Internet Revolution Strikes, Again: Both in the Streets, and on “The Street”

Every analyst on the street already seems to be on the bandwagon, and every pundit on TV believes we should be scared by so many analysts being in agreement: tech stocks are cheap. Many of them have been cheap for a decade – and they were cheap for a reason.  The explosive growth of dot.com bubble wasn’t a total farce, much of that growth was simply robbed from the future – countless companies experienced a decade of growth in 18 months……and then the wheels came off.

Less than 4,000 days later……

The growth of the internet bubble was unprecedented; with companies’ valuations sorry virtually overnight, despite an internet still in its infancy and no profits at many companies.  Companies like Global Crossing and JDS Uniphase spent billions laying fiber optic cable and acquiring companies for growth.  The result: so much bandwidth, a glut, that it would take us a decade to work off the capacity.  And so, much like the very stocks that led the boom, both the internet and it’s companies had grown wildly faster than people’s ability to connect to internet, to do so with a high-speed connection, and be able to stream content.  Much like the prices of these very stocks, these companies had grown the internet (in terms of supply of bandwidth) much faster than the growth in demand for bandwidth.

And on the market side, perhaps more than ever, valuations finally caught up to stocks.  Then the seemingly infallible Alan Greenspan (after all of his talk of ‘Irrational Exuberance’) killed the ‘Golden Goose,’ raising interest rates perhaps one too many times….and Enron was exposed as a fraud (and with it Arthur Anderson), Investment Banking and Research were flipped on their head……September 11, 2001…..the Dennis Kozlowski episode at Tyco….and sprinkle in some Sarbanes Oxley – the golden age of stocks had ended.

Accordingly, nearly the entirety of tech-land has languished for the better part of a decade (not withstanding standouts like Apple): value (cheap) companies like IBM spent an entire decade getting cheaper, and cheaper – with its stock price never surpassing $135 (for 10 years) all the while steadily growing its earnings and revenue (much like Intel, though it is nowhere near its’ highs).  Recently, in fact, IBM was finally able to break-out above that very $135 level – technically, this amounts to a break-out from a 10-year consolidation.  No wonder that only days aver surpassing $135 , IBM was able to trade north of $160 (likely on its way to north of $200).

What happened?  Many things have happened….though there are a few key factors that demonstrate that this is the break-out tech investors have been awaiting since the dawn of the internet age.

A dearth of bandwidth meets soaring data demand……

Fast forward 10 years, 4 iPhones, not even Google nows how many Androids, 3 prominent social media sites (Friendster, MySpace, then Facebook), two incarnations of high-speed mobile networks (3G & 4G), and a President elected by the social-media age, and we find ourselves in a brave new world.We finally have the streaming content, mobile access, and are so socially connected that we, as a people, have completely overrun the entire internet infrastructure.  Just weeks ago the last IP address available was used.  In New York City, where I live, my iPhone has been reduced to a paperweight during times of high data-traffic.

Governments around the world are in a race to provide the vast majority of their populations access to high-speed digital internet, while mobile carriers struggle to upgrade their networks to meet demand.  Right in the middle of at least the second worst financial catastrophe in modern civilization, we are witnessing the equivalent of a ‘digital’ New Deal.  With the world on the verge of what could be considered a long-term structural unemployment problem we are witnessing  the mass reconstruction and build-out of the entire information super highway – and many of the broken companies of the past boom are back again to reap the rewards.

Make no mistake there are, and will be losers.  Some companies did not (or not yet) adapt to the changes of the second coming of the digital age (we’ve all seen Cisco’s last few quarters).  In other areas there has been a changing of the guard; Apple is one of the rare exceptions that never skipped a beat over ten long years, and Google appears to be he new Microsoft, but better – by being the leading software provider to the ‘new’ hardware (mobile devices), all the while using their search business to literally ‘print’ money.

The Revolution will not be televised……

From President Obama to the recent uprisings in Tunisia and Egypt, we have also seen the power and scope of the internet revolution we are in the midst of.  This social revolution has created a kind of momentum, social, political, and technological, that cannot be stopped and the will forever change the course of history.  Every day we are more and more connected, and those who are unable or unwilling to adapt will be left behind; people, companies, and countries alike.  This was perhaps no  more evident than when [former] President Mubarak of Egypt spoke the world this past Thursday; he adamantly implored his people, the youth of Egypt, not to listen what the people on TV were saying/telling them what to do.  In that moment it was so obvious. This movement that began with a Google executive’s post on Facebook, a movement against a President/Dictator that, despite weeks of protests, was completely oblivious to the root of the riots and, to what the world had become.

This is a lesson not just to other nations that might rise up in peaceful democratic protest, but to all of us.  It’s been called a ‘tipping point,’ or wildfire, even cancer, but, like or not, the digital proliferation of humanity can no longer be stopped.  Perhaps more now, than ever in history, the people of the world, the masses, have the loudest voice.

The bottom line, is exponential……

This translates to a world where the most valuable infrastructure is digital, the most important security is cyber, and the majority of the world’s capital flows through fiber optic cables and is then transmitted through the air – and the rate of the proliferation of any and all of these digital trends is more rapid than anything in human history.  Faster than anything the ‘old world’ could muster other than perhaps cancer.  This past year social networking/group-coupon company, Groupon, grew from literally $0 in value to a valuation of over $1.4 billion – in less than 8 months! The company’s value literally grew at the speed of ‘word of mouth.’

Whether it’s the growth of the conservative ‘Tea Party’ or the youth of Egypt throwing their own ‘Cairo tea-party,’ we can literally see the proliferation of the internet revolution on the street.  If we look at IT spending, or at productivity, or at the growth in profits and revenues at tech companies, we can literally see the proliferation of the internet revolution on The Street.  And this time, they’re growing at almost the same rate.

The Day the Market Stands Still

Several years ago Warren Buffet proclaimed derivatives to be akin to ‘financial weapons of destruction’ – if only he knew the half of it. True that derivatives are opaque, illiquid, and often exotic.  Their very nature is both inherent to the way we do business and to the fear of how business is done today.  However, May 6th may point to a much more dire concern – how fragile is our market structure, really?

On the day of the Flash Crash one of my thoughts, on a day when most of us barely had time for a few, was that we had just seen a terrorist event.  Maybe it was (I’ve been told it wasn’t), maybe it wasn’t but, whether we like or not we were clearly exposed.   For the purposes of this discussion we will make an assumption; either May 6th was a planned mini-attack (let’s call it an incursion), or it wasn’t (a completely random perfect storm) – it cannot be both.  Either way one fact remains, certain vulnerabilities in the way business is done have been exposed.  Their have been advancements since the Flash Crash, particularly the single-stock circuit breaker that holds trading when an individual stock moves more than 10%  within 5 minutes.  Lack of uniformity was placed as the chief cause of the wild events that day, and ‘slowed’ trading on the NYSE was credited with lessening the damage. What has been exposed here is at the core of our financial system; our markets ability to operate and do so electronically, to provide liquidity regularly, are integral to our economy.  Detailed information of tick-by-tick information, not just of trades, but true market depth, called market-latency information is used, among other things, to decipher market activity and to improve quantitative models.  This information is available to anyone who can pay for it (namely hedge funds) and may most certainly be used to exploit the weaknesses of our system, but one integral ingredient is missing.

Why is that terrorists are often so difficult to overcome?  It is nearly impossible to defeat an adversary who is willing to take his/her own life; they are willing to inflict a kind of damage that no one who possesses the instinct of preservation can conquer – people willing to die to kill you are tough to beat; people with money to burn are similarly dangerous.  The markets would prove a devastating parallel to that conundrum.  Is an efficient market prepared for extremely large participants (by sheer size, or by derivative leverage) that do not care if they lose?  The market is supposed to be a zero-sum game, but I am reminded of a Keynes quote, “If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.” From ‘Long-Term Capital Management’ through AIG and Citigroup, that principal has been reinforced – be careful who owes you how much money.  What if someone deliberately created a LTCM, a ever-expanding web of leveraged bets upon leveraged bets, designed not to be bailed out (or to be bailed out, whichever you prefer)?  This is my point.

Now allow us to bifurcate.  We have two separate, yet not necessarily distinct issues; one is that, whether intentionally or not, our system has been tested and we can expect future tests, and two is that we don’t know how a market with a LTCM designed to disrupt the market would behave.  Either, in and of themselves, are completely terrifying.  What I suspect, however, is that the two need to be thought of as more intertwined, in the sense that derivatives are designed to be whatever they are designed to be – little else.  I am not saying that derivatives would be how a hypothetical financial cyber attack might be packaged.  What I am saying is that given the derivative exposure borne by the market today, that if and when such an attack were to occur it would be devastating.  An attack sever enough to close US markets for “an extended period” (as Doug Kass recently suggested) could bring renewed strain to global, and particularly US and European, markets still weak from recession.

In the absence of significant changes to market structure, and without addressing the portion of market activity comprised by automated trading, their remains reasonably high-risk in any short-run period due to market structure and possible liquidity crisis’.  With the leverage available on the futures and options offered on the myriad of financial products available today it becomes more than plausible that a, or a group of, participant(s), that may or may not care about preserving capital (they may be using capital as a weapon), could deliberately and effectively disrupt our entire market structure.  Moreover, if one combines the principles of what I’ve discussed with a breach in security, a cyber ‘hack’ if you will, they would likely discover an equally chilling prospect.

Our Grave Economic Reality: Of Reserve Currencies and Trade Deficits; Of The Oxymoron that is The ‘Service Economy’; and Of Our Planet’s Economic Carrying Capacity

-“The only way the rest of the world will hold your currency is if you run a trade deficit.  Economics is the opposite of religion, it’s better to receive than to give.”  – Warren Mosler, economist

What a fantastic notion; unfortunately we Americans prefer to purchase seemingly infinite amounts finite commodities which we deplete and can never use again.  The US seems determined to export its’ sovereignty in exchange for foreign crude oil, placing more and more of our dollars in reserve at Central Banks around the world; and we’re purchasing a single-use asset which we must continually replenish.  This is not merely the ‘national security risk’ that most pundits speak of, but also represents the mass-exportation of our wealth overseas in exchange what amounts to handfuls of magic beans (or, no-so-magic beans).  Translated: The ‘Emerging Market’ is something of an oxymoron, we’re merely allowing a great deal of economic activity that ought to take place in the US to occur overseas instead; in exchange we’re either borrowing their money (China) or relying on their commodity-rich economies (Brazil, Russia).

Being that our economy is now service based (meaning most of our economy produces nothing tangible, and that may be worth nothing in future, but certainly has no certainty of having any value for resale), we find ourselves the perpetrators of our very own self-fulfilling Ponzi scheme; we keep moving around greater and greater sums of money, but no new value is necessarily being created.  e.g. If the massage-therapist I paid recently chose to fill her gas tank with my payment, surely most of that money has now left our economy for good (who buys American anymore, that is not American?) – and, I will never be able to resell my massage.

Economic Growth, and International "Self-Delusion"

GDP Growth versus Inflation, and the Farce of a Service Economy:

For whatever reason (I’m sure an economics professor, or charlatan, once told me) no one seems to consider the rate of inflation alongside measurements of our, or any country’s, GDP growth.  To me that seems rather ‘convenient.’  In my mind, in a year where the US grows GDP at a rate of 3.0%, annualized, and the rate of inflation is 3.0%, annualized, that our economy’s GDP did not in fact grow at all.  I will not endeavor the validate that notion mathematically (I dare you to negate it in such a manner) but I will do the much more heroic thing, and be so audacious as to apply logic to an economic debate (if Congress could only see me now).  Of course GDP as we know it is adjusted for inflation, but the manner in which we adjust subjects to a suspicion of the validity of both figures – ultimately.

-‎”By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”  – John Maynard Keynes

Clearly the Fed’s recent determination to create inflation (hey, they’ve been saying for years that part of their dual-mandate was to target inflation) could have the positive effect of  making it easier to repay our foreign debt, but apparently no one responsible for US fiscal policy understands that this will only be effective if we were actually to brand China a “currency manipulator” – because most of what we owe is to them.  Thusly, as Keynes so astutely said, the true effect of the inflation we aim to create will be the mass-robbery of wealth from the American people in the form of a rapidly depreciating currency, but without a meaningful reduction in national debt.

“If I owe you a pound, I have a problem; but if I owe you a million, the problem is yours.” – John Maynard Keynes

If we were Greece, we could use the above to our advantage.  Clearly, we have little to no real interest in using the depreciation of our dollar to our advantage with regard to our national deficit as it pertains to foreign economies – such as China.  What everyone seems to forget, is that a huge portion of our deficit is owed to the American people (ah yes, all those Treasuries you own – in Mutual Funds, etc) and, as Keynes so astutely put it, this destruction of the value of the dollar is tantamount to the ‘secret and unobserved confiscation’ of the wealth of the citizens of the United States; by the United States, but not to the enrichment of the United States (as perverse as that sounds).

With regard to the trade-deficit itself (and what a deficit it is), there seems there is little that we can do in light of our never-ending quest for increased productivity and our lust for ordering and owning goods built by the lowest bidder.  What I can say on this topic involves immigration; those of who believe that illegal immigrants in this country are taking jobs from  you obviously haven’t come to grips with the fact that most of the jobs performed my illegal immigrants are simply undesirable to most Americans.  For those of you who say these immigrants are unjustly taking jobs from Americans for less money than an American would work for, obviously don’t see the cruel irony of a country, 10% of which is unemployed (though it very well is more), playing a game of ‘beggars can be chooser.’  What’s that?  You say you don’t like that these immigrants save their money and send it overseas?  Well, as I described, even if those monies were made by Americans, many of those dollars would be finding their way overseas anyway.

Economic Carrying Capacity:

While I may or may not have coined this phrase, its’ definition should escape no one.  We have all heard the notion that, for example, our planet has a carrying capacity; a limit, by virtue of space and, more importantly, resources available for the inhabitants of our planet on which to exist.  I say that there is just such a limit to the ‘real’ potential economic activity of our planet.  Clearly we know that our resources are finite.  Yet, as I described previously, we are clearly very good and creating the semblance of economic activity, as if by our divine will to make money.  If we have learned anything from our recent crisis’ (surely if we have, it is not much) then we should know by know that this type of economic activity, in the long-run, amounts to little more than an economic game of ‘musical chairs.’ – When the music stops someone will surely be left with no seat.

I am not here to say what the capacity of our planet is to produce economic activity (I don’t believe anyone could – and, I am certain we would not know it even if we were there).  What we need to realize is that, in many cases, our expectations do not align with what is possible, or even probable, in terms of economic growth – we must be skeptics, to an extent.  In a world of limited space (even if we colonize the ocean-floor) and finite resources, it stands to reason that there is a finite amount of legitimate economic activity that can be affected – the rest is either inflation, or smoke and mirrors.  Look at the past decade, for example; nearly the entirety of the US’ post-9/11 economic expansion can be explained by an easy-money fueled real estate boom; the problem is that it was a zero-sum game, lots of money changed hands and plenty of people made or lost money – but nearly $0 dollars of new wealth was actually ‘created’ (see my 1st comment, below).  Furthermore, with globalization, this notion of reaching a maximum-threshold of economic capacity allows us the delusion that we can find the growth elsewhere: Well I’m here to tell you that the growth elsewhere certainly appears to be at the expense of growth ‘here’ (insert developed nation in lieu of ‘here’).  Money managers are often accused of (or credited for) chasing growth; the reality is that we are just as much leading growth away, as we are chasing it.

The clear point is that it is likely that there is a finite amount of legitimate economic activity that can be produced on this planet, given the resources that we have.  Of course, with the beauty of inflation we will continue to delude ourselves with notion of  growth in economic activity – in reality what we will be seeing won’t be growth, but the devaluation of our currencies and appreciation of commodity assets that create the appearance of further growth.  Yes, there will be innovation.  Yes, things will be invented that I haven’t thought of that people in fact want to buy – but that doesn’t necessarily equate to legitimate increases in economic activity – gains in productivity are likely to further reduce the employability of our lower, and lower-middle classes; increasing the drag on unemployment, government programs, and socialist tendencies within governments (see Obama care).  Simply put; in addition to what I believe are the obvious (if eventual) constraints on the global economy, we will continue to see an ever-increasing role of government spending as a percentage of the global economy; and, if not, we will have to realize that there must be a limit to how many new gadgets and services can be created that we can convince the citizens of the world they cannot live without.

Measuring Risk, Weighing Unicorns, and Betting the Farm

Measuring risk is an oxymoron.  Unicorns are mythical creatures that do not [likely] exist, and hence can’t be weighed.  ‘Betting the farm’ is a metaphor for making an extremely large [if not excessive] bet; typically presumed to be risky.  The three notions meld together seamlessly; we can measure risk until we can’t, we can’t measure (weigh) what doesn’t exist [or we can’t find], and we like to make big bets.  But other than in very specific situations (e.g. you can count cards or are otherwise talented, or you got lucky) we’re not good at understanding risk or making good bets more than intermittently – and can’t identify situations when the ‘one time we were wrong’ could hurt worse than all of the times we were right (e.g. I win $1 ten bets in a row, and on my eleventh bet I lose $1000) combined.

But, how much would a Unicorn weigh?

Whether we’re talking sports betting, fantasy sports, stocks, bonds, new businesses, movie productions, or book sales, there is an inherent underestimation of the risks involved in such endeavors.  I’m told that Venture Capitalists, statistically, fare much better than their entrepreneur counterparts.  I am not surprised.  Roughly 90% of new businesses in the US fail (historically – now, who knows?) but, when they work, lookout!!! (See Google)

The point is, in investing in new companies for example, that we could over or under-estimate the risks involved.  Then we might be either unwilling to invest at all in fear of  ‘the odds’ or overly eager to invest because of how huge the ‘payoff’ might be.  Thankfully in the US we don’t have as many people in the ‘unwilling’ camp (historically) and, on the global scene, we’re viewed as the world’s risk takers – i.e. the innovators.  The problem?  As a people, we are not VC firms.  We do not spread a vast number of diversified, yet calculated, risky bets across a wide enough spectrum that we can achieve some margin of safety (and we don’t have the cash to play again to win it back).

How much for the farm?

Someone one once told be to “be wary of salesmen” and then I worked briefly with salesmen; be wary of salesmen.  It’s not because he’s trying to screw you ( he might be), it’s because there is a good chance he doesn’t know what he’s talking about, and there’s a better chance that his interests aren’t aligned with yours.  Equally, be wary of middlemen (the Madoff money-men) – they are salesmen too.  Suspect people who don’t invest their own money.  What does that even mean anyway?? It likely means that they only risk the money of others (risk nothing), and ‘eat’ no matter what.  You don’t necessarily have to be wary of the ‘free lunch,’ but of the person eating it – what did he/she do to deserve eating what you paid for, for free?.

Most CEO’s know next to nothing about the risks their companies face.  Coaches don’t know what their players are up to.  Markets, at any given moment, are inefficient.  That’s right, I said it.  Over time, or on average, markets are efficient [or close to it].  As Warren Buffet says, over the short-term the market is a ‘popularity contest.’  The world reacts, and mis-reacts, to information in knee-jerk fashion.   Point being – the world is not what it seems, mob mentality prevails, we are prone to fads and we usually over-react

We tend to define risk as something tangible that can be understood, categorized, and measured.  That may be kind of true, sometimes.  To me, risk has is what I might not be able to quantify (e.g. the likelihood that something that hasn’t happened [or is very rare] might happen).  Why do I speak of risk when questioning how much to pay for the farm?  Because if I don’t know the farm sits on a fault line I’m likely to overpay for it.  If I don’t know that the farm sits on oil reserves, I’m likely to sell it for less than I should have.  Missing a crack in the foundation is not likely to cost me near as much as either of the preceding two oversights.  The past decade has taught us that markets can stay inefficient for sustained periods of time (see real estate prices 2004-2007 in particular), and that longer the condition exists the greater the inevitable effects seem to be.  The point is that overlooking something that is entirely unlikely can, in our world, have exponentially greater ramifications that overlooking the more ‘obvious’ risk [the fault line vs. the foundation crack].

The lesson should be a different approach to ‘risk management’ [or bet selection], with a focus on determining the scenario that bares the greatest ramifications – regardless of its’ likelihood.  The lesson is not to avoid risk.  The lesson is to focus on what we don’t know, not what we know – it seems very seldom that people are surprised by the obvious risk, and more often that lives are affected by something that ‘could never have been expected.’

On Probability, Risk, & Outliers; Fantasy Sleepers, Exogenous Events, Upsets,and The Next Big Thing

In a ‘streaming’ world of trending-now topics, flash crashes, upsets,underdogs, hurricanes, earthquakes, and tsunamis, many of should be questioning; “what is it exactly that we ‘actually’ do know?”  In short, the answer is not much.  But that does very little to help any of us get out of bed with anymore certainty about what to expect ‘today,’ as opposed to any other day.  The issue, I believe, is that the one thing that has eluded us, after a century of rapid innovation, is that we don’t really know all that much.

We are conditioned to look at past events, statistics and forecasts and draw some kind of conclusion about what the future of may hold, based on that information.  I am here to tell you a number of things, not the least of which is that what you think is ‘information’ often isn’t.  Nassim Nicholas Taleb has discussed this at length in his books (‘Fooled by Randomness’ and ‘The Black Swan’), but some of  the reasons his books are so profound are that: 1, they are so in-depth and intellectual that the majority of society will never derive any benefit from them and, 2, that those who can derive benefit from them are unlikely to comprehend the vast applications of this knowledge in their day-to-day life.

This is primarily a consequence of ‘what we think we know’ as opposed to ‘what we know,’ the difference between information and noise, and the notion that what we do ‘know’ about is that history can mean little to nothing as it pertains to ‘predicting’ our future. Secondarily, our failure to understand the difference between ‘low probability’ and ‘low risk’ is perhaps the greatest flaw, and the defining characteristic, of mankind. And, thirdly, our problem of assuming low probability/high impact events are somehow more likely once we’ve experienced them (think 9/11), when the likelihood of them occurring again may actually be remote even as compared to their original probability (The notion that, by virtue of having happened, a repeat of 9/11 occurring is far less likely than the probability of it having occurred in the first place – originally we couldn’t imagine it, now that we can imagine it, it would be harder to surprise us; because we can now actually contemplate that type of attack now.  Think to yourself – Given what we know now, would someone in ‘intelligence’ again dismiss the chances of such an attack if they had a warning?  Of-course not, but the first time they did).

Probability versus Risk:

People have a habit of confusing an events’ probability (The likelihood of an occurrence) with the risk of said event (the impact of its’ affect).  As human beings, we seem hard-wired to associate low-probability events as having low risk – because, there is less ‘risk’ of that event coming to pass.  Unfortunately, however, the reality is; that which we do not expect usually ends up defining our lives.

Now, for a more practical (or philosophical) description of these concepts I will defer to Taleb but, I want to broaden the scope of areas to which we typically attribute this phenomena.  Some of the obvious areas we might expect to find low probability events that carry tremendous impact are:

  • Weather (Hurricanes, Tornadoes)
  • Geological (Earthquakes, Tsunamis, Volcanoes)
  • Financial (Crashes, Depressions, Bankruptcies, Bubbles, and the occasional Divorce [See Tiger Woods])
  • Social (Facebook, Twitter, Civil Rights, Prohibition, and the LA Riots)

There are, however, an ever-growing number of additional areas where we can be increasingly (or world is accelerating faster than we are) clueless as to the impact of what we don’t expect:

  • Financial (Counter-Party Risk, Layoffs, Leverage, and the occasional Divorce [See Tiger Woods])
  • Consumer (Penicillin, Blood-Letting, Viagra, Napster, Laser-Disk, 3-D (The 1st time), Brandy, LSD, Teflon, and 8-Track tapes)
    • Note: I include not just accidental discoveries and unforeseen successes, but also ‘the next big thing’ that wasn’t.
  • Sports (Fantasy ‘Sleepers,’ 2008 NY Giants, Tom Brady, Kirk Gibson, and the 1980 USA Men’s Hockey Team)
  • Political (Elliot Spitzer, the ‘Tea-party,’ Barack Obama, and Marxist Communism)
  • Geopolitical (The Roman Empire, Christopher Columbus can’t drive, Mussolini, Hitler, Fidel Castro, and Osama Bin Laden)
  • Media (Radio, the Phonograph, Napster, the iTunes store, Howard Stern, Mary Tyler Moore, ‘The Jeffersons,” YouTube, and the Internet)
  • Religion (the very fact that this looks like it doesn’t belong here is why it does – we’re human beings, we blame everything on religion – if a highly unlikely, cataclysmic event occurred, that was man-made, a substantial portion of the population would attribute it to religion [or rather, God]; either to blame it on or to justify it)
  • Social (the 1960’s, Disco, Google, the Beatles, and Paris [Perez] Hilton)
  • And, I’m certain, many more

What we must realize is that in a world where we can derive a measurable benefit from ‘predicting’ a fairly likely event (Super Bowl Winner, company earnings, or next week’s weather) based on observation/study of past events, that we would derive an immeasurable benefit by being able to understand that the most important events [trends, catastrophes, plagues, or inventions] in our lives will be relatively unpredictable. My fiancée told me a few months ago that on our Wedding Day the sun would be setting at precisely 6:29pm, and that pictures needed to be complete before then. Today I learned that, 4 days before my Wedding, that a computer error had somehow left us without a suite for the eve of our Wedding, and that our florist/decor-person somehow did not recall on what day of the week our Wedding is to take place.  The point is, no matter how much you plan, that whatever can go wrong will go wrong (Murphy’s Law) and, more importantly, is what you least expect (e.g. something you thought you planned for).  What I am more concerned with, however, are those things so ‘random’ that they cannot possibly be expected from our past experience. (e.g.  ‘The sun never rises on my Wedding Day.)

Final Thoughts:

We have been conditioned, in part by our very nature to conform and by the globalization of our minds, to over-expect that which we can conceive of (my friend was in a car accident, so I ride in anything with wheels) and under-expect  that which we have no reason to contemplate (the Bubonic Plague, 1929, Dec 7th, 1942, JFK, 9/11, flash-crash, stock prices in late 90’s, real estate prices in mid 2000’s, our opinions of newly elected officials, and the 2008 Giants – what can I say? I bleed blue).  What does second category have in common?  They were things that, for those who were/are most affected, were barely imaginable to most people before the fact – some could have been foreseen, and some not.  What we should consider is that if we could conceive that any of the events I mentioned were even plausible before the fact, that even if they were to occur the ramifications would be reduced by virtue of the fact that we were able to contemplate such a thing.

We did not understand disease at the time of the plague, had we understood how sickness spread then the effect of the outbreak likely would have been reduced.

On the morning of Pearl Harbor some people knew that there were planes inbound, but no one believed there was a way foreign aircraft could have had enough fuel to reach that outpost let alone launch an attack.

Yes, market crashes have happened famously a few times but, it’s always the speed that surprises – we always convince ourselves we know what to look for, and the reason we crash is partly because we didn’t think it could happen that way.

I won’t try to discuss Kennedy, but I will say this:

When the NY Giants met the New England Patriots in the Super Bowl most pundits favored the Pats in a veritable landslide. Bookies across the country fielded odds grossly favoring the unbeaten Pats over the upstart G-Men.  I was baffled.  While I saw that the Pats were far superior, and I knew that if they met 10 times, with those rosters, that the Giants would be lucky to win more than once.  But what I also knew was this: As far as I was concerned there was an extremely low probability that one NFL team could beat another 3 times in one season. The Giants had played and lost to the Patriots not only in the epic Week 17 the clinched an undefeated season for the Pats, but they also were defeated by  the Patriots in the preseason that year.

  • If you viewed that game as a lone event –  a best of one series, then you would not likely contemplate that the odds of the Super Bowl weren’t ‘will the Patriots beat the Giants today?’ But rather, ‘Can the same Patriots coaches, players, and playbook beat this Giants team for a 3rd time in 3 games (in one season)?’
  • Having extra information, such as knowledge of the ‘odds’, seems to prove to be only a danger to ourselves and others.

A Moving Precipice, Creator of Black Swans, and Bubble Popper

A loosely defined phenomena which we are seeing pervade all manner of life is something I am calling, moving precipices.  This phenomenon is pervading nearly every aspect of our lives –  typically media, it now transcends society through politics, disease, terror, technology, and investing.  What I am describing is, in our globalized world, is not unlike what was described in “The Tipping Point” by Malcolm Gladwell; that singular moment when an idea, trend, or social behavior reaches a given point, and simply explodes.

The point of contention is, however, the acceleration of the ever so opaque and difficult to predict moment.  Take Google for example, a company that, by virtue of what it was, was virtually at a ‘tipping point’ at its’ inception; achieving a market capitalization of over $150 billion within a decade.  I have no doubt in my mind that due to the ever-increasing interconnectedness of things, coupled with innovation, that in our lives we will see companies that grow from venture-stage to over $200 billion market-caps within 5 years.  Again, the precipices are moving closer and, their effects are multiplying exponentially.

Evidence of this has been seen in the medical arena, take swine flu for example.  Now you can take the other side of the argument, saying that it was overblown by the media and a non-event; but that too is the point.  The rapidity of the spread of sickness has certainly accelerated with innovation in travel, and continues to accelerate as more and more of the world becomes industrialized, but the hysteria that accompanies a potential, say pandemic, now spreads at the speed of sound.  From a business perspective, it is just as important to be able to effectively position yourself for the hysteria as much as the reality; many winners were crowned in the stock market if a company was perceived to have a ‘cure’ or viable treatment.  We saw this recently with companies that had ‘swine flu’ treatments, or years ago if you happened to have a stockpile of “Cipro” during the anthrax scare.  The point is, even in medicine, we are seeing a sort of ‘critical mass’ reached ever earlier in the life-cycle of a particular trend.

This week, for example, I believe we may have seen the pronounced effect on social networking on Andy Reid of the Philadelphia Eagles.  Laugh if you like, but think of years passed when Coach Reid was virtually oblivious to calls for his head (and his job) whilst making questionable coaching decisions.  Simply put, today the shear onslaught of backlash that is possible from the twitter’s and Facebook’s of the world (not to forget Word Press) is such that the wave of public opinion is cresting virtually moments after it initially swells.  This week, it took Andy Reid less than 24 hours to completely change his mind about his quarterback and, essentially, the direction of his entire franchise.   Also this week, an Australian boy singlehandedly (and inadvertently) caused Twitter to be hacked by exploiting a tiny bit of coding error – within seconds his maneuver had been exploited, automatic posts began redirecting users to porn sites!!  I remember the days of AOL when it took days for a virus to spread to that number of people.  But, guess what?  Now there are a lot more of us plugged in, and we’re all streaming!

For years we have seen this effect in media, and it has accelerated with every major new innovation in media since the phonograph.  Today, media darlings are crowned almost over night.  It spreads like a virus and does not just pervade music, for example, but also sports, writers/bloggers, and even with popular Twitter pages being made into TV shows.  We live an in ‘Trending Now’ world, and we have to be prepared for it because we have not evolved enough to increase our potential to process this information as fast as the speed of this information can multiply.  What am I saying? Life, much like today’s markets, happens in real-time but it is not necessarily efficient; it can be wrong.  That is perhaps the greatest difficulty navigating this type of environment; knowing when and if to act on information (that may in fact be noise, not information) that occurs in  real-time, and at any moment critical mass can be reached.

We have also seen this phenomenon in politics.  I’m sure we all have a sense of how Obama was the first Presidential candidate to reach the masses with Tweets and social-networking sites, but that’s not it entirely.  Take the Tea Party movement, a viral political movement sweeping the nation because a nation wanted it and, more importantly, it moved it the speed of  sound.  And we wonder why China wants to restrict Google, and limit the flow of information.  They realize that in this day and age that information is a contagious as it ever was; an idea can spread like wildfire and grip a nation in absurdly short periods of time.

How does this relate to finance you might ask?  Does anyone remember My 6th, 2010?  Oh yeah, the flash crash.  Well what I am saying is that this is a direct result of this phenomena.  Do I have evidence? About as much as the anyone (probably more, which is to say none at all), and I think if we had any meaningful volume since May we would’ve had another one.  But, let’s take a step back.  What were talking about here, in essence, is the confluence of three very popular schools of thought that we will call: tipping points, black swans, and bubbles.  As we continue we will delve into all manner of mania, trends, fads, epidemics, pop-culture phenomena, asset bubbles, and identifying those critical moments when an idea or trend catches like wildfire and, as I like to put it, when ‘cancer spontaneously cures itself’ (and disco dies overnight).