Random Gym Lockers

I joked in the gym locker room this evening with a guy how Murphys Law will ensure that when you are changing and there are tons of free lockers in our section he will have his kit in the locker next to me.

The point of this post is that while it feels like it happens pretty often the truth is it is nothing more than random coincidence and all the times it doesn’t happen these occurrences simply go unnoticed. I think due to the inconvenience and the invasion of space especially when dangly bits are out in the open we tend to notice the times when the lockers are next to each other and because they make an impact it feels more often than random.

This is precisely what happens in the market place. Certain setups make a stronger impact on us and this impact leads us to believe that we have identified a new trend.

I am a very statistically aware person and I feel the jar when I observe people make these misguided statements. What is even more jarring is when I observe myself make these same mistakes. 😤

Low interest rate projections

John Hussman strategic growth fund is getting absolutely killed in the current bull market but he remains one of the clearest economic thinkers I follow. His research is top draw here are some interesting insights:

“it’s tempting to believe that low interest rates “justify” elevated equity valuations. But as one can show with any straightforward discounting method, even another 5 years of zero short-term interest rates (compared with a more typical 4% short-term yield) would only justify valuations about 20% above historical norms – essentially 5 years x 4%. Instead, current U.S. equity valuations are about 112% above historical norms on reliable measures. To justify current equity market valuations, interest rates would need to be held at zero for the next quarter century. Understand that while suppressing short-term interest rates may encourage yield-seeking speculation that results in rich stock valuations, those rich valuations are still followed by dismal subsequent returns. Emphatically, low interest rates do not raise the future return on stocks – quite the contrary.”

Here are some further insights Hussman brings from Daniel Kahneman.

So why do policy makers so wildly overestimate the real economic effects of monetary policy (while vastly underestimating its effects in distorting financial markets)? In his book, Thinking, Fast and Slow, psychologist and Nobel laureate Daniel Kahneman describes the biases and rules-of-thumb that people often use to estimate the impact of one piece of information in explaining another. When presented with some piece of evidence, some judgements rely on precise calculations and historical estimates. Others, Kahneman writes, “arise from the operation of heuristics that often substitute an easy question for the harder one that was asked… As a result, intuitive predictions are almost completely insensitive to the actual predictive quality of the evidence.”

Kahneman describes the way that these intuitions give rise to inaccurate predictions. First, some piece of evidence – the stance of monetary policy – is provided. The associative memory quickly constructs a story that links the evidence to whatever is to be predicted – the most likely story being that easy monetary policy will boost the economy, while tight monetary policy will slow it. The next step, says Kahneman, is “intensity matching.” The flimsy evidence is ranked in intensity, and that same intensity is used to produce the forecast for the variable to be predicted. So regardless of whether monetary policy is actually correlated with the economy or not, we naturally assume that extreme monetary policy should have similarly extreme effects on the economy, and in the expected direction. As Kahneman writes, “Intensity matching yields predictions that are as extreme as the evidence on which they are based, leading people to give the same answer to two quite different questions.” In this case, one question is “how easy is monetary policy?”, while the other is “where is the economy headed?”

The problem here is that the quality of the evidence – the strength of the correlation – is not being considered. Kahneman offers a way to improve on these intuitive predictions. In the present context, that method would go something like this: 1) Start with an estimate of economic growth in the absence of any monetary intervention; 2) Estimate the rate of economic growth that best seems to match the intensity of monetary policy; 3) Estimate the actual correlation between monetary policy and economic growth (hint: about 0.15); 4) If the correlation is 0.15, move 15% of the distance from the baseline GDP growth to the GDP growth matching monetary policy.

[Geek’s note: You can show statistically that if Zy and Zx are standard normal variables (where, for example, Zy is just GDP growth minus its mean, divided by the standard deviation of GDP growth), Kahneman’s formula gives the best linear estimate of Y given X, since the beta in a regression of Zy on Zx is just the correlation between the two. To illustrate, the mean of quarterly real GDP growth is 3.2% at an annual rate, with a standard deviation of 3.9%. The historical mean of the federal funds rate is about 4.9%, with a standard deviation of 3.9%. So holding the fed funds rate at zero is a Z statistic of -1.25. With a correlation of -0.15 between fed funds and subsequent GDP growth, at best, this translates to a Z statistic for GDP of 0.19, and multiplying by the standard deviation of GDP suggests that holding fed funds at zero would be expected to provide a bump to real GDP growth no greater than about 0.7% annually. That figure strikes us as about right, though in practice, GDP growth in recent years has fallen short of even the baseline that one would have projected in the absence of monetary intervention].

How much impact should we expect a 0.25% increase in the fed funds rate to have on economic growth? 0.25% is only an increase of 0.06 standard deviations in the fed funds rate, which would reasonably be associated with -0.15 x 0.06 = -0.009 standard deviations in GDP growth. So based on the historical relationship between the fed funds rate and subsequent GDP growth, the impact of a quarter-point hike in the fed funds rate would be expected to be a reduction in GDP growth of just four one-hundredths of one percent below what would otherwise be expected in the absence of that change.

Fatorexia & Cognitive Dissonance

My wife tells me I am suffering from Fatorexia an affliction where I look in the mirror and see this buff well built guy, like the one in the picture (oops sorry that is not a man) but at the end of the day I am actually overweight by 5 – 10 kg’s, that is me on the right.

A few months ago I started pushing myself at the gym and I can physically feel the increase in my strength, as well as see a notable growth in the size of my muscles. What is interesting is that I cannot seem to see that I am carrying a few extra kilo’s in fat. Why is that?



There is a psychological term for this condition called cognitive dissonance. What the human mind does when confronted with something that contradicts ones original belief is to completely dismiss the new information. However, the mind is so powerful that if ones original belief is so strong, it can influence the person experiencing this dissonance to transform the negative information into a positive belief. So in my case I see the growth in muscle, and anything contradictory to that is magically transformed. What my wife is seeing as fat I am seeing as mass/bulk all positive for a bodybuilder (by the way it wasn’t only my wife, my son was pretty vocal about the bulge as well).

So what made me see the light? I am not sure exactly but on my recent holiday to Melbourne I caught a glimpse of myself in a very unflattering mirror which completely shattered my illusion. I use dramatic language here as I believe there is no way to come to your senses gently, one needs to be confronted in order to see the “true” light refracted in its essence.

I use this analogy to describe a similar cognitive dissonance the global economic world is currently experiencing, with Europe being amongst the most deluded.

In John Mauldin’s latest weekly he shows a number of sovereign bond yields. Let me start this section by saying that if you want to deposit your cash in a Swiss bank denominated in francs you can expect to pay the bank -0.75% per annum. Yes you put money on deposit and you don’t earn interest you pay interest. Let us look in the chart below a little further out on the yield curve, oh boy Swiss bonds have a negative yield for the next 10yrs. We have German bond yields negative for 6yrs and the French and Netherlands 4yrs.


To me this is DEFLATION and an ill wind is in the air. To me the world of finance is suffering from a serious dose of cognitive dissonance. It is all out there on everyone’s Bloomberg screen or the latest IMF data release or whichever investment bank you receive your daily poison from.

Just like the emperor eventually realized he had no clothes on, we will soon realize we cannot live in a world where there is no incentive to invest in sovereign government debt, and the only bid propping up these artificial egregious prices is the central banks buying, mandated by the governments issuing the debt.

Last weeks SNB “unpegging”, may just have been the shock we needed to see that with all the risk on governments balance sheets we cannot effectively price risky assets (read: stocks, corporate debt, property, etc) off a benchmark that is not truly reflecting any risk.

I am now officially issuing a warning of beware; the seeds of instability in the system as Hyman Minsky writes is now in motion and we should expect the unexpected and one thing I can promise is that it is a lot worse than a few kilo’s of schmaltz.

The Dark Side – Shadow

This is a strange topic to be writing about on the eve of Christmas where the western world is gripped in a mood of good cheer; yet here I am writing about evil. I woke up to the Dow closing above 18,000 for the first time and the S&P500 making new all time highs, and I felt compelled to share some wisdom.

Yes I am bearish the markets at the moment, and yes it is a source of irritation, annoyance and confusion so with that bit of background lets dig a little deeper. In order to do so we need to start with a quote from Jung’s Collective Works:

Unfortunately there can be no doubt that man is, on the whole, less good than he imagines himself or wants to be. Everyone carries a shadow, and the less it is embodied in the individual’s conscious life, the blacker and denser it is. If an inferiority is conscious, one always has a chance to correct it. Furthermore, it is constantly in contact with other interests, so that it is continually subjected to modifications. But if it is repressed and isolated from consciousness, it never gets corrected.

“Psychology and Religion” (1938). In CW 11: Psychology and Religion: West and East. P.131

In layman language, just like the name “shadow” implies the Jungian idea is that each persons psyche develops both positive and negative characteristics with each lived experience. The negative ones embarrass us, and we prefer not to deal with these emotions so we cast them into the shadows, i.e. into our unconscious minds where we try not confront them and try and forget about it.

I am touching on a central Jungian motif, coincidentia oppositorum – unity of opposites, which many dialectical philosophical models work with, but is an idea I am familiar with and is central to the Jewish Kabbalistic approach to creation and existence. The sitra achra means the “other side” that is from the sitra kedusha “side of holiness” and everything in the world can be seen from these polar opposites.

Ok lets get back to the subject of this note, that is the dark side our shadow. It is very important when working with the Jungian model to see psycho-dynamics in terms of energy flow. As we create positive energy so too we equally create negative energy, this is actually a very difficult concept to grasp. Here is an example; I act in a very “kind” way to Dean this creates positive energy, but there is an equal dark “mean” force created in my psyche towards Dean. That is a horrible theory you are probably saying, but that is probably your shadow acting up 😦 .

So you are probably saying assuming you accept this line of thinking – so what? The problem is that when emotions are left unconscious they form a life of their own and this is where we get ourselves into trouble. A typical manifestation of the shadow complex is for it to find expression via projection. The reason why we don’t want to allow projection to play out is due to the completely irrational / random nature of projected behaviour. Here is an example of how this plays out:

Its the holiday season and we live in beautiful Sydney a highly desirable location. Friends contact me and ask if they can stay with us for a few days as they are passing through town. I accept and I am the perfect host. I use every bit of my energy to make sure that our guests have a great time. I am attentive, I am resourceful I am all things good what I am unaware of is I am building shadow material. The guests leave having had the best stay ever, and I am just about to kick up my feet and peace out in quiet watching some cricket, and the missus says, “Mike will you go past the shops and pick up some bagels”. What do I do, I go friggin mad and scream and shout how ungrateful she is and launch into a completely irrational tirade. Do any of you recognize this pattern, I suspect so LOL :).

We have all heard that saying, “the bigger you are the harder you fall”. This is very common with politicians or other people who occupy positions of power. I think of Elliott Spitzer as a classic example of someone who clamped down on crime and prostitution only to fall for this very activity. Or think of religious people perpetrating sexual misconduct, acting precisely against what the religion they represent stands for.

Does this mean we are destined to be ruled by our shadow? No not at all, the secret is to bring our shadow into consciousness. This secret formulae has the potential to diffuse the negative energy. What is even more amazing is that our psyche can be “tricked” through symbolic ritual/activity. Marie Louis von Franz one of Jung’s greatest disciples, used to always recommend to friends and colleagues experiencing hubris to go and take out the trash or some such “lowly” activity to symbolically balance the libido/energy from the shadow.

With many stock indexes at all time highs, it is easy to develop shadow material. It is times like these when markets climb and we profit to fall into the fooled by randomness trap and think it is all us. This shadow material will eventually want to express itself, it may be through excessive risk taking due to our inflated sense of Self or it may manifest in us buying a Porsche that we cannot really afford. Remember the psyche is open to symbolic gestures, if you have benefited from the bullish markets, think of a creative way of bringing the shadow material associated with it to consciousness or less energy potent. Perhaps it may be something as simple as this:

I made 25% in my investment portfolio this year, when I take the market beta into account I actually only added about 2% through my stock picking ability. This is a simple way of acknowledging and diffusing the shadow that likes to think that all 25% was my doing.

Correlation ≠ Causation

I just had to put this point down on paper. I was thinking about it earlier and wanted to highlight the point with a strong visual image. I will go into more depth in one of my Sunday letters next year and show how prevalent this line of thinking is in trading.

How silly we seem to be seeing spooks in the dark. Actually there is something called the “confounding variable” which is one of the factors that steers us off course. More about it in the new year.

Lets keep this a little light into the new year. 😉


Media pushing an Agenda

One of my favourite market connoisseur’s Ben Hunt put this out last week.

Yesterday the Wall Street Journal ran a front page story titled “OPEC Sees Less Demand for Its Oil in 2015”, as well as another article with the following quote: “OPEC’s output exceeded its quota by 50,000 barrels a day in November, the group said.”
That’s all true, and all supportive of today’s dominant Narrative that OPEC is broken and oil is now in free fall.
Wanna know what else is true? November OPEC production was down 390,000 bbls/day from October and down 510,000 bbls/day from September. But, hey, we can’t have crucial facts get in the way of a dominant Narrative, now can we?

This is something I comment about frequently but it is always good to post examples, this helps build an intuitive filter into our psyche. You will be amazed at how attuned you become to biased media reporting when you become aware of its presence.