Speculation

4/17/2021

None of the Following is Investment advice.

As I've studied for the CFA Level 3 exam, I've listened to a lot of funk and studied a lot of art. Two pieces that struck me were "The Revolution Will Not Be Televised" by Gil Scott-Heron and “Moneychanger and his Wife” by Quentin Massys (see above). 

When released, Scott-Heron’s iconic work narrated a USA going through the Vietnam War while television was taking off. He showed how the media was just beginning to take hold of an American public that it largely still holds hostage, for lack of a better word. I recommend you listen to the powerful track while you read this. 

In his work, Massys portrayed Antwerp’s 16th century society at its very introduction to banking, where you see a couple arguably choosing wealth in favor of religion and humanity. Bolstering that argument was the inscription that ran around the original frame quoted Leviticus 19:36—“You shall have honest balances and honest weights.” 

My interpretation of the Scott-Heron’s harangue, and possibly of both works, is that life is not a tributary of the media. People should live separately, with an indelible devotion to humanity and their own human values. When you lose your humanity, what else is there? 

Each year, it becomes harder to develop and maintain individualistic value systems. I speak from experience - I have been the subject of such media-driven hostage negotiations, and fear that the distractions will continually get worse. Today, we are almost forced to believe that the only revolutions possible will be televised. 

Case in point - Speculation is deleterious behavior, encouraged by Modern Monetary Theory (MMT).

Last year, we watched in amazement almost every global asset class 'reflate' to new highs, seemingly at the stroke of a wand. If you weren't willing to buy, you realized significant loss to relative wealth. The idea was that "You can't fight the Fed". A maelstrom ensued, soothed by global central banks doing everything in their powers to right the ship. You were forced to have faith in the system, which I for one am happy to do - today is a great day to be alive. If you believed, everything you touched turned to gold, especially the riskiest assets.

So is this year the same recipe? Over 40% of all US Dollars have been put into circulation in the last 12 months. If you aren't thinking like a bull, are you 'fighting the Fed'? Are you 'fighting the Fed' when you believe inflation will precipitate, even as Jerome Powell says they will fight inflation down no matter what? Are you 'fighting the Fed' when you don't buy the riskiest assets in spite of all concerns?

This is an incredibly difficult lesson for humanity - there is less dependence on working to make money; it will be given to us as new money is circulated. But then when does it end? Will there be losers? Can there be losers? Simultaneous to this unthinkable question, we have speculators of all ages at very high precipices. A poignant dearth of commonsense.

The revolution will be televised.

A quick soliloquy - recently, a former college roommate messaged me (for the first time in nearly 2 years) that he made over $1 Million on cryptocurrencies. I congratulated him. 2 days later, he bragged about making $100,000 in one hour. What made him do that? What makes someone forget that people are more important than money by using one to put the other down? Unfortunately, many speculators either get held hostage by sales tactics or they become addicted to gambling. For my former roommate, it might be both - he is still completely sold on cryptocurrencies over everything else and he still has his entire net worth invested, likely watching it every day. While this is an extreme case, maybe it’s becoming more normal than we like to believe.  

In light of that, here are a few considerations regarding pernicious speculative activities:

1. Rule #1 - don't lose money. Not to say you will lose money, but the probability is against you. Most 'investors' proselytizing new technologies have conflicts of interest and would benefit by you buying in. Even worse, they could be pumping the technology only to take your money.
2. Either you want to make money or you are donating to a charity - don't get wrapped up in an emotional cause. Many speculators fall in love with a business or a new technology, without considering the downside.
3. The easiest way to make money - avoid mistakes. In the last year, I have become quite good at Surfing. Surfing is not about catching waves, it's about picking the right wave at the right spot. If you do differently, you waste a lot of energy, or you get injured. It takes a lot of study and experience to know what the right wave at the right spot looks like. Same as in investing. Knowing what mistakes to avoid is more important than having success.
4. Having knowledge and confidence in what types of investments will make money, you begin to see how dangerous speculating is. Knowledge is power. Wait for money makers to materialize. Sometimes it takes awhile and is very boring, especially if your friends are getting rich speculating. However, in volatile times like these, ideas happen every day.
5. Investing is never about timing the market, which is a form of speculation. It's all about finding great securities/assets at a moment in time. If they trade at a price that has a margin of safety, there's no reason to worry about downside risk. This is a secret to investing that's rarely explained well, but easy to exploit well.
6. In reality, there's no benchmark for your return - your goal is to make money. It's kind of like playing golf - you must learn to play shots that you are comfortable with and find out in the end if you won. If you are constantly competing, you are playing someone else's game. If you win that game, you still lose.
7. If you completely avoid speculation, the only significant non-systematic (non-market) loss is opportunity cost. That is to say, your biggest potential for loss is selling too soon. A couple months ago, I put out a report on APPS, STMP, and TWST, which all increased many multiples after I sold. Since that time, more and more of my picks have realized the same losses. I consider these losses even though I didn't lose money directly - but I did lose opportunity. I call this the "buying the next shiny thing" problem. The speculation is that the new investment is 'more undervalued' than the one you're holding. Very hard to overcome this one.
8. Speculation requires no skill, so skilled investors get frustrated by its successes, while the people that made money believe they have skill. The finest example is Stan Druckenmiller in the year 2000 (read the article here). That is what's addictive to many of those people - they feel special for having so much skill. It's vanity that both makes them invest and keeps them there. Vanity is a relatively poor motivation considering your goal is to make money, not express how great you are.
9. Finally, speculation is a self sentence to mental jail and prisoner's dilemma - you will never know which way is up.

• If your speculative investment drops more than 20% (and the probability is likely that it will), will you be able to hold on, or, worse, if you do hold on, will you develop lasting emotional stress that permeates your relationships? Many people who speculate successfully never are the same after the success or they might spend years of their lives recovering. We all know these people.
• If, however, you held something you believed in, buying more is a no brainer. That moment of being down 20% + is critical to determining your comfort as an investor.
• The inverse is also true - how will you know when to sell or when not to buy? When your investment shoots up in value, how will you know if it is fully valued?
• In the CFA, we are taught that two error types exist. Type 1 errors are buying bad investments or not selling them despite underperformance. Type 2 errors are not buying good investments or selling them for no good reason. These are the tests for an investment strategy. It's much easier to take the drops when you are certain of something's intrinsic value. If you aren't, you might not buy, and you might even sell.
• If you win, you will eventually come back to the table and lose more than you started with: the philosophy of Las Vegas.
• If you sell and it comes back, you will probably have a hard time dealing with that.

These are generalizations, of course. To truly master investing and not lose money takes years of brazen, stressful trial and error to know what works, and you must learn on your own. I'm convinced that these traits are not taught, but learned through passion, relentlessness, and dedication, such as the most critical life lessons are learned through the like. Engaging in speculation probably teaches bad behavior, meaning that if you do choose to become a better investor, speculation will do more harm than good. Unfortunately, most of us know 100 speculators for every 1 intelligent investor, and that investor might not be forthcoming with great lessons, so studying and reading is the only way to have what it takes. Otherwise, hiring intelligent investors is a terrific alternative. 

People speculate for many different reasons. Maybe learned behavior, maybe out of necessity, or maybe out of boredom. Perhaps it’s because we are told consistently that beating benchmarks is impossible and the only way to do it is to speculate. For years that was my thought - that you needed to take excessive risk to invest better than average. This is absolutely untrue. Some people will remember the Buffett bet, where Buffett claimed that the S&P 500 would be Ted Seides’ fund of funds. This bet became a proxy for active management versus passive management. The S&P won, not because the performance was better, but because the opposition was so poor. It was as though Buffett had bet that a professional NBA player would beat a middle school student one on one. Supporting decisions with evidence like this is a Type 1 error - you will either not try to intelligently outperform markets or you will take on too much risk trying to beat the market. 

Although, realize that I myself am the ultimate speculator. Entrepreneurs are born speculators - I have spent the better part of my life betting on myself when virtually nobody did, and almost as many told me to jump off a cliff instead. And that even though my returns have been great for years and my strategy is simple to understand, many people still don't buy my product because entrepreneurs are predisposed speculators. It takes one to know one.

Here’s my greatest lesson - buy things at that point in time when they are absolutely undervalued. Forget about all the noise. You are buying the business and its cash flows. You are not buying analyst targets, currency exchange rates, or even the price for which it sells for. Price is what you pay and value is what you get. Most people walk right by so many opportunities, or worse, condemn them for no good reason (I reference Intel here). Misunderstanding has never led to wealth creation - but it has always led to massive monetary wealth creation for people that do understand. Going off of this principle, you can see why always being invested is key - because you can always find absolutely undervalued assets in any environment. If you choose not to, you incur opportunity costs. 

To determine whether an asset is undervalued, start by comparing the cash yield to the yield of the business. The 10 year US Government Treasury Yield (“10 Year”) is the best proxy for USD yield. If the 10 year is 2% and expected to stay there for many years, and you find an asset that’s yielding a net 3% and will consistently yield that over time, that 3% yield will eventually become a 2% yield as the price rises 50% over time. Simplified but effective example. 

Note that many assets generating cash flows denominated in foreign currencies have and may continue to suffer versus USD denominated cash flows as the USD has gotten the better of nearly every exchange rate in the last 12 months. While I am cognizant of this, it is in the ‘too hard’ pile for me. 

Something else I’ve learned is that hedging is speculation. As hard as it has been to find a hedge lately, I suspect that has always been the case. The best hedge is an undervalued asset - if it drops further, you should like it more. However, to stay invested because you think "stocks only go up" is irresponsible and speculative. Likewise, having a "balanced portfolio" is speculative - historically these performed well, but why do we extrapolate historical results so liberally? I can't get myself to invest anything based on historical results, unless it relates directly to the propensity of future cash flows. And yet, the 'gurus' today are more likely than not telling everyone to blindly buy risky stocks. Even financial advisors are guilty of such sins. There’s no reason to take risks on overvalued things when so many things are undervalued at any given time. 

In March, we passed on a very desirable tech startup still in the seed stage. Why? Because companies in the stock market are more attractively priced. Equity is equity is equity. Buying tech in public markets can be just as lucrative as in private markets. It's exciting to buy private companies, but, somewhat strangely, I get just as excited buying public equity. There are some VERY exciting stories in the public market today (no I'm not talking about TSLA).

You see the history of mankind unfolding before your eyes in public markets. I’m so excited when young people get into investing because they are participating in humanity. The efficiency of the US stock market is a big reason why the USA may be history’s greatest country - because there is truth in our market. Investing in US companies encourages people to learn more than make money. These companies are incentivized to keep evolving. We watch in real time the evolution of mankind through companies of optimistic leaders. And all we have to do is cheer them on, either by owning stock or watching from the sidelines. You can fall in love with a business just as easily without taking a position. 

The best investors have lots of conviction. The last two years has seen unprecedented levels of cankerous volatility symptomatic of increasingly rogue asset markets, but who knows and who cares? Even if there were a precedent, would that be important? Fact is, every day, more things become overpriced and more things go on sale. If you don’t have conviction, this new environment of heightened volatility will eat your lunch. Or worse, make you a sociopath like many speculators tend to become. The goal is to make money.

But then again...

Money doesn't exist. I went from thinking it did in March of 2020 to accepting that it doesn't in September after I watched MMT take hold. I recommend everyone read the works of Warren Mosler.

Like finding out Santa Claus doesn't exist, we all should abandon childish behavior. Money doesn’t exist. Time is the only thing that matters. Only time exists, empirically. 

To find evidence, let’s take a trip to Omaha, Nebraska. 

Buffett studied religion early in life, and noted that religious zealots didn't live longer than the average. At age 12, he compared the lifespan of hymn composers to all the others. He found no difference in the lifespans. It isn't known whether he applied the same constraints to financial greats, but I assume he did. At 91, sharper than ever, his early studies paid off. I believe he chose the career he did solely because it provided him a longer useful life than other disciplines. 

From age 12, he recognized that the useful life of a person is just as important, if not more important, than that of a machine used in business. He is still incredibly useful to his loved ones and me too. Buffett then spent his career freeing up time for others. Think about how useful he was to society - the people he worked for were able to engage meaningfully with humanity. They didn’t need to speculate for any reason. He removed their urge to forget their humanity. He gave them so many choices. In what other field could he have done that? 

To conclude, just as every other point in time, there are speculative activities that could lead one to unhealthy and irrational behaviors. Although challenging, the only recourse is to learn how not to speculate and avoid losses. Disciplined investing is not making money, but avoiding losing money. But even more than that, money’s ultimate outcome is more time. So the most disciplined, gifted investors are those that earn more time than they would have without investing. Speculation has a very low potential of positive outcomes, from monetary, psychological, and time perspectives. Many market participants feel they need to speculate because that’s what everyone else is doing, especially if everyone is making money. Opportunity cost is a true cost, in my opinion, that you incur if you don’t own productive assets that you could own. All of these principles may not be easy to learn from me, but I hope they can help guide you in the right direction.