This Is the End

RICK BOOKSTABER

Markets, Risk and Human Interaction

April 9, 2018

Passive Aggressive Investing and FAANG

April 09, 2018
Matterhorn Disaster by Doré
You are in a buy-and-hold, passive investment. So, you will make market returns.

Not quite: With the markets, doing nothing doesn't mean you're not doing something. Because while you are sitting on your hands, things are happening around you, and your investment portfolio is changing. The reason is that you are in an index that is market capitalization weighted. The bigger the company, the more of it you are holding. This means you are going to hold more in industries and sectors that by nature have big companies. So more in big banks and insurance companies than in specialty retailers and restaurant chains. And, more important for the point I am focused on in this post, increasingly more in companies that are doing well, that is, companies that have rising market capitalization. And on the flip side, you are effectively selling off stocks that are not doing so well.

If Apple is worth five times as much as XYZ, then you hold five times as much in Apple as in XYZ. And if Apple moves up to be worth ten times as much, you hold ten times as much.  This is what will happen with what appears to be a buy-and-hold, passive, do nothing portfolio.

This is a big concern now because of the run-up in the FAANG (Facebook, Apple, Amazon, Netflix, Google) and related stocks. They have taken a large share of market capitalization as they have risen in value, and there is a momentum dynamic to be unleashed if they start to drop. This has happened time and again when cap weighting has led to extremes in the share of total market capitalization claimed by a popular sector. Consumer discretionary grew to 22% of the index in 1972; Oil 30% in 1980; TMT 34% in 2000; Banking 23% in 2007. In each case it finally got out of hand and dropped back to its earlier level and dropped the market as well. The odds are it will happen with FAANG.

Of course, the market cap does not rise by magic.  Each time investors find a reason for the sector to be gobbling up the market.  With TMT it was that the old methods like P/E were no longer relevant.  So I don't get much comfort in the justifications for the domination this time around of the FAANG and related stock.

This is bad, for both you and for the market generally. First off, you get more and more concentrated. Which means less and less diversified. Secondly, it is bad for the markets because you might be doing nothing, but the effect is to pile on.  If someone comes into the market, they are really stocking up on Apple, so, guess what. Apple really goes up.

What is particularly problematic is that when you are in cap weighted passive, you have a factor bet without realizing it. Because you are following a cap-weighted index, because you are measuring yourself against that index, the factor bet looks like "no harm done." It looks like you are simply moving with the market, the end objective of a passive position.

An alternative that has taken hold is to hold stocks based on some other factor than market cap. The problem is that any rule that is based on some factor is going to have the problem that you are still making a bet. What you want to hold is a portfolio where you can pick any factor -- P/E, capitalization, momentum, any "smart beta" factor of your choosing -- and fail to find any relationship between that and your portfolio return.

April 1, 2018

Facebook and the Awakening of Our Private Selves

April 01, 2018
I wrote about Facebook in a blog in January, pointing to ominous clouds on the horizon. (And, one looking at the future of Facebook and the world in 2011.)

For an update. Those clouds now are overhead. With the ever-growing realization that Facebook has been a channel for manipulating our life-as-we-know-it (literally so), there is the drumbeat of #deletefacebook (which I joined last week). And with this are articles showing how difficult it actually can be, which bring to the fore just how deeply Facebook has plunged itself into our being.

There are how-to guides to find alternative to Facebook. There is the recounting of the times Zuckerberg has skirted over the line on privacy, each followed by the ritualistic apology. And there is Colbert's acerbic humor on "Suckerberg", which includes screen shots showing the mind-blowing amount of information Facebook holds on various staff members of his show -- including call's made from one staffer's cellphone, the family tree of another,  and the data for the face-recognition of a third.

Many people will leave Facebook and use alternatives. Some will discover they can leave without using social network alternatives at all. People who stay with Facebook will opt out of everything they can think of, especially related to sharing their personal information with advertisers and apps. (As part of the mea culpa this time around, Facebook is centralizing the privacy settings so you don't have to navigate through twenty different places to do the job.) People will log into apps using their email addresses rather than Facebook, thwarting the insidious tunneling by Facebook beyond its own borders.

Whether people leave or decide to stay with tighter privacy controls, the targeted advertising and third-party sharing that is the life blood of Facebook will be eroded.

Beyond these short-term, but possibly devastating reactions that are focused on Facebook, it is becoming all the more likely that we are at the beginning of a broad sea change in how we view social networking and in our willingness to give up privacy for a song. Jaron Lanier pointed out the faustian bargain we have made with Facebook, Google (which at least gives us something of value in the search engine) and the like, and proposed a path for us to be enfranchised for the personal data we toss into the world.

There is an alternative to the business model of mining personal data, which is having Facebook and others move to a subscription model. But this will not sustain the valuations Facebook currently enjoys. People are not likely to pay out of pocket anywhere near the value that is implied by giving the world all of their personal data. Which suggests just how much we all are giving away.

February 11, 2018

Amazon Dystopia

February 11, 2018
The following is a brief, contemporary account of our world, which we call, for obvious reasons, the Amazon Dystopia. I leave it undated -- Nadir.


The dystopia is most evident in the control of the working class. During work and commuting time all workers are mandated to wear a “health watch”, a wristband that monitors their movement. The wristbands also tell the time and weather. Workers also wear “world view” collars and glasses equipped with biometrics and a 360 degree video display to determine the level of their exertion, and where they are fixing their gaze. The collars can generate electric impulses to encourage workers. If they fail to perform, there is summary dismissal. The government has recently added a worker-terminating explosive charge if workers are found engaging in treasonous behavior – which includes “robust criticism or a marked lack of enthusiasm.”

Cocking and the Rise of the Plutocrats

The elections are determined by majority vote, but the people’s choice becomes the tool of the wealthy once ascending to office. This transformation is known as “cocking”. This is an unfortunate play on the Koch name, but one that is not classified as robust criticism.

Cocking was first revealed in the Washington Post, which reported that the Koch brothers, a center of corporate political power, presented various incumbents with a check made out to their opponent for $25 million, with the threat that the check would be handed over to the opposition if the incumbent did not act in what the Koch brothers considered to be the best interests of the country. The threat only had to be made good one time, and the story planted for the Washington Post team to uncover, (with a Pulitzer for their efforts), before compliance to the threat became absolute.

The Consolidation of Power: From the One Percent to the One
The cocking grew, and political power became increasingly consolidated with those with the deepest pockets, until it finally has become a plutocracy of one. And having power over the press has helped to correctly frame the new order for the masses. At least the small subset of the masses that is not placated by free, unlimited streaming of videos and music.

From Each According to His Need

A value-added tax is now a primary source of revenue. Essentials such as food, clothing, and school supplies pass through a taxation station, the “fulfillment center”. Its operation is based on extensive records of every citizen, both their biometrics, gazing patterns, queries, social interactions, and of course consumption history, to infer their preferences, to the end of taxing them more highly on their purchases based on the algorithmic determination of how much they need them. This principle is promoted with the slogan, “from each according to his need.” All purchases are made with the certification of the buyer that they will not resell or redistribute, with the delivery chain iron clad from the fulfillment center to the consumer's doorstep to reduce the risk of missteps.

Luxury goods by definition are not needed, and therefore generally are exempt from taxation.

To Each According to His Abilities

The tax is paid to the agency that is responsible for the building and maintaining of this distribution system. This payment is tax exempt, because it already is a tax. The agency is in private hands because the government has determined to leave to business those things that it can do best, as measured by the profit they can extract. Thus the slogan, “to each according to his abilities.” As has been noted in various recent Washington Post articles, this is the most sure way of adding to the economy, and thus to the wealth of all individuals.

The Revolt of the Masses

Note by the conveyor of this account: As with any dystopia there is a plucky, fearless group that is fighting back. Led by Kadir and his former-rival-but-now-lover Sabella, a beautiful woman who is good with knives, this group is bringing in others to fight against the tyranny of the plutocracy.

Note by the second conveyor of this account: They are discovered and killed. The end.

February 6, 2018

Not Wages. Not Inflation. Volatility. ETFs.

February 06, 2018
The recent tumble in the market is being attributed to the wage report, a rise in interest rates, and concern about inflation. A reassessment of economic conditions does not lead to such a violent reaction. It might give a push, but then gravity does the rest. For the markets, gravity is the technicals -- how leveraged or overextended investors are, how concentrated, and how much liquidity there is in the face of a flood of selling.

This is just a quick recap of a couple of posts I have done over the past months that relate to technicals behind the current market downturn. In early November I wrote a post about how the low volatility regime we have enjoyed (if that is the right term) could blow up. We have seen the first leg of that with the decimation of the inverse volatility ETFs and ETNs. They have actually printed negative prices. What was worth $2 billion a day ago was worth $20 million in after-hours trading, and depending on how they terminate, could become zero.

The VIX went from the lowest level in history to near the highest. The next shoe that might drop will be the actual market volatility. If actual volatility rises, there will be a rash of funds that target a specified volatility that will have to sell positions -- mostly equities. If a fund is targeting, say, 12% volatility and market volatility goes from 12% to 24%, the fund will need to go from fully invested to 50% invested.

Looking at an extreme tail risk, the total failure of the inverse volatility ETF might cause ripples across ETFs more broadly. Some investors, I would think mostly retail investors, might simply hear that an ETF went to zero in one day, and think that is a concern for other ETFs. If they start to liquidate on that basis, it could lead to widespread contagion. I posit this in a post from October, though with high yield ETFs as the spark.

The cascade due to volatility and the contagion from ETFs might occur, or might not. If they do, it will be a slower process than what we have observed over the past few days. And things do not follow a straight line. There will be "bargain hunting" along the way. But depending on how that plays out, it might be piling more investors onto the thinning ice.

January 28, 2018

This is the Way Facebook Ends (And Maybe Apple and Google)

January 28, 2018
Investors tend to focus on the most likely outcome. As a risk manager, I spend time focusing on the unlikely, on the bad things that might possibly happen. Where T.S. Eliot writes, "This is the way the world ends, Not with a bang but a whimper" I would write, "This is one possible way the world might end...."

So, with that as the starting point, how might the world end for Facebook? And, by extension, for Apple and Google, because Google faces similar, but not so dire, business risk, and because much of Apple's raison d'être is to provide the hardware for Facebook and related applications.

Regulatory Backlash

As a start, there is a crescendo of regulatory backlash to the power that Facebook and Google wield. It is most manifest in recent action in Europe, and has been given some headline coverage from a speech a few days ago by George Soros at the World Economic Forum. If you want a sense of where he is coming from, the Washington Post headlined it as "Facebook and Google are doomed, George Soros says."

The current controversy on net neutrality applies to Google and Facebook. One concern is that without net neutrality there will be a stifling of the small start-ups, and increased power for the larger players. Point the rifle three clicks to the left from the net neutrality debate, and you have them in the line of fire.

A Self-destructive Business Model

Facebook and Google have a business model that is at war with itself. On the one hand they link like-minded people together, so they can share their views, interests, and product suggestions. On the other hand, they depend on advertisers for their revenue. But if their business model is perfected in the first case, there is no need for the second. People will know what they want without the advertisers that are outside their social circle chiming in.

Social Norms

Obviously a social network like Facebook or Instagram only works if people want to share on the social network. And the bulk of those who do so are acutely sensitive to the cool thing to do. If it becomes uncool, that is the end of that. Put another way, the fever pitch of social media is of the same flavor as any fad. It has no purpose other than being the thing of the moment. For social media, that moment might last another two years or another ten. But at some point there is the risk people will find it so last year, or so "what my parents used to do."

As a measure of it being a fad, what other $500 billion company could disappear from the face of the earth tomorrow and have no real impact -- except on advertisers?

And there are signs of change. When Cook states that he wouldn't want his nephew on social media, that is not a good sign. Closer to home, a month ago my fourteen year old daughter decided to get off of social media.

A recent meme is social media as cigarettes. Think of cigarettes in the Mad Men era. People were addicted, but also it was part of being social, and it was the way you kept yourself busy. If you weren't holding a cigarette, what were you going to do with your hands? Social media is addictive, social, and keeps you feeling like you are doing something with your hands.

How Does Apple Fit into the Mix?

The iPhone is the hardware that runs the fad. Take away the need for social media functionality, and there is no reason to move beyond the power of, say, the iPhone 6. Maybe you disagree with that, but by the time you get to the iPhone X I think you are at a bridge beyond. Once you deal with the battery issues and avoid dropping it, (or drop it and pay $100 to get the screen repaired), a smart phone lasts forever, and has the power you need if you are not lighting up social media. Put another way, think about how frequently you upgrade your iMac.

The Darkening of Silicon Valley

One thing that can help push social norms away from Facebook is a reframing of the Silicon Valley sphere away from the cool end of the dial and toward the menacing. The sea change that is putting Silicon Valley companies in the sights of regulators is also washing away the veneer. Soros wasn't the only one bashing the fruits of Silicon Valley. There was a litany of others along with Soros from the World Economic Forum. Undeniably, Silicon Valley is exciting, filled with great minds, and is the go-to destination for college kids. I know the feeling; that was the investment banks of the 1980's. And look where that ended up.

Case in point, there is the growing realization that Facebook is not simply a fun app, and the work of those brilliant Silicon Valley engineers is not just creating a global sand box where we can play. In the wrong hands it in can subvert a political system with more efficiency than a rioting mob. It already has. That has got to move the dial a bit in terms of perceptions.

Note: I did a post on Facebook back in 2011 that has similar sentiments, but with a more philosophical flair.

January 1, 2018

Al Franken’s #MeToo-Ish Impending Resignation

January 01, 2018

We all have nothing but support for the push against sexual harassment. No one would suggest that things can go too far. Though, actually, some think things have with Al Franken, where even front-line accusers are admitting they were too harsh and quick to judgement. Some, but not all. Kirsten Gillibrand, for one, just can't let up, asserting that any accusation of sexual harassment is sufficient to pull the plug on anyone.

Based on the second thoughts in the aftermath of Franken, I think we can imagine things getting out of control. Even the New York Times has suggested the tide of sexual harassment accusations is taking on a partisan tinge, as well as first glimmers of profiteering from ambulance-chasers. What does it mean for things to go too far. What would that look like. Some people might compare it to McCarthyism, though that is such a common label for anything that smacks of an institutionally-sanctioned witch hunt mentality. For some, images might come to mind from Maple Street or the pod people.

We all applaud the efforts to eradicate sexual harassment by any means necessary. To have it brought into the sunlight. To see women finally have their voices heard and to assert power and take action. We all revel in these men being on the receiving end. Thoughtfulness and soberness is necessary in the process, however, lest there be a backlash that scuttles these efforts.

December 29, 2017

How to Burn Four Billion Dollars: The Tailspin of the UFC

December 29, 2017
How to burn 4 billion dollars Whenever I write about the UFC, I should add a standard apology to those who are reading my blog with an eye toward the area of my expertise: finance, and in particular financial risk management. But I have enjoyed mixed martial arts (MMA) since its inception in the mid-1990's, (I also love Brazilian Jiu Jitsu, which I have been active in over the same time period), and find the current missteps in UFC fascinating. Watching the UFC, by far the largest MMA organization, in its tail spin from the incredible height of its purchase by WME-IMGfor $4 billion is becoming more interesting than watching its fights.

The UFC was a failing enterprise in the 1990's, and was salvaged in 2000 by the Las Vegas Fertitta brothers for $2 million. They each cleared over half a billion from the sale. The president of the UFC, a former personal trainer, Dana White, pulled in a similar amount, plus or minus (actually, minus) a few hundred million.

Even at the time of the acquisition in 2016 the purchase price was met with skepticism. But they did have some marquise talent, most notably Ronda Rousey. Her run is over. Not a surprise, because MMA demands many fighting skills, and there are thus many ways an up-and-coming athlete can find to break through an opponent's style, which in the case of Rousey was superb grappling without a base in stand-up fighting.

So, anyway, how is it going? Ronda is gone with no other women in a position to take on anything approaching her role. Dana and crew have latched onto Connor McGregor, a brash fighter who is both flamboyant and good in the octagon as the next big draw. They went all-in with McGregor by setting up a fight with Floyd Mayweather, the undefeated boxing champion. The fight pulled in $600 million, netting a hundred million plus for each fighter. This is the point that the UFC went full-stop into entertainment business, and as I wrote in a recent post, it is the point where it jumped the shark.

Now it is not clear that McGregor will fight again in the UFC. But with the hope he will come back and defend his title, and because now entertainment trumps sports, he continues to hold the title even though he has not defended it for over a year.

The number of viewers is languishing. FOX's recent title match was the second most-watched UFC event this year, but also was the fourth-lowest on FOX to date, with two million views (though it peaked above three million during the title bout). A UFC Christmas event drew 350,000 viewers, a tenth of the draw of last year's.

Meanwhile, it looks like the entertainment complex is doubling down after the McGregor-Mayweather spectacle by suggesting Mayweather will meet McGregor in a MMA fight. If their boxing match was a joke -- Mayweather carried him for ten rounds to give the fans their money's worth before leveling him -- this would be a farce. It would be like arguing that a 41 year-old version of Lionel Messi should spend a few games as a linebacker in NFL football because in American football, among other things, they kick the ball. Mayweather is not stupid; we will never see him in the UFC, but that it would be put out there even for a second to tantalize the UFC fans is a measure of how entertainment value is dominating substance.

And, to top it all off, I hate to say that MMA is getting boring. Maybe the push toward entertainment at all costs is reducing the focus on athletic elegance. Or maybe the nature of MMA, which requires skills in a wide set of fighting styles, kickboxing while standing, jiu jitsu when on the ground, and wrestling and judo for the takedowns, leads to a jack-of-all-trades and master of none, and for those who are familiar with the best of each of these disciplines, a sport that is less than the best is inevitably going to come to seem crude.

December 25, 2017

Bitcoin Can’t Win Against Fiat Currency

December 25, 2017
I'm not going to write anything here about the huge drop in bitcoin over the last few days, so what I am writing cannot be ignored should bitcoin get back up to the 20,000 range. And I'm not going to write about the stupid articles that espouse bitcoin. Though to get a sense of the level of thoughtfulness for the arguments for bitcoin, just to pull one recent one at random, check out this from Forbes.

I'm going to point out only one simple but devastating barrier to bitcoin becoming the standard, becoming even a second-tier means of payment:

If bitcoin doesn't find its way back into the shadows of the drug trade and underground economy on its own, it will be banished by the stroke of a pen, actually, of many pens. No sovereign will give up the power of issuing and controlling its currency. The central bank and monetary authority is one the most powerful economic tools of any government. If bitcoin or other extra-governmental currencies start to take hold, they can and will be made illegal to use for payment in one country after the other.

The cryptocurrencies will still find a market in the underground economy, where people want to avoid taxes or need to remain anonymous and untracable because their activity is illegal or subversive (It is true the ledger is public so all transactions can be seen. But the identity of the user behind the address can be kept anonymous.) But it will not be useable for the bulk of transactions, like your mortgage, credit card bill, tax payments. Or purchases on Amazon. It will be good for your recreational drugs, and your under-the-radar part-time t-shirt printing business.

A few other thoughts while I'm at it:

I can't take seriously a currency, crypto or otherwise, keeping in mind that currencies are supposed to be a store of value, when its exchange rate is determined by speculative activity, untethered to anything in the real world. Where the volatility is greater than for any asset in the real world. And where the assessment by bitcoin.org is that "it is truly difficult (and exciting) to imagine how it will play out."

To those who think there is credibility for bitcoin and other cryptocurrencies because Goldman now is considering a cryptocurrency trading operation, just remember this from Matt Taibbi:

The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

And right now, bitcoin smells like money.

Note: A fiat currency is the currency issued by a government that is declared its legal tender, accepted for payment of all debts, public and private. The word "fiat" means it is not backed by anything. No gold or silver; the government declares it as currency by fiat.

December 16, 2017

The Cry of the Pod People

December 16, 2017

Twitter was not available to the pod people in The Invasion of the Body Snatchers. They had to confront the humans directly, pointing and screeching to muster the mob to attack. But now that we have Twitter, a pod person in our day and age can efficiently and remotely signal a human to the pod-people mob with hashtag HumanToo.(This hashtag is already used in other contexts, but always by humans, so no problem.)

We don't have body snatchers right now, and, for what it is worth, we have put in legal protections should the event ever occur. Barring a dystopian state, (probably inevitable should the instance arise), no one can take someone's body without due process. No one can point and screech and have the mob take over from there.

At least that is true if body snatching is considered an assault on civil liberties that are protected by law. I suspect that is the case. Just as there are other actions that require due process. No one can be incarcerated without due process. No one's property can be seized without due process. However, there are harmful actions that can occur outside the constraints of due process, like accusations that do not rise to a threat of harm or to libel. While immune from the requirement of due process, they can destroy one's character and reputation. (Thus the term character assassination.) It can leave the victim unemployable, and set them apart from society.

The pod people had bad intentions from the start, at least from the human's perspective. But sometimes there are things going on that justify some pointing and screeching. Unfortunately, what starts off with noble motives can move into body snatcher mode. And when pointing and screeching is given free rein, that is where things inevitably arrive. With the excesses, the social winds finally turn, and any value, any noble cause, is lost in the process, even met with a backlash.

In a recent post I discussed McCarthyism. This is a good example of how a legitimate concern -- there really were spies tied to the Soviet Union infiltrating the government, intent on subverting our government -- can turn into body snatching. Accusations could be made without support. People could be targeted mistakenly or even for ulterior motives. (And, getting back to the pod people, what if a timid pod person is not body snatching, but is only body touching. Do we pile him in with the full-throttle snatchers?) All with the result that, in so charge an environment, and based on the accusation alone, they were destroyed.