On George Soros - Taleb's Perspective

There are two ideas in Nassim Nicholas Taleb's Fooled by Randomness worth addressing. They are highly pertenant states of the mind that is necessary in navigating through the markets.

The first is on the idea of changing one's mind:

An old trading partner of Taleb's, a man named Jean-Manuel Rozan, once spent an entire afternoon arguing about the stock market with Soros. Soros was vehemently bearish, and he had an elaborate theory to explain why, which turned out to be entirely wrong. The stock market boomed. Two years later, Rozan ran into Soros at a tennis tournament. "Do you remember our conversation?" Rozan asked. "I recall it very well," Soros replied. "I changed my mind, and made an absolute fortune."

Speculating how or why Soros could change is mind would be a fruitless exercise. Taleb's interpretation was that George Soros knew how to handle randomness by keeping a critical open mind and changing his opinions with minimal shame. (Which carries the side effect of making him treat people like napkins.)

The second ideas is on the idea of knowing...nothing:

My lesson from Soros is to start every meeting at my boutique by convincing everyone that we are a bunch of idiots who know nothing and are mistake-prone, but happen to be endowed with the rare privilege of knowing it.

When managing money, especially one's own, the first rule above everything else is, as Warren Buffett said it best:

"Rule No.1: Never lose money. Rule No.2: Never forget rule No.1"

Soros, for whatever reason, knew when to change his mind, but he did not do so on a whim or a guess (as it sounded in the book). There was detailed work done when an investment strategy was developed. However, when an strategy and investment thesis is carried out but is not working, even more work is needed to make up for losses.

The second idea is about being in a state that frees our mind from trying to control or model the unknown. Not everything may be forecast or predicted, and that which is unexpected to take place can take place. Knowing this (without actually knowing the unexpected) is something investors need to account in the analysis of stocks and the stock market.

Questions that Need Answering:

Here are a few things happening in the market that need resolution:

1. The U.S. 30-year Treasury prices are rising (yields are falling), and yet the stock market is rising. Is U.S. debt not the "safest haven" for investing? How are the debt auctions doing well if China is said to be buying metals instead of U.S. debt?

2. The S&P 500 rally since March was on declining volume, was without conviction, and sentiment was that of complacency (as indicated by the volatility index). Is there a risk of big players stepping in (or out) of the market in the next few weeks?

3. Will there be more government stimulus packages? Once the current programs run out, will markets ask for more?

4. If insiders are heading to the exits (insider selling is 95:1) why would ordinary investors be buying?



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Predicting, Forecasting, and Luck (vs. Skill)

Nassim Nicholas Taleb: A Crazier Future



This video found its way via Zerohedge.

Taleb is the author of "Fooled by Randomness" and "The Black Swan." This video summarizes the concepts discussed in his books, in which Taleb comically describes The Black Swan is a re-write of "Fooled by Randomness." (See @1hr 5min)

Most admirably, Taleb (@1hr 15min) reveals how no one wanted to publish his book. Complete with many rejection letters from publishers, the author prevailed by posting his manuscript on the web, gaining attention, and eventually overcoming this set-back.

This video will take 1hr 30min to watch.

In this video, Taleb talks about some of the things we all would want:

• Predicting the future
• Illusion of control @46:16
• Forecasting
• Moving from Theory to Practice
  

Some of his Tips:

• The Best advice comes from those who give you NEGATIVE advice (as opposed to positive advice). (Reference: @57 minutes)
  

• Do not use forecasts in a qualitative way or for anxiety relief.

• Create small Rules of Thumb

• Do not take advice from people wearing a tie!

• Respect Tradition and Age (Reference: @1:03)

On Managing Risk:
In the Q&A segment at the 1hr 13min mark, Taleb talks about minimizes risks in the stock market in the maximum way: simply by holding an amount he is willing to lose. For example, he says holding 7% in stock would result in a maximum loss of 7%.

On Applying "Black Swan" to Decision Making
@ the 1hr:22min Taleb is asked:

How does focus on black swans affect quality of decision making? Does it increase paralysis or inaction?

His Response:
(my transcription may have errors)

Being skeptical makes you take more risk in some domains. I take more risks on some domains. If you are aware of black swans, focus your risk taking on some things and not [on] others. This allows you to take more risk in tinkering trial and error, and a lot less risk with when you rely on someone else's opinion who can be full "experts."

Taleb is working on the next book that discusses how we are better at doing things than knowing things. When this book is out, it should make for a very controversial reading from the academic community.

My True Colors

The rapid reversal in sentiment in the past month is breathtaking.

It is really difficult to keep your head about you, when everyone around you is losing theirs and blaming it on you. Rudyard Kipling may not have referred to the stock market in his poem, “If,” but those who still doubt the sustainability of the market will not have been loudly heard in March.

The S&P rose almost 20% in March. This, by historical standards, is the biggest 4-week rally since 1933. Note the key word in this sentence is "historical." Yet unemployment grew at levels not ever recorded since being tracked. The Intelligent Investor is a value investor. Historical events and market patterns play little to no role in the valuation of a company. In effect, "Efficient Market Hypothesis" would need to be rejected, and the work involved to value a company is "bottom up" not "top down."

I have written and analyzed the market from a top-down perspective. Why? The broken banking system (failure of banks to lend) has affected companies in their ability to finance. This means that companies that were running on weak balance sheets will rally along with the other good companies investors should be holding.

Beware of those companies. It is still possible that the banking system is not fixed, and these companies will ultimately fail. Notice that HSBC sold 18 Billion dollars worth of “rights." This will improve the company’s balance sheet, but the buyers of this issue will probably suffer a paper loss if the market reverses in the weeks ahead.

The 20% increase has also made good companies more expensive. This will reduce your margin of safety, but in the long run it will not matter.

Differentiating good and bad companies will be important in the weeks and months ahead, as the market may move up more of implode because assumptions from a macro-economic level do not play out.

Highlights from Matt Blackman’s newsletter

(http://tradesystemguru.com/content/blogcategory/34/68/) , there are a number of factors that remain troubling:

• Unemployment rose less than expected, but rose nonetheless. That’s like coming home and being content with scoring a D+ instead of a D-
• Conviction was lacking: every week that went by was met with lower trading volume, even though the market rose
  

Coming this Week! The Real Report Card

Companies will start reporting earnings this week. It would not make sense that they would be reporting strong earnings, given the continued economic weakness between January and March of this year. I do suspect some technology stocks will do well this quarter. RIMM, for example, already reported very good earnings.

My True Colors:

When does one's true colors reveal themselves? When under duress? When one is at his/her most calm state? That is, in good times or in bad?

I have been reviewing my investment strategy in light of viewing the recent events made by Congress. Keeping a high cash position when the market rallies 20% is a difficult thing to do. However, the phrase "easy come, easy go" comes to mind. it is preferable to position a portfolio to take advantage of real opportunities: one based on fundamentals and not based merely on market fluctuations.

It has been my experience that anything - not just stocks - built on a solid foundation will last longer than profits that come easily.

The same cannot be said for triggering losses.

When the dust settles, companies with solid fundamentals will be the ones left standing.

Two amazing readings that I would strongly recommended are Seth Klarman’s “Margin of Safety” and Nicolas Taleb’s “The Black Swan.”

Nassim Taleb Says Geithner’s Bank Plan Will Fail

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