present tense
Moontower #320
In this issue:
investing orbits
present tense
Friends,
I save my editorializing for the section at the end today. Let’s go straight to Money Angle.
Money Angle
This week, I take the 12+ year-olds into the lab during market hours to buy their first portfolios for real. You can see the course recap and guide for prepping for the lab.
What’s inside:
What we covered: businesses → compounding → picking stocks → risk → markets
Where investment returns come from
Why a long time horizon changes how you invest
What to own besides stocks, and why not bonds
The effect of valuations and fees on returns
Three starter portfolios, plus rules for picking individual stocks
A checklist for lab day
[The language in the recap is AI-talk which I hate too, but the material is certainly what I want to convey. Unlike writing this letter, I need to be efficient and not mastermind every word to actually make this stuff happen.]
For all the course materials see:
🧠The Investment Beginnings Course Page
Money Angle For Masochists
Here’s a summer reading book rec for investors:
My wife and I are both reading this. It’s laugh-out-loud funny. Gary is an excellent writer. The novel is written from the point of view of an elite school’s endowment CIO. It presents as a series of meetings with prospective managers, deals with politics within the endowment but also with the external culture of the investing world. If you are in finance, Gary’s sharp eye will delight you til no end.
I’m less than halfway through it and already I can’t recommend it enough. It was recommended to me by an allocator (thanks Tom!) and I saw in a recent Byrne Hobart letter that one of Byrne’s friends physically accosted him for not having read this book yet.
You can see Matt Levine’s endorsement in the screenshot. I wouldn't have articulated what Matt wrote, but once he said it, I noticed that’s the exact feeling I get reading it.
The CIO’s banter, verbal chess, and inner monologue reveal a fox-like savvy honed by years of battle with both the market and the managers who make convincing cases for how they’ve mastered them. It gave me a tremendous appreciation for the difficulty of the job. If you are not a professional investor and have confused the most generous market run in anyone’s living memory for your own brilliance, then considering the CIO’s constraints will update your context for the pro version.
I found this recently reinforced by Jeremy Giffon in this terrific interview on ILTB.
Patrick: You have this funny view that the whole myth of how difficult it is to beat the market, however you want to define the market, is wrong. I’m curious for you to expound on that. That seems to have become, post-Jack Bogle, one of the deeply held truths of the market is that it’s extraordinarily difficult to beat the market, so you shouldn’t even try. You should just opt out of the battle. I think you have a very different view on this.
Jeremy: Buffett and Munger were my main teachers on investing. Buffett says that he wants his estate outside of Berkshire to be put in the S&P. That’s his advice to the general public. People take that to say that Buffett’s saying you can’t beat the market. I don’t think that’s what he’s saying. I think he’s saying for the average person, you shouldn’t try and beat the market. Implicit in that statement is leaving out any sort of active investor. Maybe the anecdotal side would be Buffett saying you should put all your money into the S&P. That’s the most rational thing you should do. On the other side is the sort of empirical argument, which is, look, most professionals don’t even beat the market after fees. This is this one-two punch of — the godfather of investing says, don’t try. Seemingly the smartest people with the best incentives in the world can’t do it.
And then the other thing is, for a professional manager — and this is sort of the paradox with the Buffett thing — it is really hard to beat the market because you have all these other factors that the average person doesn’t have. And this is the Peter Lynch argument — and increasingly I think Peter Lynch was a genius about this — which is that, yeah, when you’re a professional manager, by and large, you have all these mandates, you’re running a business, you have customers that you need to keep happy. It’s more difficult for the professional money manager to beat the market than the average amateur.
This is from Mandy Xu at the CBOE this week:
The outperformance of small-caps is a sign that the equity rally – which has long been dominated by the mega-cap Tech names – is starting to broaden out. In fact, over the past month, Tech has been the worst performing sector (-10%) while YTD laggards such as Healthcare and Financials have been the best performing (+12% and +8%, respectively). The calm at the index level (SPX Index -1.7% over the past month) belies these large rotations underneath the surface. This is why single stock volatility has been so elevated, even as the VIX® Index has fallen. The spread between the two, as measured by the VIXEQSM-VIX Index spread, widened to an all-time high of 31% last week.
If the single stock volatility is high relative to the index volatility, that’s another way to say the realized correlation between the stocks is very low. The index is dampening volatility because it’s acting well-diversified. A so-called stock-pickers market.
There’s so much violence under the surface. A momentum rotor whirring to give different categories an unpredictable spotlight before abruptly re-targeting.
I’m going to think aloud here a bit.
On the one hand, the momentum rotor feels like a market technicals concept. It’s the signature of flows and liquidity reaction functions. The intent of the orders that generate these flows might have a fundamental thesis behind them. In an investing mind. The trading world is indifferent to the ultimate intent but seeks to collect a service fee by spreading the acute dollar pressure in one part of the investing crust to another part of the surface.
From this perspective, the marginal price is set by an active investor. Perhaps the cumulative orders of levered pods.
At the same time, we hear of the “passive” bid. The Trump accounts and their monogamy to the SP500 (for the moment anyway) being yet one more increment to the bid.
If passive is the marginal price setter, I’d actually expect correlations to be structurally increasing. Not only do they seem to be structurally falling, they are conspicuously dormant at today’s historical lows.
I’m not sure the best way to reconcile these arguments. Is it an artifact of observation at a short time scale (rotor flows) vs a longer time scale (a slice of S in the GDP identity is pro-rata routed to the SP500 as long as the economy grows)? It’s reminiscent of the Earth’s dual rotation, where the planet spins on its own axis while orbiting the sun. The momentum rotor is called a “day” and the steady levitation of valuation comes from the passage of the “years”.
Regardless of the reconciliation of orbits or lack thereof, I am fractured by an ongoing dissonance:
I don’t discuss any of this in the Investment Beginnings Course!
It’s easy to anticipate a commoner’s consolation. “Kris, you are right to be teaching the textbook basics; we want the kids to learn investing, not gambling.” But it does feel quaint and too convenient to not address the marginal price setter. Buffett does so in a particularly striking way based on Graham’s allegory:
He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him…
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
Mr. Market is there to serve you, not to guide you.
Yet, I have my humble reservations about Buffet’s view. It’s not that I think it’s wrong, it’s that it leaves you in a quandary about a critical aspect of decision-making. How do you weigh information when forming an opinion?! A strict reading of Buffet is that Mr. Market is emotional and irrational. But traders are taught to respect bids and offers. They are made with real money in proportion to conviction. It’s exactly why we say betting is a tax on bullshit. The essence of trading decisions is how you form priors and then Bayesian update. You can’t ignore bids and offers if you think they contain information (and you certainly would care about if the bids and offers are forced or “uneconomic”).
[The maximalist Buffet view is that “short-term”, an admittedly poorly defined descriptor, price behavior contains no information. I’m not actually opposed to this possibility under some conditions but it’s obviously not universally true. The price signals from shortages and surpluses in the physical world matter. It’s the entire basis of capitalism. Insofar as share prices are an inference on the supply and demand of the physical world, we should not ignore their deltas. But the amplification embedded in the math of capitalizing those inferences into a multiple leaves a lot of room for accepting and refuting its justifications.]
Circling back to what I teach the kids in the future or possible course edits might be to discuss macro simply in terms of Kalecki-Levy type accounting identities. They aren’t predictive but they are explanatory. Every liability is someone else’s asset. So if the G deficit spends, the private sector savings mechanically increase (I need to review the framework, to be accurate in teaching it, but you get the gist). Some of that S wll be siphoned into stocks creating structural demand to be weighed against the arrival of issuance (ie supply).
From that foundation, one can see the movement of the index of all corporate shares as one orbit, and the micro discernment of relative value underneath being the subject of traditional valuation canon, while the trading/gambling science informing the physical “equations” that govern the sector rotor.
I stuck with physics in adherence to the orbital analogy but we all know investing is biology.
But I’ll wrap with a quote from my article about why it feels like astrology (this remains the most widely read post in moontower history):
In a recent interview on Corey Hoffstein’s Flirting With Models, volatility manager Cem Karsan explains:
In the very long term, all that matters is cash flows. At some point you’re gonna have a liquidity crisis and when the liquidity is not available, companies have to create their own liquidity and that’s where fundamentals matter…they matter, to the extent that they are necessary for purchasing their own stock or buying other companies.
I’ve used this analogy before, it’s kind of hokey, but I can’t think of a better one. If you’re on an airplane, 30,000 feet off the ground, that 30,000 feet off the ground is the valuation gap. Valuations are really high, but those engines are firing. Are you worried up in that plane about the valuations or are you worried about the speed and trajectory of where you’re going, based on the engines, based on the flows? The flows are what matter for where you’re going.
But when all of a sudden those engines go off, how far off the ground you are is all that matters. And so, [valuation] is more of a risk management tool, and ultimately it really matters when you have a liquidity crisis. It also matters if rates were to go back to 8, 9, 10%. Something crazy again, where nobody can borrow money, and there is no liquidity. Cash flows are all that matters again and we have a world where fundamentals are all that matters. So I want to be clear. It’s not that fundamentals don’t matter at all, it’s that they don’t matter in a world of massive liquidity.
I’m not naive enough to envision a unifying theory of investing, but teaching the class does motivate an impulse to do better than the textbook in tying things together in a way that is not just correct-ish but useful and relevant. And respectful to preteens and teens’ intellects, for whom education is increasingly patronizing.
From My Actual Life
I turn 48 today. Once again grateful that another year of life insurance premium went to waste. It’s a reflective one, not because of me but because my eldest turns 13 tomorrow. I didn’t ask for it to be reflective, but my wife was watching old videos of him from ages 2 to 5 before bed and I got drawn in.
I never seek out the old videos. I figure one day I will when I need to make a slideshow or something. It’s a strange feeling. Because I forget what their little voices and mannerisms were like, so it feels like I’m watching a film that wasn’t actually my own life. And in that period, their constant need for you absorbed all your free time and energy. It’s a moment where all the young parents reading are in right now feels like forever. When you’re on the playground with your toddler and think how a 1st grader seems so old. Be careful ruffian, can’t you see my boy is only two and a half.
But it’s a flash. And all of it that absorbs you right now will cease to be remembered in detail. Only in shape. I can’t tell you about any one Saturday, but I can tell you about all of them together. The Tilden train every Saturday. Your day’s 2 halves. Before and after a nap. Each part starts with another coffee.
I’m not here to say enjoy it because it’s fleeting. I mean it is, but another phase will start. And it’s great. They’re all great. But if my memory of only 10 years ago is already foggy, I’ll predict that will be true for all that’s happening now when I’m 58.
I think I used to carry some anxiety about “will I remember this?”, “how will I remember this?” And you don’t really think about how the kid’ll remember this because you know they won’t. But as they get to elementary school age and older you know they’ll remember. And everyone wants to do core-memory-maxxxing for their kids. Us too. It would be nice if when they’re grown they look at their childhoods fondly. Or even better, if they think it helped them become whoever they’ve become, especially if they’re proud of that person.
Enjoy it, but not because it’s fleeting and not because you’re playing memory inception.
Enjoy it because it’s all there is.
You have no control over how matter might organize itself to bombard all that you love, all that you remember, and how you remember it. Your mind mediates reality, which itself we can only glimpse from the limited frames of our attention. The whole you-don’t-notice-your-breathing-until-I-say-pay-attention-to-your-breathing thing. The memories are sensitive to not only what you happened to notice but on the revisions that life’s future path dependence cast backwards.
The personal past (as opposed to big H History) to me is a social thing. A laughback with friends. A reminiscence you bond over. It’s not something I care to meditate alone on. Meanwhile, the future is a paradox. You want to watch your kids’ story unfold. You want to see the world with your partner and loved ones. There’s so much to look forward to. Yet you want time to slow down. You’ve got an awesome trip coming up in 6 months, but you don’t want to say “hurry up and get here” because the last thing you want to say is “hurry and let my kids/parents/pets be 6 months older”.
My 13-year-old is building a gym in the garage. It’s that time of life for him. He notices who has a 6-pack when they play shirts and skins. He wants to be stronger in the paint. I’ve been selling stuff on FB marketplace to make space for this iron temple. This week I sold a piano stool to the most energetic 82-year-old woman. She was apparently telling her karate instructor she never learned music and he offered to teach her piano. So here she is, stoked to be learning something new. You’d like to see that every day.
Knowledge and preparation demand we think of the past and the future. But you don’t want to live there.
I leave you with one of my favorite songs.
[The musical build from the delicate flanger-tinged mixolydian walkdown to the drop-d dirt of the chorus and its desperate message…straight into the vein.]
This week in The Options Trench
📺Erik and I decode the inputs to Black-Scholes-Merton
Stay groovy
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On kids: when I was very young (but old enough to remember, I was sitting next to my mother and one of her friends. Her friend asked my mother if she would like to keep her children young forever. My mother replied yes but she would not wish it upon us.
I did not understand that until I became a parent.
Thanks for the memories.
Happy bday Kris!