Capitalogix

Hedge Funds: Do Not Go Gentle Into That Good Night

Hedge Funds - and active managers in general - have been under fire for several years. Almost 50% of Hedge Funds saw a decline in assets under management (AUM) in 2018.

On the surface, it makes sense ... during a long-term bull market, indexes and other passive options like ETFs become en vogue. During a bear market, active management offers more opportunities to outperform the market. 

Hedge funds are designed to, you guessed it, hedge risk. So, when investors see less risk in indexes, the demand for active management declines. Especially when performance declines as well. 

via Bloomberg

When something monumental changes the past is left behind and you begin a new future. When electricity was created, no one was going to make candles the primary form of lighting. After the introduction of the car, horses & buggies were never going to be the #1 mode of transportation, and we're also seeing that with the adoption of AI & automation. 

Most changes aren't monumental.

I have a fundamental belief that things go in and out of phase and that what's once old is often new again. You see it with fashion, music, phones - etc. First phones got bigger in order to do more, then smaller for convenience, and then larger again so that old dudes like me can read the text. 

I believe it's the same with active management - the techniques may have gone out of phase - but active management still offers the potential outperformance. The trend mirrors the stock market; bulls turn to bears when buyers run out - so as outflows from funds continue to peak, and funds continue to close, it seems reasonable that there will come a time when demand rises again. 

At that point, "active management" will give way to "Active Switching™" (which goes beyond stock picking to choose the markets, techniques, time frames, risk levels, allocation strategies, etc. using a variety of techniques, data sources, and real-time contextual clues).

This is part of what's covered in my upcoming book, "Next On Wall Street: Understanding AI's Inevitable Impact on Trading."

Looking forward to launching that book in early 2020.

Here Are Some Links For Your Weekly Reading - December 8th, 2019

For a candidate with an "age" issue, not sure if this was a smart move ...

 

 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• Don't Apologize for Having High Standards. (LinkedIn)
• Automation is Not Intelligence. (Forbes)
• How to Talk to Aliens. (Economist)
• 52 Things I Learned in 2019. (Medium)
• McLaren Unveils $1.7 Million Supercar with No Roof and a Windshield Made of Air. (CNN)

 

Trading Links:

• When to Buy into Aramco. (Wall Street Journal)
• How Spices Have Made, and Unmade, Empires. (New York Times)
• The First New US Airport since 2010 is in North Dakota's Oil Country. (TPG)
• This Widening Crack in the Mortgage Market Could Sink U.S. Home Prices. (MarketWatch)
• One Man's Quest to Challenge Wall Street With a New Silicon Valley Stock Exchange. (Telegraph)

What Do You Do When AI Beats You?

When Beethoven was at the peak of his career, several of his contemporaries struggled to deal with the realization that they may never create anything that lived up to his creations. Brahms, for example, refused to make a symphony for 21 years. Schubert is quoted as saying, "Who can ever do anything after Beethoven?"

We're apparently seeing the same effect via Artificial Intelligence. 

When it comes to popular AI, not much surpasses the popularity of AI's growing chokehold on gaming. Recently, I've shared about AI winning at video games,  but in 2016 I shared about humans losing to AI in Go for the first time. 

What it is:  A computer has just beaten the world's best Go player. AlphaGo, a program created by Google-owned AI company DeepMind, beat European Go champ Fan Hui all five times they played in tournament conditions, and also won 99.8% of Go games against other computer programs. Unlike IBM's Deep Blue, which defeated chess champ Garry Kasparov, AlphaGo wasn't programmed to play Go. Instead, as Nature reports, it learned how to play via a general-purpose algorithm that interpreted the game's patterns.

Why it's important:  AlphaGo's learning technique means it can recognize complex patterns, long-term planning and decision-making: refined skills that were once stricly human in nature. Imagine the possibilities when neural networks like AlphaGo, infinite computing and the 'Internet of Everything' converge.

via - Google AI Algorithm Masters Ancient Game Of Go - February 2016

This week, a former Go champion who was beaten by DeepMind retired after "declaring AI invincible." 

Lee Se-dol quit for a couple of reasons. According to him, even if he's the #1 human, there's an undefeatable entity above him and he felt he had failed his country by losing to the AI. It's an unfair fight - AI plays untold millions of games to learn to play better and it doesn't get tired, bored, sick, distracted.  - we can't do that.

Much like Beethoven, AI is discouraging competition. 

Was Lee wrong to quit? It's hard to say, but as AI gets better at more activities, it's an issue we're going to see more often. There's always someone (or something) better - and a purely utilitarian approach isn't necessary or productive. 

I'm an advocate of intelligently adopting AI, and a believer that the scale of AI's "wins" is going to skyrocket - but I'm also a believer in the idea that "the game isn't over until I win". If I enjoy something, I'm not going to let 2^nd place stop me. 

 

 

The passionate pursuit of a goal is valuable regardless of the result, and bettering yourself at a skill - like Go - may not be a sustainable job, but it can still make a great hobby. 

AI is coming - but it doesn't have to be joy-sucking. 

Onwards! 

 

Here Are Some Links For Your Weekly Reading - December 1st, 2019

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• How Artificial Intelligence and Machine Learning is Changing Medicine. (NewsNetwork)
• The Lines of Code that Changed Everything. (Slate)
• Why All Birds CEO Just Asked Amazon to Steal Its Idea. (Inc)
• Storytelling is a Powerful Communication Tool Here's How to Use It, from TED. (Ideas)
• 3,000-Year-Old Tablet Describing Babylonian Noah's Ark Tale Could Be 'Earliest Ever Example of Fake News,' Scholar Says. (FoxNews)

 

Trading Links:

• Eyeing Presidential Bid, Michael Bloomberg Makes Big Television-Ad Buys. (Wall Street Journal)
• This Invisible Company Powers Almost the Entire Finance Industry. (Forbes)
• Malls are Dying. the Thriving Ones are Spending Millions to Reinvent Themselves. (Washington Post)
• These Maps Show How Many People Will Lose Their Homes to Rising Seas – And It's Worse Than We Thought. (Popular Science)
• Billionaire Hedge Fund Manager Ray Dalio Says the Economy Isn't Growing Because 'The World Has Gone Mad'. (CNBC)

Leveraging Astrology: Millennials Need To Be Stopped

Millennials ruin everything. I don't really believe that ... but it feels so good to type – and the following two stories make it sound true. 

Trading is more accessible than ever before. We've gone from scrums of traders in trading pits to armchair experts investing in real estate, cryptocurrencies, options, and more from the comfort of their couch in their underwear. 

With accessibility often comes misuse. Here are a couple of examples.

Infinite Leverage Glitch on Robinhood

Robinhood, which launched in 2013,  has been a pioneer in app-based commission-free investing. While based on a solid mission of democratizing the financial system, it has also created an opportunity for "kids" to abuse the system. 

The most recent glitch allowed Robinhood Gold users to abuse the allowed 2:1 Margin. Robinhood incorrectly counted the stock price and the option value as account value, raising margin limits. Users would sell puts and take in option premiums, use that to buy more shares of that stock, and then sell puts against those shares, Ad Infinitum. So, with a couple thousand dollars of risk, a user could take millions of dollars of risk. 

The speculators at r/WallStreetBets famously used the glitch (which has been around since January) to lose massive amounts of money. 

Here's a video of a man opening his Robinhood account to record the effect of the market open on his AAPL puts. If you look at his total return you can watch it go from 0.00 to -47K in an instant. 

 

ControlTheNarrative via MetraMan09

Here's an album of a user's account with $1M in equity from $4K in cash by levering Ford shares.  If you scroll to the end you'll see him with -$368,735.19 in buying power.

If they wanted a safer investment, they could have gone to Robinhood's bug bounty program and netted a cool $25k. Oh well, who needs risk management?

 

"Mercury Is In Retrograde ... Should I Sell My Stocks?"

A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts. - Burt Malkiel, “A Random Walk Down Wall Street”

My son brought to my attention a new iPhone app - Bull and Moon; "Find stocks whose stars align with yours".

Human Mel via Twitter 

After you create your "astrological investor profile" their "proprietary financial astrology algorithm recommends an optimal portfolio of six stocks, and shows your compatibility score with thousands more." 

Bull and Moon via Zach Getson

It's fun to hear about things like the Big Mac Index  or the Super Bowl Indicator ... but this seems pretty out there.

The picks were pedestrian: Oracle, Hasbro, American International Group, Microsoft, Yum! Brands, and FedEx. 

The logic and commentary were entertaining. The choices were based on "similarities in business decisions," "shared outlooks on humanity," and "strong mutual success metrics."

My favorite excerpt is 

Zach can usually let strong FedEx Corporation lead the relationship, but at the same time, Zach will invest many times over. This relationship will be full of success, understanding on many levels, and a lot of fun. 

At least it's entertaining ... but I don't think it constitutes an edge.

 

 

And as the last note to the millennials behind these two great travesties...

 

 

Here Are Some Links For Your Weekly Reading - November 24th, 2019

Hope you are ready for the Thanksgiving holidays.

 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

 

Lighter Links:

• Gartner's Top 10 Strategic Technology Trends for 2020: the Good, the Obvious, the Renamed & the Missing. (Forbes)
• New Cardiology A.I. Knows If You'll Die Soon. Doctors Can't Explain How It Works. (DigitalTrends)
• The Science is Extremely Clear: You Need to Prioritize Sleep. (Wired)
• How to Get Die-Hard Meat Eaters to Try Impossible Burgers: Trick Them. (Wall Street Journal)
• Japan's Cheapest Hotel Will Charge You Just $1 Per Night If You Don't Care About Privacy. (OddityCentral)

 

Trading Links:

• The USPTO Wants to Know If Artificial Intelligence Can Own the Content It Creates. (TheVerge)
• 100 of the World's Most Promising Start-ups to Watch in 2019. (CNBC)
• Bezos Interested in Seahawks? Maybe. NFL Interested in Bezos? Definitely. (WashingtonPost)
• The American Dream is Alive in China. (Palladium)
• How Jim Simons Became the Most Successful Investor of All Time. (Economist)

Happy Fibonacci Day

Yesterday was Fibonacci Day - 11/23  -  because when the date is written in the mm/dd format (11/23), the digits in the date form a Fibonacci sequence: 1,1,2,3. A Fibonacci sequence is a series of numbers where a number is the sum of the two numbers before it.

 

Arthur Benjamin via TED

The Fibonacci Sequence is one of the ways that nature has a way of repeating itself fractally. You can see the sequence in nature, art, architecture, music, geometry (and in the eyes of certain traders, in the Markets). 

It fascinates me how many places these patterns occur naturally. 

Interesting stuff!

Here Are Some Links For Your Weekly Reading - November 17th, 2019

The holiday season is coming fast.

 

 

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• What's New in Gartner's Hype Cycle for AI, 2019. (Forbes)
• What Monkeys Can Teach Us About Being Human. (NPR)
• Why It's Time to Take Electrified Medicine Seriously. (Time)
• What's CRISPR Doing in Our Food? (Gastropod)
• The Problem that Google Solved with Quantum Supremacy.(DataScienceCentral)

 

Trading Links:

• Why Hedge Fund Billionaire Ray Dalio Loves Silicon Valley.(Finance)
• Tokenized Venture Capital. (DailyFintech)
• Betting on Bitcoin Prices May Soon Be Deemed Illegal Gambling. (Economist)
• Map: The Richest Person in Each U.S. State. (Money)
• Here's What Quantum Supremacy Does and Doesn't Mean for Computing. (TechReview)

November Round Table With John DeTore - Part 2

Peak Capital is running an online roundtable in November with our CIO John DeTore, John Mauldin, and Sam Stovall.  You can check with them to get the full answers from the various panelists, but I wanted to share some of John's answers ahead of time. I previously shared Part 1. This is Part 2 and will finish this piece. 

November 2019 PCM Roundtable 

Peak: Consensus suggests the U.S. economy is slowing and that trend will continue. What might cause an unexpected rise in GDP going into 2020?

John: Well, a cascading set of trade deals would now set us up for that.  It would be politically beneficial for Trump to wrap them up soon.  So that means 1) he will try really hard, and 2) other countries (and his political adversaries) will use that to their advantage. I have no idea who will win that one.  For instance, look for the house to ignore USMCA until the election.

Peak: The Fed takes its cue from the economy, so it is unusual with virtually full employment and strong wage growth they are cutting rates, and everyone expects QE4. Any non-consensus views about the Fed's policy going forward?

John: Well, they are cutting rates not because the economy is weak, but because they figured out that they overdid it in 2018 by raising the rate.  They started out too low, they raised it too much, and are now in the process of fixing it.

Peak: Earnings season started strong with better than expected earnings from banks. Are initial results going to be reflective of the broad market's earnings for the remainder of 2019?

John: Earnings are not going to be a problem for us. 

Last year, earnings benefitted from very substantial corporate tax relief and deregulation.  This will continue for several years, but the benefit is front-loaded, and the tailwind will ease off.

We fall into the trap of looking at year-over-year EPS growth to judge the strength of our public companies.  They are earning good money!  Profits are not being driven down by any undue systematic force.  Even if they don’t grow fast, they are still quite profitable.

Peak: Looking out 12 months, 1 month prior to the 2020 election, do you believe the stock market will be higher, lower, or generally flat from today's level?

John: The market assumes Trump will win and very much will want Trump to win, if only to avoid the painful experiment with the far-left policies of the current Democratic candidates. 

You would think Trump would be unbeatable given the success of the economy and a democratic candidate pool that is oddly positioned to the left of the Democratic party in general. 

But there really is Trump Derangement Syndrome (TDS) in the country today …don’t remember there ever being a President with such venomous detractors since Nixon … right before his resignation.  So, we can’t assume.  And Hillary might get into the race which will cause the market to take off if only for the entertainment value.

The answer to the question is that I am biased to the market being higher.  If it looks like Trump will probably lose the market will have a hard time with this and could be off quite a bit.

Peak: The search for yield has not gotten any easier in 2019. What concerns do you have for pension plans and retirees who require steady income?

John: A lot of concern.  Long-term rates, in fact, act as a negotiation between generations.  Retirees, who need income, lend their life assets to young families, who borrow for home formation.  As discussed earlier, long-term rates are too low.

While “too-low” rates do in general stimulate the economy, lots of awkward or even negative side effects occur:

• Pensions go deeper into unfunded territory because of the assumed discounts on future obligations.
• Low rates mean low mortgage rates. While this is initially good for borrowers, there is an equilibrium that drives up housing prices.  Most of America buys their home with a mortgage and set what they can afford based on what they can borrow.  Low rates push housing prices up.
• While retirees get hurt by low rates, it's unclear if young families will get helped in the long run. They end up with more debt for the payment they can afford.  It can lead to a housing price bubble.
• There are other disruptions of too-low rates like “zombie companies” supported by too-easy credit.

Not to sound all 50’s about it, the solution for income for retirees (that don’t pursue active management) might be to seek out strong US public companies that have significant dividend yields.  The S&P yield is now competitive with bonds.  Remember also that we have gone through a multi-decade process of accepting that stock-buybacks are often preferred by investors to dividend yields.  You don’t just get the dividend payment, you get the buybacks in the form of capital appreciation.

Those who are interested in alpha should find approaches that will work in the new environment.  The three major sources of return available to typical U.S. investors are bond yields, the stock market, and a return from active management.

As yields fall, active management must work less well to keep up.  The bar has been lowered. 

There has been a mass exodus from active management into index funds and ETFs.  So many people I talk to say they don’t want to take the risk of active management.  But a S&P index fund has more risk than most retirees should take with the core of their assets.  Active management in general needs a careful new look by investors.

Peak: Switzerland, Germany and Japan have negative yields going well out on the yield curve. Do you expect negative yields at any point in the U.S.?

John: No … but I didn’t think they would go as low as they have so far either.  

I’ve heard educated arguments that falling yields are a counter-intuitive result of too much government debt.  But this just seems wrong-headed to me.  I brought it up earlier:  the yield of bonds is set by supply and demand.  Supply is certainly up given our deficit spending, but, counter-intuitively, rates are down.   I am left with only one good answer: demand is up more than supply.

My suspicion is that the culprit is the post-2008 waves of regulation with its haircuts to allowed leverage, and complex capital ratios that favor first-world sovereign bonds.  I see no reason why so many would be willing to hold a bond at negative rates unless they really had no legal choice.  The sky is not falling, there are many great places to invest capital for positive rates.

To answer the question, sooner or later we will better understand why negative rates happen.  We should try and fix it. If we don’t, it's probably a matter of time 'til it happens here.

Peak: Correlations between stocks and bonds this year have made maintaining a diversified portfolio relatively easy. Anything on your radar that may make this more difficult in the future?

John: Bonds obviously respond to changes in interest rates.  Stocks, through the P/E ratio, also respond to interest rates in the same way.  Lower rates mean a higher P/E, all things being equal. 

In periods of rapid rate changes or big changes in inflation expectations, the two asset classes will be correlated because they are both responding primarily to rate changes.  Both will have positive returns when rates drop.

Hmm … but right now the market has refused to play this game.  While the yields on bonds are in many cases at ALL TIME LOWS,  the corresponding yields on stocks are near average.  It is as if the stock market is saying: “these really low bond rates are crazy ... this can't last for the next 5-10 years … I’m waiting this out.”  If the market ends its obstinance and plays along, IT WOULD NEED A 50x P/E multiple.  It might even be saying “The stock market is rational, but the bond market is a bubble.”

The stock market is responding to the EPS side of the equation, though.  When EPS come though unexpectedly, the market rises.  When perceived growth increases the market rises (and the bond market falls).

In addition, the market has been really (too) preoccupied with politics and the political divide in the country right now.

This adds up to a low correlation between the stock and bond markets.  It is lower than usual and will eventually go back to normal. 

Catalysts that would cause low correlation to rise: 

1. it will happen naturally if bond yields and P/E ratios normalize,
2. it will also happen if we go into a recession and the stock market re-adopts it “bad news is good news” posture and rises with every rate lowering move by the Fed.

 

Peak: If I gave you a magic wand that allowed you to change just one thing about the financial markets or investing, what would it be?

John: (I genuinely, seriously wish I had invented high-frequency trading back when it was fun and innovative.  I promise I would put my $B’s to good use.)

But seriously, I wish we would pass legislation (tax or regulation) that made it attractive to spinoff companies rather than merge them.  Many evils in our economy stem from too few firms that are too large and influential (drugs, tech, banking).  This is doable and would affect income disparity more than any of the proposals I hear from politicians.  It would add many more senior and middle managers who are talented and can drive innovation better with some independence.

via USFunds

Here Are Some Links For Your Weekly Reading - November 10th, 2019

Here's a quick reminder about Veterans Day.

Here are some of the posts that caught my eye recently. Hope you find something interesting.

Lighter Links:

• Why Futurists are (Almost) Always Wrong. (ZDNet)
• AI Rising: How Companies, Police and the Public are Already Grappling with Artificial Intelligence. (GeekWire)
• Macallan Bottle Sells for $1.9 Million, Breaks Whisky World Record Again. (Forbes)
• Suzy Batiz's Empire of Odor. (NewYorker)
• The 35 Best CEOs in the World, According to Harvard Business Review. (BusinessInsider)

 

Trading Links:

• Lilium is One Step Closer to Making Its Flying Car a Reality. (FastCompany)
• Gartner: Corporate Blockchain Won't Take off for Another Decade. (News)
• Singapore is the World's Most Competitive Economy. What Can Others Learn? (WEForum)
• The Countries with the Most Millionaires. (Statista)
• The Unicorn Bubble is Bursting. (SeekingAlpha)