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Book summary: Invest with the Feds by Robert R Johnson, Gerald Jensen and Luis Garcia Feijoo

Types of federal monetary policy environment

  • Expansive
  • Indeterminate
  • Restrictive

Expansive monetary policy

  • Small cap companies benefits by gaining easier access to credit for expansion
  • Mortgage REITs experience lower interest rate expenses and improved profit margin
  • cyclical sectors will tend to outperform during this period – tends to have high beta
    • autos
    • construction
    • manufacturing
    • technology

Restrictive monetary policy

  • Small cap companies will experience more difficulties raising capital to fund expansion as compared to blue chip companies
  • Equity REITs will outperform Mortgage REITs during this period
  • Commodities will out perform in a restrictive monetary policy environment aimed at curbing inflation – especially industrial metals

Consistent performance across all monetary policy environment

Tends to have low beta

  • energy
  • utilities
  • food
  • financing
  • consumer goods

Stages of business cycles

  • Early stages
  • Late stages

Early stage of business cycle

  • Technology and transportation will outperform

Late stage of business cycle

  • Consumer staples and energy will outperform

International strategies

  • Scandinavian countries have the least correlation against US economy
  • Scandinavian countries has the least amount of debt to GDP versus
    • US
    • other European countries
  • Scandinavia countries have a higher savings rate
REITs returns versus Stocks and Bonds across various monetary policy environments
Strategy returns across various monetary environments
Commodity returns and asset class returns in various monetary policy environments
Sector returns in various monetary policy environments
Sector beta

 

 

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Chats with Ilya on hedge funds

  • Management fees are too high to be sustainable for funds sized below 300 million
  • Funds sized above 300 million tend to have a shelf life of 10 years
  • staying motivated and dedicated to the business is hard when you already have a lot of cash
  • funds that last for a long time have founders who are absolutely focused on building up an institution that will sustain beyond the founder
  • it is much more lucrative to build and own the system than to be working in the system
  • Sharpe ratio above 1.5 is acceptable
  • SnP Sharpe ratio tends to be really low
  • important to figure out how to still generate returns in a down market
  • qualitative assessment of the business model is what drives outsized investment returns
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Evening out watching Rambo, last blood

From Sujit on trading

  • not necessary to get numbers further back than six months
  • stock market subjected to fractal distribution
  • it is possible to generate returns of up to 140% per year by trading on stocks that are moving within a range
  • going all in on each position each time leads to a very low Sharpe ratio
  • Sharpe ratio should be calculated separately for method and for SnP benchmarked against US treasury interest rates. The difference is the actual returns

On Rambo Last blood

A movie is a reflection of the culture and attitude of an age. Rambo was a very popular cultural icon during the eighties and the early nineties when memories of the Second World War and the Cold War against the communist were still very fresh in the minds of the people in America.

If you looked at the world today through the eyes of someone like Rambo, you would have been able to easily draw facts to back the narrative painted by Trump prior to being elected president.

When operating in an environment of uncertainty, a decision maker formulates multiple often competing narratives in the head that best explains majority of the facts presented. He calibrates the weightage assigned to the probability of each narrative as new pieces of data become available. He simultaneously utilizes multiple ones that are assigned high plausibility in his decision making to strive for the best possible expected outcome . It is a cognitively demanding iterative activity that goes on indefinitely.

  • common themes between movie and Trump’s narrative
    • Mexico drug cartels
    • Mexico prostitution rings
    • The world is a dark place
    • illegal border crossing
    • poor border fence
    • white male
    • Rust belt
    • Protagonist is in his 70s
    • Freedom fighter who fought the communist in Vietnam and Russia
    • guns and lots of blood
    • man of steel
    • manifest destiny
  • Cognitive biases
    • Narrative fallacy
    • Framing bias
    • selective bias

Related readings

  • Expert political judgement, Philip Tetlock
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Key insights from mooncake festival at house of Jerry and Liza

Technology trends

  • Companies are increasing shifting their service from one-off on premise licensing deployment monetization to cloud based SaaS recurring subscription models
    • revenue hit in the short run
    • increased customer LTV in the long run
    • affected publicly traded companies will experience short term discounts to their shares
  • Artificial intelligence versus Augmented intelligence
    • companies are increasingly shifting away from automatic insight generation to systems that help decision makers simulate and model potential outcomes when specific policies are executed
    • demand is shifting from insight generation to data cleaning services
  • Corporate adoption of artificial intelligence
    • CEOs are increasingly considering how to leverage AI as a tool for their trade
    • primary use case is figuring out how to increase their sales volume
    • experiencing challenge on how to apply AI on in-house data to achieve monetization goals
  • Rise of deep vertical data networks
    • EverString – provides sales lead refresh for all client companies ends up becoming a large database for decision-making executives information, approximately 6 million records
    • StreetSine.sg – cleans up real estate data to help agents better price houses for sale by utilizing in-house agency ends up becoming a large database of high quality real estate data
  • Crypto-currency
    • Bit coin is still the main poster child
    • general population still skeptical about libra
    • main argument is still to remove central bank controls
    • main adoption hurdles
      • writing throughput volume
      • a stable store of wealth
      • starting to be using as a means to facilitate transaction in China
      • Inability to increase or decrease currency supply in times of need is going to be hard as a means to provide much needed stimulation during economic recessions and inflations

US/China trade war

  • sources of conflict
    • technology theft
    • forced technology transfer
    • unfair trade practices like subsidized state owned Chinese companies operating in the export markets
  •  economy
    • China is experiencing inflationary deleveraging
      • local farmers are not growing critical food sources
      • critical food supplies are imported
      • price of imported goods are denominated in US reserve currency
      • shifting of supply chain out of China to
        • Vietnam
        • India
        • Taiwan
      • capital flight
        • Li Ka Shing moved funds out from Hong Kong in 2013 to Europe
        • raising funds for US Venture capital from China was easy prior to Chinese and US government shut down
    • US is experiencing deflationary deleveraging
      • businesses are concerned about macro environment and are reducing fixed investments
      • manufacturing is slowing due to decreased demand both locally and overseas
      • consumer spending and confidence is still strong
  • Chinese domestic concerns
    • Potential US meddling in Chinese domestic affairs – Hong Kong’s demonstration and demands
      • Revoking of National Education
      • Revoking of extradition bill
      • Resignations of HK Chief executive
      • universal suffrage: freedom to elect their own leaders
    • destabilized situation presents a challenge for Xi JinPing’s party to retain control of power over former Jian Zemin’s faction
  • value system
    • US is a highly rule based system
    • China’s system of control is highly subjective to the individual in power.  Direct government intervention in the distribution of wealth is a major source of concern

US/Mexico and world issues

  • NAFTA agreement was too one side and failed to take into account large  imbalance between the two economies
  • US’s arrangement of allowing Mexican tax payers the right to claim dependents ultimately resulted into tax claims and refunds for entire extended families in Mexico. This has the effect of subsidizing Mexican’s at the expense of Americans living along the rust belts
  • Its observed income inequality is becoming prevalent across the entire world not just within US and China.

Related readings

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Key insights from weekend with Jerry, Liza, Ada and Dan

On US/China trade war

  • 25% tariff basically wiped out whatever profit margin importing from China could bring
  • China’s labor cost have been increasing over the past few years that it is no longer a competitive advantage
  • China’s main advantage is the expertise they built up over the years. A company can easily spin up 25 manufacturing lines in China very quickly
  • US companies are all rapidly shifting their manufacturing activities out of China
  • New locations are Taiwan, India and Vietnam
  • Chinese staff that were retained by Google are now flying to new manufacturing facilities spun up in these countries to oversee the spin up process

On alternate data

  • Real estate
    • the rise  of platforms like AirBnB has lead investors to seek out alternate data that can help predict short term rental yield as opposed to long term rental yield in a neighborhood
    • government agencies are seeking such data to detect neighborhoods where they should focus their efforts to crack down illegal subletting on AirBnB
  • Sports
    • being able to predict strategy coaches of football teams will employ in real time will help support strategies
    • being able to predict starting line in close to real time and the corresponding outcomes will be valuable for coaches in making play decisions

On HongKong/China protest

  • Public opinion is the agenda for the ongoing protest is now getting really murky
  • Airport has stopped operations, it’s hard to even get in and out of the country
  • Foreign Chinese nationals are supportive of protest in HongKong
  • Topics pertaining to Taiwan, Tibet and TianAnMen massacre are sensitive topics amongst mainland Chinese
  • Funds of funds from Hong Kong are still very liquid
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Reflections of erroneous trading over the past 48 hours

Market has been pretty volatile in the post and pre market hours. Been automatically buying into the maximum possible over priced positions during the non-market hours or immediately at the start of market.

Rectified action

When buy signal is generated during the prior day in 3 month time frame

  • Company operates within my circle of competence
  • RSI was ever less than 30 during this period of dip
  • MACD has crossed over positive
  • $.VIX is below 15

To mitigate intraday noise, enter into position in the last hour of the trading day, between 1130am to 1pm period when market prices have stabilized for the day and the spreads are narrow.

To stop the practice of programming trading action into system the prior night.

Ok to skip buying into position if price has advanced above buying range. It’s much better to have erred on omission than to have erred on mis-execution.

Related references

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Book summary: The Asian Financial Crisis by Shalendra Sharma

This book describes how the 1997 Asian Financial Crisis transpired.

Impacted countries

  • South Korean
  • Indonesia
  • Thailand
  • Malaysia
  • Singapore
  • Hong Kong
  • China

Key lessons

  • Only 2 of these three conditions can be allowed to be true without causing inflationary recession
    • Fixing the currency exchange rates against other reserve currencies
    • Control over domestic interest rates
    • Control over capital inflow
  • On foreign capital flows
    • huge volume of foreign capital flows into a country
      • economic growth rate increases
      • inflation rate stays low
    • huge volume of foreign capital flows out of country
      • economic growth rate decreases
      • inflation rate goes up

Common pattern across countries

The build up

  • Long periods of high export lead GDP growth attracts high levels of foreign investments. Huge volume of foreign funds originated from Japan which was having a very loose monetary policy
  • Countries peg their exchange rates to reserve currency to ensure stable prices for both imports of raw materials and exports value added products
  • Countries currencies are not reserve currency, hence foreign loans were denominated in foreign currency
  • Excessive leverage within the country by domestic parties who take on short term loans denominated in foreign currencies at lower interest rates to finance long term projects that generate returns in domestic currencies
    • Stocks are purchased with borrowed money. These stocks are then further used as collaterals to borrow more money
    • Real estate are purchased with borrowed money. These real estates are then further used as collaterals to borrow more money
  • Moral hazard due to corruption of financial system
    • banks are arm twisted to finance projects that are not financially viable by governments and politicians

The economic headwinds

  • countries face increasing export market pressure
    • Competition at the low end of the export markets from China
    • Competition at the high end of the export markets from Japan
  • Japanese government instructs central bank to tighten monetary policy to reduce real estate. This severely restricted liquidity from Japan and reduced availability of short term foreign loans to affected countries

The crash

  • Borrowers within these countries increasingly experienced difficulties rolling over their foreign denominated short term loans to finance their long term illiquid domestic projects
  • Many of them started defaulting on their loans
  • Foreign investors started getting spooked and started withdrawing their funds or refusing to allow their loans to roll over
  • Non-performing loans builds up amongst banks within these countries
  • Capital flight continues causing downward pressure on the exchange rates of these countries
  • Countries continued defending their exchanges rates by buying up their own currency and selling off foreign reserves (assets held in foreign currencies)
  • Countries deplete their foreign reserves and are unable to uphold their exchange rates. Since most debts are denominated in foreign currencies, they are not able to print money to pay off these loans.
  • The economy grinds to a halt and hyper-inflation occurs within their financial system at this point
    • domestic production stops and locally produce foods is no longer available for sale
    • due to shortage of foreign reserves imported products become very expensive in local currency
  • Countries approach IMF for loans to tide through this liquidity crunch.
  • IMF steps in and with a lack of understanding of the economic patterns imposes these requirements:
    • Countries required to impose high domestic interest rate. It has the effect of further reducing the money supply within these countries causing more defaults domestically.
    • Countries will reform the financial systems to remove cronyism lead financing
  • Riots ensures and Anti-establishment governments get elected in some countries

The recovery

  • IMF releases the misstep in policies and relents
    • Countries lower their domestic interest rates to increase liquidity within their financial system
    • Countries allow their exchange rates to float freely
  • Relatively cheap asset prices within these countries starts attracting foreign investments again
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Afternoon with Tomasso on the limitations of Artificial intelligence’s application

For us to be able to successfully apply artificial intelligence on any domain, the following needs to be true

  • The behavior the system to be modeled must not be stochastic
  • The state of the system must be decipherable by the data scientist
    • it should be possible to understand the state in which the system is at through interpretation of data gathered
  • The domain can be modeled
    • the parameters for modeling the domain must be well defined

Only when all three premise are true can we determine where the adjustment should be made when a model fails to predict an outcome

The financial markets is stochastic  in the short run.

The underlying parameters are constantly changing and thus hard to model due to the emergent nature of impacts caused by human activities. The data is qualitative and thus hard to convert into clean quantitative datasets.

While the price movements are obvious it is hard, it is hard to attribute impact to the various parameters.

As such, it requires human neural networks that consumed all these qualitative data to perform the prediction/decision making.

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Why banks are trading at or below net book value

After the 2008 financial crisis, legislations like the Volcker Rules to inhibit big banks from behaving like hedge funds. They are no longer allowed to engage in any forms of trading or financial innovation which leads to excessive multiplying of money supply leading and excessive leveraging within the banking systems.

Their income is thus restricted to investment banking commissions and net interest incomes.

Related references

Long-Sought Volcker Rule Revisions Land on a Changed Wall Street

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Book summary: The Savings and Loan Crisis – Lessons from a regulatory failure

This book documents the series of regulatory missteps from the 1980s to the 1990s that lead 50% of savings and loans in the US to insolvency. During this period the total number of savings and loans decreased from 3,234 to 1,645.

Operating mechanism

The savings and loans are a special group of banks that are encourage to grow by the US government to enable affordable housing after the world depression.

They take in short term savings deposits at lower interest rates and lend out long term mortgages at higher interest rates. They profit through the net interest income generated between the short term interest rates and the long term interest rates. If you think you’ve become a victim to such practice, then you can always get help here in order to extricate yourself from the situation.

Events leading to massive failure

  • During the Vietnam war, inflation which drove short term interest rates increase. This cannibalized SnLs’ profit margins.
  • De-regulation of short term interest rates which lead to increased competition by other banks for deposits.  This lead to the inability to attract deposits at feasible rates to finance SnL’s long term illiquid mortgage loans.
  • The US government instead of recapitalizing these insolvent SnLs opted to de-regulate by allowing them to enter into other high yield investment instruments. This is in hopes of they will be able to rebuild the capital and thus minimize the amount of burden to be imposed on tax payers
  • Entrance of new entities
    • mutual funds competed for deposits
    • Freddie Mae and Freddie Mac competed for mortgages
  • SnLs ventured out of their areas of expertise and started buying into high yield corporate junk bonds and unsecured commercial loans.
  • With minimal equity stake in the game due to years of erosion and an implied government guarantee for a bail out in case things go south, SnLs began aggressive leveraged into these positions.
  • The US government reversed it stance and past regulation against SnLs holding high yield investment instruments. The forced liquidation of relatively illiquid positions further exacerbated the situation.

Lessons learned

  • Government meddling in market mechanism to further political agenda is generally a recipe for disaster
  • Venturing beyond circle of competence in search of high yield is generally a recipe for disaster
  • Overt or implied guarantee of government bail out is a source of moral hazard that leads to excessive leverage by operators which is definitely a recipe for disaster