engines. We take them for granted here in America, but they’re what makes the modern world work. And China is just getting into the modern world. So they’re going to need lots and lots of copper. And Ivanhoe’s got it. So you get the China play…big time. And you get gold too – millions and millions of ounces of it."
*** "Not so fast," said another friend, a geologist. "It’s one thing to find a deposit of metal. It’s quite another to get it out and make the project profitable. This thing is in the middle of nowhere. They just don’t have the technical or logistical support to make this work. What’s more, from a mining point of view, the project is no piece of cake. It’s a huge deposit. But the deposit lies under the surface. You have to get at it somehow. And that’s going to cost of lot of money. No doubt about it, the Ivanhoe story is going to draw in a lot of investors. You can probably make money by riding the stock up. But there’s no guarantee that the mine will ever produce a penny of profit. So, if you get in…don’t forget to get out."
*** China’s economy is growing at an 8% annual rate. Even that may be understated. Its currency is increasing (M2) at more than 20% annually. It recently replaced Japan as the world’s 3rd largest importer – increasing purchases from abroad by 41% in the first 9 months of this year.
How do you say ‘bubble’ in Chinese? Oh yes, pao mo.
*** Today is Edward’s 10th birthday. A friend sends encouragement: Bill,
I read with amusement your apparent reference to your son having an incident with a BB gun.
I myself had one at the age of 14 or so in New York City. My parents were against guns in any form, so I had to promise mightily to be very careful with the thing. However, I was persuaded by a more adventurous friend to shoot out some windows in a nearby building. A local beat cop was called to the scene, and walked up to the roof to investigate.
We, however, had missed his ascent, and were standing in the hallway blasting away at a rubber ball lodged behind a pipe when the good officer made his descent down the stairs. We were caught red-handed. Officer McCarthy at first looked like he was going to haul us in. However, when he hard my Irish name, he seemed a little bit more kindly disposed. We were no longer hoodlums, just mischievous lads.
He took the BB gun and gave me a receipt, and told me if I wanted it back I’d have to bring my parents to the station. Off he went, and not knowing what to do, I hid the telltale paper in a cigar box, under a pile of miscellaneous items, on a top shelf in my private bathroom in our apartment, while I pondered a suitable story.
However, my room was a mess, and in "helping" me clean it while I was away at school one day, my mother discovered the telltale paper in that very cigar box. It was kind of like Officer Obie finding Arlo’s name on the piece of paper under the half a ton of garbage in Alice’s Restaurant.
I was in trouble…however, it was almost "illegal search and seizure," and I didn’t get in as much trouble as I might have.
I did not get the gun back.
Fortunately, I never killed anyone, and although my ex-wife might accuse me of terrible wrongs, I’ve never been convicted of a crime in a court of law. And I’ve managed to be fairly successful.
This all may or may not be reassuring. But I thought I’d share my experience.