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Fisher Investments Analyst’s Book Review: The Greatest Trade Ever

July 21, 2010 Leave a comment


I’m not accusing anyone of plagiarism—not at all—but…well, let’s just say, as I read Gregory Zuckerman’s The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History, I, um, realized it’s startlingly close in parts to Michael Lewis’ The Big Short. (Zuckerman’s book predates Lewis’ by about five months.)

I don’t know if they used similar sources or what (they did write a book about the same thing after all), but adjectives describing certain people and other situations seem very close. Again, I’m not accusing anybody of anything—I don’t have the time or desire to conduct such an investigation. It’s just an observation to make this point: These two books mostly function interchangeably. So read one or the other, but not both.

That said, Zuckerman’s book is a country mile better than Lewis’. (Read my review on The Big Short here.) Zuckerman’s book is about the main player, John Paulson, and does a better job describing how he profited in the bear market than other books I’ve so far read. One gets the sense Lewis would have loved to have his book be about Paulson, but couldn’t since Zuckerman beat him to the punch, so he had to focus on the smaller players instead.

Don’t confuse John Paulson with Henry Paulson, the former US Treasury secretary. John Paulson is a hedge fund manager. And, actually, isn’t all that interesting a guy. Zuckerman does his best to make the biographical bits about him seem provocative, but it’s a bore and I often skimmed those parts.

The real virtue of this book is its depiction of how Paulson became a billionaire in what some believe to be the most profitable trade in history (estimated to be $15 billion for his fund, and a personal profit of ~$4 billion). What’s fascinating isn’t just the innovation and forward-thinking required to profit by betting against real estate through this period, but also how difficult it was to do and the sheer determination needed to follow through on it.

Not only did Paulson have the whole world telling him he was crazy to bet against real estate, but most of those who also predicted the downturn in housing couldn’t figure out how to actually profit from it. Paulson was one of the very few who did that. In a nutshell, he bought insurance against the failure of CDOs in the form of credit default swaps. This was hugely risky and costly if he was wrong, and very painful for his clients as they continually saw the fund’s money used to buy more and more insurance contracts. It took awhile for the bet to blossom, and for a long time Paulson looked wrong.

From this, there are two important points for long-term investors.

First, the “biggest trades” just about always come from folks like Paulson because the best investors who think long-term never go for broke like this—they’re not even interested in betting the farm on a single, high risk/return scenario. That’s why it’s treacherous for long-term investors to regard the Paulsons of the world as ever-prescient gurus. They’re really all-or-nothing types who hit the jackpot. Let’s not forget the very many hedge funds that went bust too, and also that such things are not repeatable and Paulson has no prior or post history of being so “genius”-like. So let’s not mistake him for Warren Buffett. The best long-term managers can be wrong through periods such as these but still achieve their clients’ ultimate investing goals—a very different game than Paulson’s.

But, let’s also give Paulson a ton of credit. I still marvel at the kind of fortitude it must have taken to persevere with this trade…to be wrong for months and years, yet remain fully convicted and to keep pouring money into CDS contracts with no return. This is a tremendous feat and the stuff market legend is made of.

Second, let’s not vilify him. There’s no point. Populist politicians will always react to public anger when we see someone profit from plight. But plenty of investors benefit through upheavals and bear markets all the time. And we don’t have to love them, but we should at least respect them—there’s always someone on the other side of a trade.

In April, Paulson’s fund was mentioned in court fillings against Goldman Sachs where it’s alleged Goldman “materially misstated and omitted facts in disclosure documents for a synthetic credit default obligations (CDO)” to which Paulson’s fund was attached. As of now, Paulson’s fund specifically isn’t being sued, and it should stay that way.

Ultimately, this book is a good accounting of the frothiness of the housing market in the middle of the last decade. Like most of the crisis books I’ve reviewed in this space, it fails to sufficiently link how those problems infected equity markets and the broader economy. But, if you want to know how one of the most famous bears of the decade made his one killer trade, this is the right book.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

Fisher Investments Analyst’s Book Review: Myth of the Rational Market

July 16, 2010 Leave a comment
One of my favorite Saturday Night Live skits aired in 1994, the year of the Major League Baseball strike:

Super Sports Tours is proud to announce its 1994 Fall baseball cruise! On September 28th, it’s all aboard the Pacific Queen for a week of fun and sun with some of your favorite baseball stars. Including:

…Baltimore’s Cal Ripkin, Jr. And Chicago’s Sammy Sosa. And Mark Grace. And the Tigers’ Cecil Fielder. And the Red Sox Mo Vaughn. And also from the Yankees: Don Mattingly, and Mike Stanley, and Paul O’Neill, and Jim Leyritz and Danny Tartabull and Jim Abbott, and Randy Velarde and Gerald Williams and Matt Nokes. Annd don’t forget about the Angels’ Chili Davis, and Tim Salmon and the Padres’ Tony Gwynn. And many more!

The commercial went on and on, literally rattling off a hundred names plus—at a certain point the sheer inanity and repetitiveness became funny. Well, consider Jonathan Fox’sMyth of the Rational Market the financial equivalent of the Fall Baseball Cruise.

The book is a comically comprehensive recounting of the personas influencing efficient market theory, primarily over the last 100 years, but at times reaching all the way back to Adam Smith. Comical because, if you read the book’s title and synopsis, you’d think you were picking up a book of theory arguing against the idea of rational markets. This ain’t it. Instead, it’s a history book touching on everything from economic theory to financial innovations to behavioral finance to accounting principles to investing gurus to corporate governance…and more!

Which is a boon and a bane. Boon, because it shows how deeply the idea of efficient markets has influenced economic activity over the last century. Bane, because the book’s breadth ends up clouding the central question of market efficiency. On balance though, this was a worthwhile read.

What Is a “Rational” Market?

Among the greatest human technologies—ever—is market-based pricing. Just think of it—all possible information and opinion reflected in a single number! But we can only make that statement in a theoretical sense because in practice it’s not so clean and easy. There really is no “pure” market—distortions exist. Similarly, there is no “rational man” that always makes well-informed decisions, yet most economic theory is predicated on him.

So, pure theorists tend to dwell on the wrong issues when it comes to market efficiency. It ought to be self evident people aren’t fully rational, nor are markets fully efficient. The question for a practical person is whether markets are the best mechanism available to create pricing information and move capital to where it’s best used. It’s particularly appalling how often markets’ adaptive features are ignored in academic debate. When mistakes or “irrational” decisions are made by real people (which is constantly), it’s spellbinding how nimble and able economies, capital, and people adapt in a market environment versus, say, government bureaucracies. This is what makes Fox’s book so fascinating: it’s a tremendous panorama of the impractical debates that have dominated economic thought for decades.

Learn from the finance pros! Like Kenneth Arrow, Roger Babson, Louis Bachelier, Henri Poincare, Fischer Black, Myron Scholes, John Bogle, Warren Buffett, Alfred Cowles III, Irving Fisher, Eugene Fama, Milton Friedman, William Peter Hamilton, Friedrich Hayek, Benjamin Graham, Alan Greenspan, Ayn Rand, Michael Jensen, Daniel Kahneman, Richard Thaler! And many more!*

My own definition of market efficiency doesn’t include anything about rationality. It’s about bringing all the adaptive intelligences and perspectives—dumb and smart and all in between—together to reveal the true prices and values of things over time, better than any one mechanism, person, committee, or equation can. It’s not that anyone is perfectly informed, it’s that the balance of opinions tends to tease out the most accurate result over time.

So…markets are hugely efficient in the sense they generally reflect what’s widely believed to be true. Which means they aren’t always right, but are right more often than anything else we know of. That also means they aren’t a “random walk” of perfect rationality. Markets are as human as…humans.

In the short- or medium-term, markets can gyrate wildly and disengage from economic reality. But a simple overlay of corporate profits and stocks over time shows how closely these two things match in the long run, and how stock prices are consistently the best forward-indicator of future economic activity. But markets do need an overlay of strong property rights, oversight, transparency, limited and non-politicized institutions like the Fed, and also mechanisms to stabilize liquidity when appropriate. For two reasons. One, confidence is a key to market activity, and we need enforceable, stable rules to get that. Second, capitalism is sometimes wild and features occasional upheavals we’re not willing to put up with as a society. Pundits tend to describe this as a “shortcoming” of capitalism. It just is what it is—if we as a society decide to dampen capitalism’s “animal spirits” for social reasons, that’s a moral/social decision, not an economic one. Free market advocates (like me) tend to bristle at the creation of governmental stuff that doesn’t serve either of these two purposes (which unfortunately constitutes a lot of bureaucratic oversight), but only adds a layer of inefficiency. (I’m willing to bet, for instance, any new oversight committees created by the new financial overhaul will have a dismal record of overseeing so-called “systemic” risks.)

Economics: Not Fully Science, Not Fully Math

Another key lesson of the book: Economics isn’t even close to being a hard science, and much of finance is the same. Yet, economists have argued stridently for decades that they are. It’s simply delightful that Fox spends time arguing finance and economics owe much to philosophical scientific thinkers like Thomas Kuhn and Henri Poincare…and then uses them to display economics shortcomings based on those metrics. It both reveals economics as a social science and deepens our understanding of how “hard sciences” actually work.

For example, take the notion of “equilibrium” prices—the foundational metaphor of classical economics, borrowed from the hard sciences. Only in theory is equilibrium even a possibility for markets. There’s no sense in contemplating it in the real world. The idea gets constantly misapplied: a price is agreed upon by separate parties, it’s not a natural reverting point of settlement. Instead, markets (and prices) adapt and react in a continuum of dynamic, complex, and ever-changing circumstances. There’s never a point at which we settle upon an “equalized” state, as if markets were somehow homeostatic.

…other superstars of economic history like John Maynard Keynes, Hayne Leland, Mark Rubenstein, Robert Lucas Jr., Fredrick Macaulay, Burton Malkiel, Benoit Mandelbrot, Harry Markowitz, Jacob Marschak, Robert Merton, Myron Scholes, Merton Miller, Franco Modigliani, Wesley C. Mitchell, Oskar Morgenstern, John von Neumann, MFM Osborne, Victor Niederhoffer, Harry Roberts, Richard Roll! And many more!

Here is where Fox delivers his best insights: asserting that theoretical economic theory infected finance in the last decades—a field that once upon a time was concerned only with practicality. Essentially, finance started using the theory of pure market efficiency as a baseline for pricing assets. The result is bad accounting rules like FAS 157, which rely too much on market-generated prices where there isn’t enough liquidity or price discovery. In theory, it should work; in practice, it doesn’t.

Financial equations work great when circumstances are known and probabilities are clearly and easily assigned, like with a coin flip (only two possible outcomes and they’re both known). Anytime real uncertainty is added—that is, where the probabilities are not known but can only be guessed (which is how most of the economic world works), the math behind finance becomes grossly inadequate and even dangerous. This is why, for instance, bonds are somewhat easier to price than stocks, and the mathematics for bond pricing is more developed. Bonds have an end date, which makes the math for pricing them more reliable. Stocks have no end date, and thus there is no math in the world that can forecast a reliable price consistently. (This isn’t to say future bond prices can be gamed by math alone, there is still an element of uncertainty, just generally less than stocks.)

Theories Do Matter

Fox finishes what turns out to be a very fine book about the history of market efficiency with an important lesson: philosophy matters. It shapes how we interpret events, and how we decide to act. Theory is one of the vital ways we make sense of a chaotic world. And, even when it’s all hypothetical, theories are hugely important to how the real world ends up going. A few paragraphs ago, we were pretty hard on equilibrium. But then again, its ability as a concept to help us create economic models and heuristics has been a very useful thing.

One of the all-time free market fundamentalists, Ayn Rand, ranks as among the most lucid on the importance of theory and philosophy. Her nonfiction work, Philosophy: Who Needs It, is one of the most turgid but cogent books available on the nature of ideology, theory, and philosophy, and its role in real world decision-making. The prevailing worldview—however conceptual—shapes our decisions and opinions.

Fox’s book is exhaustive, but he has a light touch and a good feel for the material. If you find yourself soul-searching about capitalism and free markets these days (many are), this is a good place to go.

…hear the spectacular finance insights of Barr Rosenberg, Stephen Ross, Mark Rubenstein, Paul Samuelson, Leonard Jimmy Savage, William F. Sharpe, Robert Shiller, Andrei Shleifer, Herbert Simon, Joseph Stiglitz, Lawrence Summers, Amos Tversky, Edward Thorp, Jack Trainer, Meir Statman, and Holbrook Working…

…and many more!

*All these names were pulled from the book’s appendix, which is an exhaustive list of the cast of characters described in the book.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

Fisher Investments Analyst’s Book Review: Wrong

July 14, 2010 Leave a comment
Successful money managers are hugely pensive, introspective, and meditative on their mistakes (because they all make them, even the great ones, and with frequency). They stew and mull them, contemplate them, never forget them. They know their mistakes inside and out. So I’m always on the lookout for books that help identify wrongness of all kinds, searching for a better understanding about why and how it happens.

So I was excited, but ultimately disappointed, with David H. Freedman’sWrong. Or, the full title, Wrong: Why experts* keep failing us—and how to know when not to trust them *Scientists, finance wizards, doctors, relationship gurus, celebrity CEOs, … consultants, health officials and more. It’s a pyrotechnics show of all the stuff so-called experts flub on, but not much else. Disappointed, because I’ve otherwise enjoyed Freedman’s work (Brainmakers: How Scientists Are Moving Beyond Computers to Create a Rival to the Human Brain was a fun book!).

I was hoping for a thoughtful, multidisciplinary book positing a coherent view of how and why folks who are considered experts tend to be wrong in their prognostications. Instead, it’s a relentless showcase of examples where experts are wrong (which is very often), but you never really learn why at the cognitive level it actually happens. The book just keeps saying (over and over) stuff like, “This study was wrong! It turns out cell phones don’t cause cancer…or, maybe they do!” But what group of readers needed to be told fitness and financial gurus, or breathless studies about cell phones, are dubious?

In sum, the book functions more like an updated and cluttered How to Lie With Statistics. Most of it deals with how studies and findings get distorted and how wrong predictions or findings actually come to be. Freedman fills many pages with discussion not really germane to the book’s topic, saying, for instance, that Google and other internet filters/search engines aren’t good “experts” at helping us find what we’re looking for. (But who regards Google as an “expert,” and what does this have to do with “why humanexperts keep failing us”? My favorite example was a rant about how Netflix doesn’t recommend movies Freedman likes.) It’s bizarre, and one gets the feeling such topics were added simply to give the book a little heft. Why not burn a chapter or two about those few experts who do get things right? What characteristics do they share, and why, and what makes them different?

Even the “knowing when to trust them [experts]” part is trite, filled with a loose amalgam of advice that doesn’t add up to anything practical. For instance, saying to avoid advice from gurus that involves “steps,” or is overly “simple,” or is too “easy” to execute, or “confirms what people already thought,” and so on. But plenty of the best advice is heuristic-based, easily actionable, and simple. Like, the easiest way to increase savings is to make sure savings is the first thing to come out of your paycheck (most folks tend to make their savings a residual from the month’s expenses). This is a great little heuristic that came from tons of behavioral finance studies by experts in the field.

Some bright spots? The second appendix, buried at the end of the book, is a short history of wrong-headed experts—from the Pharaohs and Aristotle all the way to NASA—which was fun to read. Also, a full chapter diatribe on the biases and distortions in the academic world is worthwhile and will make you think twice before you trust a tenured professor again. The book also astutely observes that retroactive advice is always in high supply. It’s amazing how many “experts” came out of nowhere telling us how bad things were after the financial crisis hit. No sign of most of them beforehand.

Simply, and with all due respect to Freedman as a journalist, this book might have been better left to, well, experts. He seems to avoid stuff like the nitty gritty of financial markets prediction because he doesn’t fully grasp how it works. (It’s particularly telling that after so much text about the foibles of academic science, Freedman is mum on global warming—the ultimate of all expert scientific prognostications.) Also, Freedman goes into some detail about whether we can trust “the wisdom of crowds” (a la James Surowiecki’s bestseller), but he constantly misunderstands the differences between crowds and markets. Markets pit opinions against each other in a forum where prices provide information (there are always two parties in each trade who agree on a price), but groups and committees working toward a shared goal is something entirely different. He tends to use these things interchangeably, or lumps them together too often.

Perhaps the most frustrating part about the book is its shallowness. There’s little reflection, little weighing of the potential societal value of all these “wrong” opinions. Innovation, productivity gains, profitability, living standards—progress itself—is hugely dependent on a vast panoply of ideas, mixing and colliding, being tested and rejected or accepted by the public and other experts, and so on. There should always be many magnitudes more ideas than there are good ideas. Experts should often disagree and be wrong. And all that should be aired, freely, to whoever wants to listen. That’s the world we progress in, not some orderly, precise world where experts are always right and we only ever do what ends up being the sensible thing—Darwin would be horrified.

Later this summer, I’ll review Being Wrong: Adventures in the Margin of Error by Kathryn Schulz and Think Twice: Harnessing the Power of Counterintuition by Michael J. Mauboussin (one of my favorite financial authors), in search of some greater thoughtfulness on the topic of being wrong. In the meantime, you’re better served skipping this one.

*The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.

Fisher Investments Analyst’s Book Review: The Rational Optimist

July 1, 2010 Leave a comment
I was in Austin, Texas recently and met with a client who is a retired French literature professor. After a lively afternoon discussing markets, economics, and geopolitics, the conversation turned to French modernism and Albert Camus. I quipped that Camus was a master author, but his philosophical writing is better than his fiction. Her eyes lit up, she sat up, and spoke through a wide smile, “Yes! Yes. The Myth of Sisyphus. Brilliant! Excellent! Oh!”That’s a lot of enthusiasm for a book about suicide! Well, that’s not fully true. The point of Sisyphus (a longstanding work of the modernist pantheon) is to start with the apparent meaninglessness and absurdity of life, but actually conclude with hope as the only rational response. Indeed, it’s in our nature to hope—to see a way forward, even be overconfident in our ability to achieve a brighter future. And it has been! Humanity’s traversed an accelerating upward trajectory for a long time, albeit with bumps along the way.

But we tend to be hopeful about ourselves, not the world at large. We worry about the world and its future. That’s probably for many reasons but this effect’s been pronounced over the last decade, as it was in the ‘70s. Optimism is the four-letter word of our time. The perfect antidote? Matt Ridley’s new book, The Rational Optimist. This is the best investing book of the last several years—bar none. A sweeping account of human history through evolutionary and economic lenses, this book is a devastating, fact-driven, often empirical, cogent argument against today’s de facto media dourness. Ridley uses economics and evolutionary psychology to chart the upward trajectory of human civilization with astonishing acuity and insight.

Yet, this book rarely mentions investing at all. I went on Amazon recently and noticed it ranked #2 in the category of Early Civilization and Civilization & Culture books, and #1 in Technology and Futurology, but wasn’t listed in the economics or investing categories that I could see. This is status quo, to my view. The best investing books and ideas are rarely explicitly about those topics. Economics and investing are too narrow—married to their metaphors of equilibrium, market efficiency, supply and demand, bizarre calculations, and so on. Their practitioners cannot usually see these are useful—but limited—metaphors for describing the world. Mistaking these things for real observations about the world, they regard equilibrium, for instance, not as an abstract Platonic ideal, but a real thing. Thus, many spend their time seeking precision and depth in a field founded upon abstraction, as if economics were a physical science. I’ve never been a big Paul Krugman fan (the Nobel laureate and New York Times columnist), but he’s dead right when he says economic theory is best used as a “scaffolding” for positing a point of view that can eventually be stripped away to baser elements of an argument.

Additionally, intellectuals writing economics books—as a group—don’t tend to be optimists. It isn’t becoming of them to be cheery (the rare times they are, look out…a bear market’s likely afoot). If they didn’t have warnings to the populace about stuff, why listen at all? (The recent popularity of Nouriel Roubini’s persona “Dr. Doom” is case in point.) Tiresias never had good news; seers generally have foreboding tidings. Yet, to view history broadly (especially market history) warrants a good dose of optimism.

As a staunch optimist, yes, Mr. Ridley is very biased. He’s a freewheeling, no-apologies capitalist. He believes capitalism is as natural as natural selection. He thinks humans’ natural overconfidence in themselves and capitalism are intertwined and symbiotic because capitalism is all about the pursuit of individual goals and not those of the elite. And while his rhetoric is highly compelling (in the opening chapters he bludgeons us with statistic after statistic of positive things in the world), one could easily argue he’s being myopically optimistic just as pessimists will be myopically pessimistic. It’s not until the end of the book that he balances his argument and acknowledges—almost in an obligatory way—much of the world is still a heinous place with big challenges ahead of it.

But at the very least, I encourage everyone to balance today’s thrum of pessimism and get a dose of optimism with this book. The part I have trouble with is that it doesn’t give pessimism its due. Worry, fear, and the preparation and adaptation they spur in us is a very necessary thing for the progress of mankind. Personally, I want folks overreacting to bird flu, the ozone layer, potential terrorism, etc. It makes us prepare and anticipate—often negating problems before they happen or expand. It’s just not a good baseline perspective for long-term investing.

Economics as Historical Lens

One of the main shortcomings of history is its lack of economic perspective. We have books aplenty about wars and revolutions, and scads of biographies about famous leaders, but little of real quality about the economic forces that truly shaped much of history. That’s mostly because we like narratives about people, not abstract, impersonal forces. (Though, Jarred Diamond’s attempt with Guns, Germs, and Steel is an often flawed but noble attempt to highlight those faceless forces.)

In a way, this book is a recapitulation of Adam Smith—both his Wealth of Nations and the less touted but equally tremendous The Theory of Moral Sentiments—with updated scientific language. Ridley’s crucial point: Economists and pundits who preach doom tend to ignore the most salient feature of life—adaptation. Which is also a baseline ingredient of capitalism. The human race is a collective problem solving machine. As individuals and as a society, we tend to figure stuff out and move forward. Which is a big reason why Malthusian arguments about food supply and energy constraints have never held. Sages and economists through the ages agree that the only thing that’s constant is change and dynamism. It’s therefore insane to extrapolate today’s situations and potential problems into the far future—the world will adapt and change. This is where Ridley is most convincing, and a point that, admittedly, requires some faith in order to be optimistic. There’s no explicit guarantee we’ll adapt through time, but I’d bet on it.

Ridley makes some excellent economic observations about adaptation and progress through history. For instance, birth rates tend to go down with developed, highly productive nations, helping solve future population problems. He provocatively explains energy development and the Industrial Revolution’s onslaught of efficiency effectively eradicated slavery through much of the globe—making slavery unprofitable and unneeded relative to steam engines, etc. But instead of going the route, as many do, of then worrying about how we’ll fight over fossil fuels in the future, he observes that the most likely outcome is we’ll figure out even better ways to harness and access energy, and as that happens our potential for even more prosperity also increases.

Ideas, Mating

Through all this, Ridley offers an interesting critique of science and the nature of innovation. He sees science as an appendage to the intellectual community where the real innovation and invention come from the mixing of ideas and technologies in the world at large. Ridley believes in trial and error as more powerful than hypothesis and testing. He predicates this on the observation that new discoveries tend to come from the private sector and via immediate needs, not the Academy or government. (Ask any major pharmaceutical company how they create new life-saving drugs, and you’ll quickly realize just how haphazardly new discoveries are often made.)

The basis for this view of progress is technology. Ridley describes technology as a “mash up” of existing things (piggybacking off of Brian Arthur’s excellent book, The Nature of Technology). Technologies are what create productivity, and therefore wealth. This is facilitated by idea exchange and self-interest (here’s where Adam Smith pops in), and by the economic “technology” of exchange for mutual benefit and division of labor (trade)—what human communities and their mechanisms of exchange (like markets) are designed to do. Which, to Ridley’s view, is the reason cities will naturally overtake rural areas—they bring us in to closer proximity and thus facilitate more exchange. In other words, the freer and more capitalistic the society and the more we’re interconnected, the more innovation we can have. Thus prosperity and higher standards of living ensue in a positive feedback loop. This feature can and has accelerated through time.

This is a form of evolution—but out of the biological realm and into human civilization/culture (Marvin Minsky observed this with his idea of “memes” decades ago). Ideas, just as much as machines, are a form of technology and are dependent on reciprocity, exchange, and community to create wealth. Interconnection is the key. Without trade, innovation can’t happen because there’s no incentive for it.

These are not new arguments, but remain provocative because synergy doesn’t come naturally to us—we tend to be very skeptical of it even though we behave in accord with it daily. We tend to be more comfortable with the idea of life as zero sum—dividing up a finite pie instead of making a bigger one. People think of trade and capitalism as selfishness because it’s not natural think in terms of mutual benefit—most of life on earth has been about the struggle for scarce resources. This is especially true since capitalism rewards value creation as a core value versus egalitarianism. But nothing’s been more effective at wealth creation through time.

The Nature of Hope

James Hillman, perhaps the greatest living thinker in the field of depth psychology, is harshly critical of hope. He views it an illusion. He says hope creates expectation, which can only lead to disappointment. We should live without the future and stay in the present.

That isn’t possible. We humans think forward, we expect, we build, we accomplish, and we transfer those ideals to the next generation. And with those innate drives, we hope. Hope isn’t an illusion, it’s the motivator—and it is undying. The will to survive and thrive, to move forward, this is a big part of what it means to be a person. It’s inherent and irreducible and even if it subsides for awhile (as it has communally these last years, at least in economic terms) it won’t go away.

And that reason alone is why—above all the economist-speak about incentive, laissez faire, self-interest, profit; above all the hyperbolic political talk about fairness, independence, and freedom; above all the psychology clap-trap of loss aversion, biases, and behavior—beyond all those things, hope propels the world and its economies onward, especially where capitalism allows it to flourish. Today is no different.

Long-term investors simply must on some level believe in that. To stake your future on investment in any form (that is, on the future prosperity of the world), but particularly equities, you must on some level believe that the world will grow, that wealth will continue to be created, that higher standards of living will prevail. To be otherwise is against our nature. As Camus says, “The struggle itself…is enough to fill a man’s heart.”

*The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.

Fisher Investments Analyst’s Book Review: The World Is Flat

May 13, 2010 Leave a comment
It’s simply amazing to think The World Is Flat was first published in 2005, and already feels really old. These ideas just seem so self evident now. Penned by New York Times columnist Thomas Friedman, the book is in its third version. It certainly has its flaws, but ultimately is among the best tomes out there about modern globalization. In fact, the concept “the world is flat” (that is, technological advances and trade liberalization have evened the competitive global landscape) is near universal in today’s business lexicon. Yet in the five years since the book’s release, euphoria over the benefits of globalization and technology has been replaced by anxiety about competition and outsourcing. This book is a touchstone of that anxiety.Nonfiction books today often try to establish authority by saying, “This is the biggest change in the world!”, or “This book’s topic is the underlying reason for all things that are happening!” The World Is Flat is no exception. I’m not sure why folks so love the idea that this time is different. We’ve been outsourcing and reinventing our economy forever, and globalization has come and gone in waves for hundreds of years. So, rather than documenting some strange, new phenomenon, this book is an excellent analysis of a modern economic trend.

Mr. Friedman is more journalist than economist, which makes for entertaining reading, but the book is way too long. (I’ve long wondered whatever happened to editors over the last few decades—nonfiction titles are growing ever longer and more tedious.) Now the book has three editions, and Mr. Friedman has been goaded into stuffing it full of more stuff. It’s chock full of anecdotes and provocative but ultimately useless interview questions like, “What was the moment you realized the world was flat?” (Who cares?)

There’s a free market capitalist lurking in Friedman, and it’s great when he lets it run: He extols Ricardian trade (which says trade is ultimately a win/win), roots for globalization and competition, reminds us capitalism isn’t about how the economic pie is shared but about increasing the size of the pie (i.e., wealth creation), and cheers the entrepreneurial spirit.

He is right in all this, and those who fear outsourcing should visit the book’s first third. A chart of US unemployment over time shows it’s never—ever—been driven by how many jobs are going overseas, but rather by recession and expansion. The business cycle creates wealth by increasing productivity—allocating jobs and resources to the most efficient places (even if they’re in another country) actually adds to wealth creation. The US has reinvented itself—of its own volition—many times, and will do so again. Note that throughout much of the last decade (as the world was “flattening”), unemployment was quite low (under 5%). It wasn’t until a global recession that unemployment spiked. Short-term dislocation effects of unemployment are a legitimate concern, and certainly fuel populist support for protectionism. But since when has moving between industries been a bad thing for the US or global economy? Or would we still prefer to be an agrarian economy as we were 150 years ago to “save” jobs?

For all this, Friedman can’t help but often take a pessimistic tone about the US. A vast chunk of this book warns US citizens they must change to compete in the flat world. This is off track and more than a little offensive in parts. A true free marketer would never dictate what society must “learn”; instead, folks should be free to pursue their own self interest. But Friedman’s convinced the only real future job growth will be in software engineering, math, science, and such. Therefore, we need programs to create more scientists, engineers, and PhDs generally. He mixes this with an abundance of vague dictums like “we must be more versatile than ever before,” but we must also cultivate “greater depth” in our citizens.

Why is it that, suddenly, here on education, Friedman abandons his free market views for mercantilism? I don’t know. To dictate what a society must “learn” requires an omniscience and flexibility no single human can have. Which is one of countless reasons dynamic free market capitalism is so effective—it adapts without a central planner. It’s been precisely the freedom to choose that’s created such vast economic strength over time. I wish Friedman had the courage to go there. Instead, we get didactic gobbledygook about what we need to do as a society, which weakens his argument for free trade. Keep things free and fluid and opportunity should flourish. That will be, as it always has been, a stronger force for wealth creation than any command from on high.

Folks often don’t think in this way, but jobs and skills today considered ironclad may not always be. Decades ago we used to say learning certain skills or trades would provide a great career forever. But through time skills can become “commoditized”, that is, many workers become able do the work, and perhaps technology can largely replace those skills—like robotic assembly lines for cars. Today, we tend to believe trades like software engineering and the sciences will always provide job safety. Probably wrong. My guess is, as the world continues to develop, many parts of engineering and the sciences will become commoditized too. For instance, mechanical engineers are facing tremendous competition from software programs that can design products faster and better than ever before. Because of this effect, it’s imperative to allow the workforce to remain fluid rather than direct folks into this or that field of study.

The reason all this is offensive is it’s predicated on the myth the US is a nation of ignorant, indolent, lethargic, stupid folks more occupied with Britney Spears than Noam Chomsky. We’re Yankees. Yet, paradoxically, we’re also known as the most “Type A” workaholic nation ever. We take less vacation than anyone, have more stress, and more families working two jobs. We’re the biggest economy in the world and it’s in better shape than most after a nasty global recession. How can we be those things and simultaneously fat and lazy? They can’t both be right. If the education gap were truly so dire, then how can we explain that in the US grads are heading to college in record numbers?

This book attempts to be all-encompassing, and Friedman won’t stay away from politics. Our politicians must be “inspiring” and able to “explain” the situation, he says, to direct folks to get the needed skills to become competitive. We need an army of John Kennedys, according to Friedman, to lead all this new centrally planned competition. Wrong. Ronald Reagan (love him or hate him) is the best example of fostering competitiveness in a flattening world. Reagan indeed inspired the populace with his “Morning in America” concept. But instead of some bizarre and misguided centrally planned education expedition, he let Americans achieve their greatness by choosing their own paths.

Ultimately though, despite these weaknesses, Friedman delivers a book that asks us to embrace globalization, see the tremendous opportunities it can generate, and invites us to participate—a worthy message in an age of anxiety. *The content contained in this article represents only the opinions and viewpoints of theFisher Investments editorial staff.

Fisher Investments Analyst’s Book Review: I Am the Walrus (Goo goo g’ joob)

March 19, 2010 Comments off

Sean D. Carr’s The Panic of 1907 illustrates just how familiar—and also different—the events of 2008 really were. A truly mind-bending trip, man.

Book Review -- Michael Hanson

J.P. Morgan is one of the most fascinating and important characters in all financial history. Yet, every time I see him, I can think only one thing: he looks like a walrus.

It’s that big bushy mustache. (See the photo above.) And when I think of walruses, I think of the Beatles’ trippy tune, “I am the Walrus.” Legend has it the walrus in question references Lewis Carroll’s “The Walrus and the Carpenter” in Through the Looking-Glass. Lennon later said he had Allen Ginsburg in mind after a series of acid trips, but he ultimately regretted choosing the walrus at all because Carroll’s allegory is about capitalism, and the Walrus is the villain. Go figure.[i]

That strange loop of interconnection takes my mind to Sean D. Carr’s ThePanic of 1907—an account of a truly mind-blowing era in capital markets history, where Mr. Morgan, the Walrus himself, was the hero. Morgan was in essence the first Fed chair—at a time without a Fed. He was the dominant banker of the era and a legendary dealmaker, which made him thede facto financial leader folks looked to when trouble hit. He was not only the first sort-of Fed chair, but the most famous one by far until we get to Volcker and Greenspan in the early 80s. (He even mentored the first real Fed chair, Benjamin Strong, a prominent Morgan banker and one of his right-hand men in the panic.)

1907 features scintillating stories of daring do! J.P. himself can be seen hastily making his way on foot through the streets of New York—to the cheers and hisses of those who recognized him—to meetings in dark, smoky rooms where the fate of US banking hung in the balance! Even a midnight train was commandeered for the US Treasury Secretary (at the behest of Teddy Roosevelt himself!) to consult Morgan first thing in the morning and save the system![ii]

Indeed, the Panic of 1907 is high financial drama of the first caliber, which makes it all the more amazing there isn’t a whole lot written about it for the general public. That’s probably because it’s before what many consider the “modern era” of investing (somewhere in the mid- to late-20s), and thus such events feel too archaic and don’t get as much attention. The “Middle Ages” of finance if you will.

This is a shame and also mostly false. Capital markets at the turn of the twentieth century were burgeoning, dynamic, and free-wheeling. Juggernauts like the Rockefellers, Carnegies, and others are fighting the trustbusters, the industrial revolution is taking the western world by storm, and the US is getting set to emerge as a world superpower. While it is true that data is shakier and less available so far back, the basic mechanisms of banking as a social function—to allocate capital efficiently, that is, to take in deposits and lend longer term—are very much the same as today and worth our study.

Carr’s concise and accessible book— you can knock it out on a longish plane ride and all the financial bits are in laypersons terms—gives us a sense of that. He tells a good story in the first half; above and beyond what’s normally reserved for analyst/academic fodder. Then he offers economic analysis in the second, featuring a smattering of appendixes on various topics for the econo-phile in you. (There’s even a quirky little appendix in which Carr investigates the many definitions of what a “panic” actually is.)

The concluding chapters offer an analysis of common features of market panics. In this, Carr is sometimes spot on, other times less so. One highlight is Carr’s adept use of the “prisoner’s dilemma,” a common theoretical problem of game theory, to see the real world choices a banker and/or trader must face when liquidity evaporates, often creating a vicious cycle. But he is right to put himself through such paces. The real value of this book is its clear depiction of human behavior—that is, the most repeatable element in market cycles. Times change, and at an accelerating rate—tomorrow will never be the same as yesterday. Yet comparing a hundred years ago to now, we see how consistent human behavior is. Greed/fear; love/hate: Carr’s storytelling shows those things don’t change no matter how much capital markets evolve.

1907 lacked today’s sophisticated financial and economic theory, today’s hardcore mathematics, all the investing products we have at our fingertips now, the information readily available to us. But when it came right down to it, a crisis in confidence and banking woes sparked a liquidity squeeze and panic that shook the whole system. That’s more or less the story of 2008. Such eras of turbulence are often catalysts for regulatory change. 1907’s events were the impetus for creating the Fed, and called very much into question the notion of the gold standard. Again, today’s regulators vie to overhaul the financial system—a key political issue of 2010—and some are even questioning our dollar-centric exchange rate system of fiat currencies.

To some, the world is as psychedelic, chaotic, and disassociated as theMagical Mystery Tour. But if you study the lyrics enough, an undercurrent of repeating patterns and meanings emerges. 1907, like 2008, was market vertigo, but the human response was archetypal. Goo goo g’ joob.

[i] Of course, when it comes to Beatles lore, there are a thousand different tales and explanations about how and why lyrics were as they were. This is one tale. I’m sure there are many others.
[ii] These, too, are events shrouded in legend and apocrypha by now.

Fisher Investments Analyst’s Book Review: Geopolitics, Battlestars, and the Next 100 Years

March 16, 2010 Comments off

George Friedman’s The Next 100 Years is an ambitious and fascinating glimpse into the future of geopolitics.

That the imagination exists at all is one of the most interesting features of our minds. Conceptualizing and thinking about things outside our immediate perception, or that may not exist at all—to plan for the future and what could be—is not only a spectacular feat, it’s one of the most important differentiators between us and other animals. Forward thinking is the crux of the stock market—not a depiction of the now or the past, but a signaling of the future’s earnings and growth—the crowd’s best guess about what’s next.

Speculating on the future is one of the great pastimes of intellectual life. Years ago I asked science fiction author David Brin what he thought of the genre. He said [paraphrasing], “This isn’t science fiction. It’s speculative fiction. Those who are serious about this genre are endeavoring to make serious and necessary hypotheses about how the future might look.”

So maybe we can call George Friedman’s book, The Next 100 Years, speculative fiction of the most rigorous kind. Dr. Friedman is CEO of Stratfor, a leading geopolitics analysis and information source. He’s done something not many serious geopolitical forecasters would ever dare in public: Forecast how the world might look in 100 years.

Theories about predicting the future have been around forever. Most, in some form or another, use the past to predict what may come. This can be anything from qualitative trend analysis to hardcore statistical arbitrage. Economics, sociology, meteorology, physics, and countless other disciplines (of both the hard and social sciences) aim to know what comes next. In fact, the usefulness of a theory is often defined as its ability to predict.

You’d be hard pressed to find a field with more theories about the future than stock market forecasting. But let’s have no illusions here—thinking 100 years into the future has little or no value for even the longest-term equity investors. At best, market prices are a reflection of a few years from now, but nothing like 20 years, let alone 100.

Nevertheless, this is a useful and provocative book. Friedman’s view of the future includes tremendous insight about the here and now. Everything from how and why geopolitical alliances are formed, to the uses of cutting edge robotic technology, to how today’s global energy turmoil will evolve and rob the Middle East of its current power, and much more.

He’s at his best when explaining why China isn’t necessarily going to be a dominant global power decades from now (as is widely assumed today); at his most interesting and whimsical when speculating on the conquest of space as the next geopolitical frontier (the US will dominate space with “battlestar” war stations by 2060!); and at his weakest when attempting to explain how the year 2080 will look based on current circumstances and decades’ worth of assumptions he’s built up throughout the book (Mexico will vie for dominance of North America!?).

For Friedman, the specifics of the moment or the individuals in power at any given time don’t much matter. Instead, he sees huge, impersonal forces constantly shaping the geopolitical landscape. These forces tend to be cyclical, and tacitly predictable. The details might not be precise, but the outcome over the long run is certain. This isn’t such a far cry from the logic of economics—Adam Smith’s notion of the “Invisible Hand” is just such an inevitable, huge force guiding larger scale free market economies.

That Friedman can make such topics so interesting is a feat in itself. We don’t tend to like reading about the abstract and impersonal—we’d rather our sweeping biographies. Historians, for instance, have a penchant for chronicling decisive events—wars, elections, and so on—but spend comparatively little time on the larger scale, less provocative economic forces that truly shaped the course of history.

In truth, the world’s more random and chaotic than Friedman’s vision, and the true “inevitable” forces that shape things are clearest in hindsight. Friedman himself admits as much. This is a prime reason, for instance, it’s best to only try and forecast stock markets no more than 18 months into the future. Anything longer is treacherous. Think, for example, where your mind was in 2000. Did you see all that would happen these last 10 years—from 9/11, to wars, to housing booms, to recessions, and all the rest?

It’s vital for a society to think forward, and Friedman provides one of the most rational, interesting views of it in some time. But you’re probably best suited keeping your stock market predictions separate from your feelings about battlestars for now.

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