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Federal reserve rate cuts

3rd March 2020

  • reduce interest rates from 1.5-1.75% to 1-1.25%
  • purchase of government bonds
  • purchase of agency back mortgage securities

15th March 2020

  • reduce interest rates from 1-1.25% to 0-0.25%
  • effects are in very early stage within the US
  • First signs affected industries
    • Tourism
    • Hotel
    • Travel industry
    • otherwise not showing up in data but sentiment forecasts

Key take aways

  • mandate
    • maximum employment
    • price stability
  • Context
    • Economy propped up by US consumers
    • US unemployment is low
  • Dealing with corona issue
    • Actual impact of US economy is uncertain
    • Ultimate solution will come from health professionals
    • Broader spread of the virus is what changed hence potential risk to the economy
    • Uncertain how long the economy will take to recover
    • Health care, Fiscal and Monetary policies
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Thoughts on Fake News

A stroll through the peaceful streets of Rome. In contrast, it felt like the end of the world is here if you read news about Italy recently.

The human brain is a remarkable pattern recognition engine. When given incomplete information it will conjure up the “missing” pieces to generate a coherent whole that could be comprehended. More often than not what gets generated is the worst case imaginable scenario. In a normal time and age this is a wonderful function to have running automatically in the background to keep this primate alive.

However, this automatic function becomes problematic as three trends converge.

Trend 1 – big tech like Google and Facebook consolidated advertising revenue putting news entity under increasingly pressure to sustain themselves as their advertising revenue dwindled

Trend 2 – the proliferation of publication medium means anyone can now claim to be a news entity.

Trend 3 – Proliferation of Growth hacking techniques perfected by tech companies like Facebook that hijacks the human brain’s automatic fight or flight to generate user action that gets converted to revenue.

News entity generate revenue with hyper inflated news that drives readership and vitality by tapping into fear and anger. This drives wide spread panic. Corona  is perfect catalyst.

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Book summary: What it takes, Stephen Schwarzman

Profile

  • Partner at BlackStone

Personal effectiveness

  • the bigger the goals the more significant the consequences
  • since you can only do one important thing at a time, always pick the most important one to start with
  • most important lessons are learned at inflection points between when failure turns into success
  • the best executives are made not born, they absorb info, study their own experiences, learn from mistakes and evolve
  • The goal of education (questioning and thinking) as a discipline is to learn how to think, it only ends when you die
  • there are as many realities as individuals, study more individuals
  • find a great mentor
  • Cultivate inner fortitude: Helps preserve morality and ethics in the face of fear and greed
  • The harder the problem the more limited the competition
  • The first job is foundational. Always look for one with a steep learning curve and strong training.
  • when caught in a tight spot, don’t become fixated on your own problem but on someone else’s
  • when seeing a huge transformative opportunity don’t worry that no one else is pursuing it.
  • never get complacent
  • make decisions when you are ready not under pressure
  • objectively assess the risks of every opportunity.

On finance and trading

  • master uncertainty: finance is a dynamic world where you will need to adjust to situations, people and new information quickly
  • build a model to explain a certain phenomena and then test it
  • do not mistake interest in making money versus interest in psychological comfort
  • market tops
    • loose credit conditions and a rising tide
    • buyers generally overconfident
    • number of people you know who become “accidentally” become rich
    • number of IPOs increase at the top, so does the valuations and size
  • market bottoms
    • very hard to bring companies to IPO
    • difficult to detect
    • markets are declining and economy weakens
    • most buy too early or under-estimate the severity of recessions
    • usually takes a year or two for market to get out of recession. even then asset value takes time to recover
    • risk is the least after a crash
    • best time to enter is after position has experienced 5-10% recovery from a crash
  • practice discipline and sound risk assessment
    • wait till the cycle fully plays out
  • Cycles are powered by supply and demand characteristics
    • understand and quantify them
    • e.g. real estate top is when building is valued significantly above replacement cost
  • Sometimes a trend especially negative ones will exhibit symptoms spread across various territories (escalating land prices Spain, India and US prior to 2008)

On building a company

  • fund raising from an LP for a new fund you are starting yourself will be harder than the prior company whom the LP already has a relationship with.
  • make sure there is not sole decision maker for important decisions to avoid getting blind sided
  • Accessing an idea
    • big enough for you to devote your life
    • unique enough as an offering that people will want it
    • timing must be right
  • transition from gut to system during the middle of the life cycle to continue further scaling
  • a business is an integrated system. Understand how one part works by itself as well as in relationship with other parts. Information is the most important asset in business

On management

  • being a strong and accurate accessor of talent is the most critical skills of entrepreneurship.
  • look for cultural fit.
  • Get the candidate into conversation mode
  • its as hard to start and run a small business versus a big one. Choose one with potential to be huge. Why waste time asking for 5-10 million USD when you can ask for 50-100 million USD?
  • find people who sense problems, design solutions and takes the business in new directions
  • be proactive in addressing personal differences over day to day operations

On deal making

  • ultimately comes down to a few key critical points
  • clear away the clutter and focus on these points to be effective
  • learn to slow things down
  • practice intense listening

Related readings

  • Outliers, Malcom Gladwell
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Book summary: George Soros the unauthorized biography

Profile

  • Founder of quantum fund

Key take aways

  • There is a gap between perception and reality
    • Its the distortion that shapes events
    • Market participants operate with biases and these biases influence the course of events
    • Market prices are always going to be wrong because its offers a biased view of the future
    • biases works both ways
    • biases are self reinforcing, overreaction happens
    • boom and bust are attributed to the flux and uncertainty due to this gap
    • since the market is always wrong if you follow everyone else, you will perform poorly
  • On risk taking
    • Its alright to take risk
    • When taking risk don’t bet the ranch
    • Once you know what the market is thinking, bet on the unexpected
    • look for a sudden change in the market not yet identified by anyone else
    • develop a thesis and test it on the market
    • take a position where you have time on your side
    • learn how to survive
    • Attain superior long term returns through preservation of capital and home runs
    • Its not whether you are right or wrong but how much you make when you are right and how much you lose when you are wrong
  • On positions
    • be willing to endure the pain of following your logic when everyone else is going the other way
    • pick the best and worst performers in an industry
    • if your investment is going well, follow your instincts and go with all you’ve got
  • To avoid
    • lopsided trend following is necessary to produce a violent market crash
    • investors trying to influence prices by acquiring a large position in a currency will face disastrous results when position is sold
  • At times gut feelings will need to override logical analysis
  • gain access to world leaders for better insights

Related readings

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The alchemy of finance by Georgo Soros

  • A gap exists between perception and reality
  • The theory of reflexivity
    • herd mentality dictates that the market driven by momentum will eventually over extend itself.
    • the herd will eventually realize its over extension and revert to mean
    • however momentum will once again do its work and result in over extension in the opposite direction
  • at times you will need to be somewhat schizophrenic by keeping in mind two equally plausible but conflicting mental models and predictions while doing your trade.
  • What matters most is your gain when you are right and your losses when you are wrong
    • When you know you are right, go for the jugular
    • it is the correct but non-obvious trades that generate the most outsized returns
  • A country with poor fundamentals, high level debts and limited foreign reserves will have limited ability in propping up its foreigns reserves much as it attempts to do so
  • maintaining a wide network spread across multiple territories will help in forming a better informed mental picture on the state of things
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Corona Virus versus SARS virus

2002 SARS outbreak

  • Fatality rate of SARS virus is 9.6%
    • Total infected: 8,098
    • Total deaths: 774
  • SPY from start to lowest is a drop of 11.28%
  • SPY ended SARS period 8.5% higher than starting period

2020 Corona Virus outbreak

  • Fatality rate of Corona virus: 3%
    • Total infected: 2900
    • Total deaths: 81
  • SPY from peak to latest dip: 2.02%

Ebola outbreak

  • Fatality rate of Ebola virus: 50%
    • Total infected: 28,646
    • Total deaths: 11,323

Related references

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Federal Reserve interest rate cut decision 20191030

Outcome

Core inflation at 1.8% continues to run below target 2%.

Federal reserve decides upon another 0.25% cut in interest rates, targeting range of 1.5% to 1.75%.

Action is taken to provide meaningful support to the economy in response to global economic slowdown and the increasing disinflationary pressure felt from around the world. The special characteristics of this particular slow down is a lack of any large imbalances in the economy.

Dual mandate of the federal reserve

2% symmetrical inflation target

  • Stable prices
  • Low unemployment rates

economic indicators

  • Consumer confidence remains strong
  • Unemployment rate is at historic low
  • Business fixed investments has slowed
  • Global exports has slowed
  • Manufacturing compared to a year ago is down

macro environment risk

  • protracted US/China trade risk is down
  • No deal Brexit risk is down

economic health monitor

  • Leverage in financial system: low
  • Funding risk in banks and non-banks: low
  • Asset prices: no major bubble, high in some
  • Leverage in non-financial sector
    • households:  gone down
    • businesses + corporate debts: historic high

Liquidity concerns

  • Concerns in Overnight Repo markets persist.
  • Banks have liquidity in excess of required reserves level but choose not to participate in the markets.
  • Federal reserve will seek to inject short term liquidity into the system
    • build up short term treasury reserves
    • buying into short term treasury bills thereby boosting treasury reserves
    • opposed to the standard QE mechanism which entails buying up of assets and securities with longer maturity periods

Related readings

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Mother Nature versus City – public utilities

View of wind speeds in the area during the public utilities shutdown
The sizzling power lines
Large dips in PCG attributed to scheduled blackouts and negative ruling by judge.

 

Climate change reduces land mass under occupation.

Overview

Wind speeds across inland California has a negative correlation with public utility company share prices.

Our infrastructure is constructed above ground to avoid disruption from earthquakes when they occur. This makes them susceptible to producing sparks when strong winds blow. Combine that with increasingly dry weather conditions caused by climate change and we have the perfect recipe for power disruptions either by fire hazards or controlled shut downs. 

Utilities are natural monopolies in their region of operations giving them very inelastic demand curves. 

They also happen to be public companies which incentivized them to optimize performance for the short term thereby on a quarterly basis. This thus leaves them disincentivized to invest for the long run (aka infrastructure upgrade) without active government intervention. 

The government does actively intervene when circumstances go awry. They need these companies to continue operating least the whole population plunges back to the Stone Age. The previous instance was when the same utilities went bankrupt during the 2003 oil crisis when prices shot into the stratosphere. They ended up on the receiving end of a government bail out.

In a nutshell, the residents are basically setup to bear the brunt of this shit show. 

The last time I walked under one of those power lines on a windy day, the sound of those sizzling brought a chill down my spine

Proposed models

  • Wildfire (fire)
    • Wind speed
    • Temperature
    • Humidity levels
    • Vegetation density
  • Tornados (air)
  • Earthquakes (earth)
  • Floods (water)
  • Hurricanes (water/air)
  • Tsunami (water/earth)

Related references

 

 

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Simultaneous inflation and deflation pressures in China

China simultaneously experiences imported deflation and inflation. 

Drop in global demand for exports causes credit to unwind within the manufacturing sector. 

Swine flu and depleting foreign reserves causes price pig to increase. 

This will be a useful case study to observe the monetary and fiscal policy China implements to deal with simultaneous inflationary and deflationary pressures. 

China Factory Deflation Worsens as Pork Drives Consumer Prices  https://www.bloomberg.com/news/articles/2019-10-15/china-factory-deflation-worsens-as-pork-drives-consumer-prices

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An unchanging constant as the source of trust

Trust is the ultimate source of wealth in any society. The level of manifested physical wealth correlates positively with the level of perceived trust members of society have for an entity.

When an entity, be it a phenomena or a behavior, is observed to be consistent across time without much falter, it soon becomes accepted as the norm. Overtime this norm gets deeply embedded within a society and becomes an integral part of its culture. It thus becomes trusted and a source of credibility.

Societal commerce is built on trust. Trust accumulated through consistency overtime can be converted to other forms of tangible currency. These currencies can then be used to direct resources within the society towards the achievement of very material goals.

When comparing between two entities that are embedded within the cultural fabric of society, the one that exhibits a higher level of consistency inevitably gains more trust. This explains why while fiat currencies comes and goes, the value of gold remains consistent across time.

While it might be tempting to equate trust with value, there is a subtle difference. While trust elicits value, value need not necessarily elicit trust.

Expressing the entire civilization’s undertaking at any point in time as an linear equation, any essential variable that happens to be the most restrictive in supply at that point inevitably becomes the most valued. However wide fluctuations in value does not elicit trust in the long run.

Sources of trust

  • the rotation of seasons and our subsequent practice of agriculture
  • the constant speed of light and it’s use in Einstein’s theory of relativity
  • gold with its scarcity and it’s persist use as a store of wealth
  • well run institutions with well defined constitutions
  • fiat currencies with under sound government regimes
  • individuals who exhibit consistent behavior overtime

Qualities of viable currencies

  • Ability to be divisible
  • Ability to be moved
  • Ability as a store of wealth overtime
    • consistent levels of supply
    • scarcity

Functions of currencies

  • a means to facilitate transactions
  • a store of wealth

Examples of trust erosion

Example 1: Michigan Pulls $600 Million From Ken Fisher an individual After Lewd Remarks

https://www.bloomberg.com/news/articles/2019-10-12/michigan-pulls-600-million-from-ken-fisher-after-lewd-remarks

Example 2: 1918 Germany as an institution, towards the tail end of WWI.

When it became evident that the country will loss the war, it experienced increased inability to raise debt to in domestic currency denomination to continue financing its war efforts. It’s currency soon lost it’s reserve currency status and it was increasingly forced to denominate debt in foreign reserve currencies.

Post WWI debts denominated in domestic currency where inflated away through printing of cash by the  German government to pay of debts denominated in foreign currencies.

Example 3: Africa use of glass beads as a failed form of currency

Europe was able to cheaply produce this in abundance . Europeans for a period were able to exploit this asymmetry by exchanging cheap glass beads for valuable natural resources. When value within the African society became depleted,  Europeans were eventually able to subjugate the entire African population and exploit them through the slave trade.

Example 4: Wall Street crash and the Great Depression of the 1930s.

Bankers increasingly became concern of easy credit driving share prices to stratospheric valuations. An eventual tightening of credit lead to rapid deleveraging within the system. The lack of trust within the system prevented the circulation of money and credit. The central bank ultimately had to step in to restore trust.

It did so by first preventing the flight to value. This was achieved through the banning of conversion of USD dollar to gold.

Example 5: An ongoing slow erosion of fiat money

With the deliberate pursuit of constant 2% yearly inflation by central banks around the world current fiat money are failed stores of wealth .

The currency of the Roman Empire is a perfect example of where we will be headed. Overtime less gold per coin is used. Their currency was ultimately replaced by paper which allowed rampant printing by the government during times of war. The effects of inflation eroded the Roman empires currency as a long term store of wealth.

Examples of persistent sources of trust

  • The institution of the Catholic Church
  • The consistent adherence to a set of sound principles by Berkshire Hathaway’s reinsurance business over multiple decades. 
  • Federal reserves consistent adherence to the dual mandate of 2% inflation and low unemployment rates

Conclusion

To build trust is to build wealth. The key to doing so is to adhere and operate on a consistent set of sound principles over across time and in all environments. Being slow and steady is a pre-requisite of this process.

Related readings