Cognitive Biases – Ignore At Your Own Peril

Since I first stumbled upon it around 2 years ago, I’ve been consistently reminded (especially during these er “unique” financial times) of how important it is for every investor, nay, for anyone to be aware of the most common manifestations of human cognitive bias.

While hardly an exhaustive, academically rigorous presentation, I strongly suggest each and every one of you reads this list of cognitive biases – and even better, try to catch yourself exhibiting them.

http://en.wikipedia.org/wiki/List_of_cognitive_biases

Seriously, you don’t need a degree in Psychology to get the point.  The human brain, even the most disciplined, aware, and cognizant one is susceptible to these mental shortcuts.  The implication for investors is that once informed, we can not only catch ourselves taking these shortcuts before its too late, but more importantly, recognize when others are doing the same, and capitalize on the situation.

Yes, I just linked to Wikipedia.  If its not immediately apparent why, well, frankly, I’m not sure I can help you.

Zero – Entrepreneur in Under 2 Weeks Or Your Money Back!

I can’t get Amazon to serve the ad again, but when I was looking at Harry Markopolous’ book “No One Would Listen” I shit you not the site delivered an ad for a Certified Entrepreneur program, “in as little as 2 weeks!”

Sigh…

The first Google search result is for “The Guanzi Institute.”  Below, I’ve copied the meat of the “About the Institute” page for your reading (dis)pleasure:

Guanzi Institute for Management and Entrepreneurial Studies provides e-Learning, workshops and seminar services in business, entrepreneurship and management.  Through Guanzi Press, they provide opportunities for experts in all fields to become published authors and develop e-Learning programs
The book of Guanzi is a compilation of Chinese economic and political philosophic materials named after 7th century BC philosopher Guan Zhong, who was Prime Minister to Duke Huan of Qi 齊.  The actual authors of the Guanzi are unknown, perhaps because it is a compilation of the vast knowledge accumulated through the years by some of the wisest Chinese philosophers and scholars.  However, it is widely believed that Guan Zhong originated many of the core concepts of the philosophy before it was passed along and improved during the following ages.

Sigh…

It gets better (worse):

Thinking about going back to school for an MBA? Save yourself from taking the GMAT, $100K and 2 years of your life.  Earn a certificate in Entrepreneurship and gain all of the knowledge you need in just two weeks!

That’s right, why spend tens (hundreds) of thousands on an MBA when for the low, low price of $495 you can become a “CERTIFIED ENTREPRENEUR?!”

Clearly, the two are equivalent, no?

Frankly, while I’m inclined to practice my usual vigilance in calling this scam out for what it is, part of me sees it differently, like this sheista is doing God’s work, that is, separating fools from their money. Seriously, as far as I can tell, all $495 gets you is a 250-ish page ebook that contains the same albeit far less reputable version of the same stuff you can get in any run-of-the-mill Entrepreneurship/Business Plan book at Borders or Amazon for $20 or $30.

Sigh…

Stuff I’m Reading This Weekend: Psy-Fi, Econ Profs, A Blast From My Past, and Blog(ger) Battles

• I’ve had this tab open for a while, but I strongly recommend reading (and bookmarking) The Psy-Fi Blog – “A Sideways look at psychology and finance.”  I’ve also added Psy-Fi to our blog roll.  One of many great articles I’ve read talks about the ways in which the financial services industry obfuscates products so as to give the impression of differentiation, when, in fact, most are largely commoditized.

• I’ve also been dabbling with Columbia/Barnard Economics Professor Rajiv Sethi’s blog, definition worth a look, although I don’t always agree with some of his opinions.

• A bit of an ego boost, although a little bittersweet, FINALLY we’re starting to see some progress, well, “progress” in two areas in which your humble author formerly dabbled: Smart Grid and WiMax.  (about half a decade ago I did some corporate development and strategy work at a tech company.)  I’m a long-time supporter of both technologies – especially the former – but the beautiful thing here is that they’re complementary; adoption of one drives adoption of the other, and vice-versa.  More specifically, Utilities can use WiMax in their Smart Grid infrastructure (instead of cell or proprietary networks) to transmit data and run their transmission, distribution, and metering networks more efficiently and cost-effectively.  Wide-spread industrial and enterprise adoption of WiMax will not only increase visibility of WiMax as a viable wireless technology, but drive-down costs to the point where we may finally see adoption in the consumer market.  I’ll try to get into a more nuanced discussion in a later post if there’s enough interest, but for now, all you need to know is that just like in the Million Dollar Man: We have the technology (we just have to freakin’ use it!)

• I don’t see the Felix Salmon v. Henry Blodget debate as one between two people, but one between two ideologies (or something); Blodget seems to represent the – what I believe to be mostly antiquated and discredited – “the more eyeballs the better, end-of-story” philosophy, while Felix understands that each set of eyeballs is not created equal, that is, its not just quantity, but quality.  I’m also a major proponent of blogs as a form of media, especially those blogs/bloggers committed to best-practices; minimal synthetic click/traffic “creation”, in-line link citation to external content, etc.  So, again, as they say in “Getting to Yes,” I’m not going with who’s right, but what’s right, and, in my not-so-humble opinion, the viewpoint espoused by Felix is correct.  I read Business Insider regularly, but as a reader, I absolutely abhor some of the bullshit practices the site employs:  Misleading, sensationalist headings, slideshows purely to generate clicks, effectively copying others’ content and representing it as their own, etc.  Luckily, every now and then one of the site’s writers – some of whom are pretty damn good in and of themselves – puts up something actually worth reading, but unfortunately, I have to parse through a dozen or more nonsense “articles” just to get there.  Look: I get it, Blodget is trying to make money.  That being said, I don’t see that business model succeeding, not when it doesn’t appear to differentiate, let alone acknowledge the simple fact that certain eyeballs are worth more than others, and should be treated as such.  Felix does a much better job explaining the issues (make sure to click some of the links he mentions as they’re a big part of the story, too), so I’ll end it with this: I wish no ill-will towards Henry or anyone else at Business Insider; quite the contrary, I wish them only the best of luck and the utmost success.

Stone Chartology

After graciously accepting the invite to become a contributor to Stone Street Advisors, I couldn’t let the opportunity go to waste (plus it was a wonderful exercise in firing back up LiveWriter and dusting off the old R chart functions).

Before I begin my inaugural post, I’ll give you a little background about me. I officially started in Finance, circa 2003~2004 before hitting paydirt and landing a job at Bear Stearns in Chicago. From there, I moved on to the fancy NYC digs that JPM now owns at 383 Madison where I stayed for a year or so. I’ve been at a lot of firms in the NYC region, mostly concentrated away from the Disneyland effects of Midtown. I’ve always had a keen interest in all things Fixed Income which my mentor at the CBOT picked up on almost immediately and gave me a plethora of things to study on. That’s where I find myself today. I am part geek/part finance and even after the crisis of 2008, I still have a full head of hair. I hope that you will engage in the discussions here, feel free to challenge my assumptions. I tend to look at things in a slightly different manner, sometimes it’s the absolute wrong way to look at a situation or problem, but it is a unique way, nonetheless.

Ok, now that I suck at writing introductions, on with my inaugural post. Oh. I have one thing to mention: I tend to write short pieces that include lots of graphs most of the time. I believe that a picture sometimes is worth more than someone rambling. Nevertheless, it’s 12:36AM, so I’m going to ramble.

I, along with probably everyone stuck in our little corner of the globe, saw CNBC and the perpetual cheerleading machine on today giving a blow by blow account of the minute movements of the Dow and S&P today. Normally I tune out such banter by turning on Drum and Bass, but today, for the first time since 2008, CNBC actually piqued my interest and got me thinking. I present the following chart, which shows yield performance (on an absolute basis, not taking into account actually owning a bond and the math behind cashflows,etc.) vs. the S&P 500:

The lows for most of US bond yields with the exception of the 2Y was reached around mid-December 2008. I’m pretty sure you, Joe The Plumber and even Christina Romer know why yields were so depressed in the latter part of 2008, so I will save you from myself. Continue to look carefully, you will see that even though most of the yields began to rebound heading into the end of the year and into 2009 as people begin to shift assets around, the S&P did not bottom until nearly 3 months later (almost to the day that bonds reached their lows). Even then, once the S&P did rebound, in terms of price (yield movements) the majority of the action did not go into the S&P. Consider this:

Albeit a lagged ROC series, 10’s and 30’s in this realm continue to outpace the S&P 500 and are set to almost reverse the yield losses pre-crisis (at least the 30Y is).

This was just yet another idea that I was thinking about yesterday. Obviously one event does not have any significant meaning, so once I can whittle down my to-do list, I’ll dust off the historical yields and prices dating back to the early 80’s and 90’s and try to compare former “crises” to see what, if any effects the FI market had before/during/after the event. Fire away with your comments, and thanks to Anal_yst for the invite.

PS: A question I get asked a lot is how did I make my charts? I use R (+ a ton of packages, some self-built, others from CRAN).

Private Equity Comeback: Goodluck, and Godspeed

PE Hub just did an interview with GTCR principle Phil Canfield about all sorts of fun stuff, like this impending M&A Boom that’s coming this year.  Before I get into his remarks, let’s do a quick and dirty summary of our last PE/M&A boom (Forgive the gross over generalizations and run-on-sentence):

Lazy/unqualified investors (Pensions, endowments, CLO’s, etc) seeking yield, outsourced “diligence” to the NRSRO’s, themselves hopelessly conflicted with these same investors, enabled various corporate and sponsor M&A deals, often themselves enabled not by fundamentals (or even “fundamentals”) but by “innovative financing” the details of which were often too complex for these aforementioned investors and Ratings analysts.  As this snowballed, equity prices zoomed skyward as everyone adopted a “mee-too” mentality, further adding-to the mountains of M&A/LBO debt and associated derivatives until, *shocker* it all came crashing down.  The equity, the debt, and, oh yes, the derivatives.  Anyone remember Gordian Knot?  Perhaps the most aptly-named financing vehicle in history, but I digress (and realize that’s a much larger/slightly different issue, but couldn’t help myself, shh!)

The Reformed Broker mostly echoed my expectations a few days ago, although as you’ll see, mine are a bit more harsh, another *shocker* I know.

GTCR’s Canfield cites a few reasons why he and his cohort expect a new M&A boom (these are partial summaries and my reactions.  Read the PE Hub article for his full responses):

• Rebound in valuations: Non one wanted to sell their company at 2008 levels even though everyone wanted to buy cheap, alas, no activity.  This year, while I disagree but am not surprised to hear, acquirers and targets see more eye-to-eye on valuation.  Let me remind you, while I have no doubt there’s exceptions and good values to be had, just taking a look at the retail index and the broader incicies, really?  Check it out, that’s the past 3 years, 3/07-3/2010.  Somehow (and again, this is very 30,000′ level), were it my money at stake, I’d be VERY careful buying any company at 2007 valuations, especially consumer discretionary.

• Availability of financing and increased liquidity.  True, high-yield issuance has recovered substantially, but, and this is what I love (but not my area of expertise so  I’ll be brief), CLO markets.  Also, he mentions the increased cash on S&P 500 companies balance sheets…Does anyone see a similar pattern starting to emerge here?
• Oh, and the best part, the true reason (at least for sponsor-backed deal-making): half a trillion dollars of committed but uncalled capital, capital that’s only locked-up for another 2 or 3 years.

So, lets make sure we all understand what’s going on here: If PE firms don’t spend this $500bn in the next 2 or 3 years they have to give it back to investors.  I think, well, hope, even the most novice observer should realize by now that little, if any of that money will go un-spent.

Instead, PE firms are on the clock searching for deals, AFTER valuations have largely jumped back to pre-crash levels, with the same/similar kind of financing arrangments/structures that caused (at least fueld) the bubble.

What’s the saying about myopia again? “Those who fail to learn from history are doomed to repeat it?”

Ya, this will end in tears.

LP’s: I wish you the best of luck with your PE portfolio’s over the next 5-10 years.

UPDATE:

A sharp twitter follower points out (and I can’t believe I didn’t think of this myself, argh!), there is a solution for some LP’s: systems like GS TRuE.  I’m hardly an expert on unregistered securities trading, but seems like his suggestion could work…anyone care to comment?

Use of Phrase/Term “Toxic Assets” Banned

Period.

Any author caught using the term, sans clarification/serious explanation of the assets in question, what particular feature(s) make(s) them so “toxic” shall, whenever I’m alerted, be tarred, feathered, and – depending on the severity of the offense – drawn and quartered.

I am not fucking around, either.  Be forewarned.  I will hunt you down, I will eat your young (metaphorically speaking), and you will tell me what is so fucking toxic or may god have mercy on your ignorant, lazy, biased, lack of a soul.

Oh, and I’m back in the U.S; no bitternes what-so-ever (but seriously, any author, like this dude, Senator Jim Webb, caught using the phrase, be on high-alert.  Stone Street Advisors has the following, the implements, and most importantly, the desire to expose you as the hack you are.

Also you pandering fucking hack (Webb), while I appreciate the situation in which you find yourself (having to pander, or under the perception to do so), that article is so wraught with fucking bullshit were you my representative I would actually run against you, I shit you not, and I would, if nothing else, make you sound as economically fucking retarded as Barney Frank and Maxine Waters illicit love-child so help me god.

Cut the bullshit.  Seriously.  We, on Wall Street, exist to play this game better than you, better than anyone else.  That is our fucking job.  You want to chastise us for it?  Bring it.  You are a public “servant;” we serve our clients and shareholders.  If they have a problem with how we run our business, they take it up with us.  Oh, and remember, only 40% +/- of U.S citizens pay a dime in Federal taxes.  Oh, and those that did got paid well, for their “investment.”  Slow.your.roll.

Michael Lewis: Bipolar or Just 20+ Years Too-Late?

In Aruba still so don’t have the screenshot or transcript, but Michael Lewis is on Bloomberg here now talking about “The Big Short.”  He’s shifted back/forth more times than I can count after a week of vacay, what the hell?  Is he going senile or is it just me?

Let me know, seriously, I can’t possibly be alone in these observations, although you’re all amp’d on coffee and I’m still drinking vino, so, uh…

UPDATE:

So apparently Lewis is of the idea that ibanks are “in the wrong” when their clients (*CalPERS*, *AIG* you get the idea) request X risk profile with Y rating, yadda yadda, and lo and behold, said banks, shocker, deliver the product.  Just because, as I’ve discussed and debated (Janet Tavakoli, Yves Smith, etc), if the VOLUNTARY counter parties (“clients”) to financial transactions are contractually committed to a bilateral deal, and INEVITABLY, one parties’ assumptions turn out to be wrong, or in any way, shape, or form divergent from said parties’ expectations, that is NOT – -NO SERIOUSLY, ABSENT BLATENT ILLEGAL BEHAVIOR – – THE FAULT OF THE COUNTERPARTY.  FUCKING PERIOD.

FD: I’m neither a lawyer or whatever.  Bring the criticism.