My editorial
on You Tube
On February 24th, after I
posted my last update ( Bloody hard to make a strategy ), I did what I was declaring I
would do: I bought 1 share of Invesco QQQ Trust (QQQ) for $224,4, 5 shares of Square Inc, at $76,85, thus investing $384,25 in this
one. Besides, I have just placed an order to buy one share ($33) of Virgin Galactic Holdings, mostly because it is high tech.
These are the small steps I took,
but now, as financial markets are freaking out about coronavirus, it is the
right moment to figure out my endgame, my strategy. Yes, that’s surely one
thing I have already nailed down as regards investment: the more the market is
driven by strong emotions, the more I need to stay calm. Another thing I have
learnt by experience is that it really pays off, at least for me, to
philosophise about the things I do, would it be science or a business strategy.
It really pays to take a step back from current events, sit and meditate on
said events. Besides, in terms of scientific research, I am currently working
on the ways to derive economic value added from environmental projects. I guess
that fundamental questioning regarding economic value and decisions we make
about it will be interesting.
When I philosophise about anything
connected to social sciences, I like talking to dead people. I mean, no
candles, no hand-touching, just reading and thinking. I discovered that I can find
exceptionally deep insights in the writings of people labelled as ‘classics’.
More specifically, books and articles written at an epoch when the given type
of economic institution was forming, or changing fundamentally, are
particularly insightful. It is a little bit as if I were an astrophysicist and
I had a book, written by an alien who watched the formation of a planet. The
classic that I want to have a word with right now is Louis Bachelier. I am
talking about Bachelier’s ‘Theory of Speculation’ , the PhD thesis from 1900,
originally published in French as ‘Théorie de la spéculation’ (Bachelier 1900[1]).
Here’s how Louis Bachelier introduces his thesis: ‘INTRODUCTION. The
influences which determine the movements of the Stock Exchange are innumerable.
Events past, present or even anticipated, often showing no apparent connection
with its fluctuations, yet have repercussions on its course. Beside
fluctuations from, as it were, natural causes, artificial causes are also
involved. The Stock Exchange acts upon itself and its current movement is a
function not only of earlier fluctuations, but also of the present market
position. The determination of these fluctuations is subject to an infinite
number of factors: it is therefore impossible to expect a mathematically exact
forecast. Contradictory opinions in regard to these fluctuations are so divided
that at the same instant buyers believe the market is rising and sellers that
it is falling. Undoubtedly, the Theory of Probability will never be applicable
to the movements of quoted prices and the dynamics of the Stock Exchange will
never be an exact science. However, it is possible to study mathematically the
static state of the market at a given instant, that is to say, to establish the
probability law for the price fluctuations that the market admits at this
instant. Indeed, while the market does not foresee fluctuations, it considers
which of them are more or less probable, and this probability can be evaluated
mathematically.’
As I see, Louis Bachelier had very
much the same feelings about the stock market as I have today. I am talking
about the impression to be rowing in a really tiny boat across a bloody big
ocean, with huge waves, currents and whatnot, and a general hope that none of
these big dangerous things hits me. And yes, there are sharks. A natural
question arises: why the hell stepping into that tiny boat, in the first place,
and why leaving shore? If it is that risky, why bother at all? I think there is
only one sensible answer to that: because I can, because it is interesting, and
because I expect a reward, all three in the same time.
This is the general, duly snappy
reply, which I need to translate, over and over again, into goals and values.
Back in the day, almost 30 years ago, I used to do business, before I went into
science. For the last 4 years or so, I am thinking about getting back into
business. The difference between doing real business and investing in the stock
market is mostly the diversification of risk. I dare say that aggregate risk is
the same. When I do real business, as a small businessman, I have the same
feeling of rowing in that tiny boat across a big ocean. I have so little
control over the way my small business goes that when I manage to get in
control of something, I get so excited that I immediately label that controlled
thing as ‘successful business model’. Yet, running my own small business is so
time and energy absorbing that I have hardly any juice left for anything else.
I have all my eggs in the same basket, i.e. I do not hedge my risks. With any
luck, I just insure them, i.e. I share them with someone else.
When I invest in the stock market, I
almost intuitively spread my equity over many financial assets. I hedge the
business-specific risks. Here comes an interesting question: why did I choose
to invest in biotechnology, renewable energies and IT? (see Back in the game ). At the time, one month ago, I
made that choice very intuitively, following my intellectual interests. Now, I
want to understand myself deeper. Logically, I turn to another dead man: Joseph
Alois Schumpeter, and to his ‘Business Cycles’. Why am I knocking at this
specific door? Because Joseph Alois Schumpeter studied the phenomenon of
technological change with the kind of empirical assiduity that even today
inspires respect. From Schumpeter I took that idea that once true technological
change starts, it is unstoppable, and it inevitably drives resources from the
old technologies towards the new ones. There are technologies in the today’s
world, precisely such as biotechnology, information technologies, and new
sources of energy, which no one can find their way around. Those technologies
are already reshaping deeply our everyday existence, and they will keep doing
so. If I wanted to start a business of my own in any of these industries, it
would take me years to have the thing running, and even more years to see any
economic gains. If I invest in those industries via the stock market, I can tap
directly into the economic gains of the already existing businesses. Egoistic
but honest. I come back to that metaphor of boat and ocean: instead of rowing
in a small boat across a big ocean, I hook onto a passing cruiser and I just
follow it.
There is more to the difference
between entrepreneurship, and investment in the stock market. In the latter
case, I can clearly pace myself, and that’s what I do: every month, I invest
another parcel of capital, on the grounds of learning acquired in past months.
In entrepreneurship, such a pacing is possible, yet much harder to achieve.
Capital investment required to start the business usually comes in a lump: if I
need $500 000 to buy machines, I just need it. Of course, there is the
fine art of engaging my own equity into a business step by step, leveraging the
whole thing with credit. It is possible in an incorporated business. Still, the
very incorporation of a business requires engaging a minimum equity, which is
way greater than the baby steps of investment.
Incidentally, the very present
developments in the stock market make an excellent opportunity to discuss more
in depth. If you care to have a look at the NASDAQ Composite Index , especially at its relatively
longer time window, i.e. from 1 month up, you will see that what we have now is
a typical deep trough. In my own portfolio of investment positions, virtually
every security is just nosediving. Why does it happen? Because a lot of
investors sell out their stock, at whatever price anybody is ready to pay for
it.
Have you ever wondered how do stock
prices plummet, as it is the case now? I mean, HOW EXACTLY? Market prices are
actual transactional prices, i.e. prices that actual deals are closed at. When
stock prices dive, people who sell are those who panic, I get it. Who buys? I
mean, for a very low stock price to become a market price, someone must be
buying at this specific price. Who is that, who buys at low prices when other people
freak out and sell out? Interesting question. When the market price of a
security falls, the common interpretation is: ‘it is ‘cause that security
has become less attractive to investors’. Wait a minute: if the price
falls, someone buys at this falling price. Clearly, there are investors who
consider that security attractive enough to pay for it even though the price is
likely to fall further.
When a whole market index, such as NASDAQ Composite, is skiing downhill, I can see the same
phenomenon. Some people – right, lots of people – sell out whatever financial
assets they have because they are afraid to see the market prices fall further
down. Some other people buy. They see an opportunity in the widespread
depreciation. What kind of opportunity? The one that comes out of other people
losing control over their behaviour. Now, from there, it is easy to go into the
forest of conspiracy theories, and start talking about some ‘them’, who ‘want
to..’ etc. Yes, there is a rational core to those theories. The stock market is
like an ocean, an there are sharks in it. They just wait patiently for the prey
to come close to them. Yes, officially, the spiritus movens of the present
trough in stock markets is coronavirus. Wait a minute: is it coronavirus as
such, or what we think about it? Wait another minute: is it about what we think
as regards the coronavirus, or about what we expect other people (in the stock
market) to think about it?
When I look at the hard numbers
about coronavirus, they look refreshing. When I divide the number of fatalities
by the number of officially diagnosed cases of infection, that f**ker is, under
some angle, less deadly than common flu. Take a look at Worldometer: 85 217 official carriers of it, and
2 924 of those carriers dead. The incidence of fatality is 2924/85217 =
3,43%. A study by the Center for Infectious
Disease Research and Policy at the University of Minnesota finds an even lower rate: 2,3%. As
reported by CNBC, just in the United States of America, during
the on-going flu season, the flu virus has infected 19 million people, and
caused 10 000 deaths. The incidence of death among people infected with
flu is much lower, 10000/19000000 = 0,05%, yet the absolute numbers are much
higher.
Please, notice that when a real
panic overwhelms financial markets, there is no visible fall in prices, because
there are no prices at all: nobody is buying. This is when pricing is
suspended, and the stock market is effectively shut down. As long as there are
any prices in the market, some market agents are buying. Here comes my big
claim, sourced in my recent conversation with the late Joseph Schumpeter: the
present panic in the stock market is just superficially connected to
coronavirus, and what is manifesting itself deep underneath that surface is
widespread preparation for a bloody deep technological change, coming our way
right now. What technological change? Digital technologies, AI,
robotization, shift towards new sources of energy, and, lurking from the bottom
of the abyss, the necessity to face climate change.
I am deeply convinced that my own
investment strategy, should it demonstrate any foresight and long-range
planning, should be most of all espousing the process of that technological
change. Thus, it is useful to understand the process and to plan my strategy
accordingly. I have already done some research in
this field and my
general observation is that technological change as it is going on right now is
most of all marked by increasing diversity in technologies. What we are
witnessing is not just a quick replacement of old technologies by new ones:
that would be too easy. Owners of technological assets need to think in terms
of stockpiling many generations of technologies in the same time, and the same
place.
From the point of view of an
entrepreneur it is what the French call “l’embarras du choix”, which means
embarrassingly wide range of alternative technological decisions to take. I
described it partially in ‘4 units of quantity in technological
assets to make one unit of quantity in final goods’. Long
story short, there is a threshold speed of technological, up to which older
technological assets can me simply replaced by newer ones. Past that threshold,
managing technological change at the business level becomes progressively more
and more a guessing game. Which specific cocktail of old technologies, and
those cutting-edge ones, all that peppered with a pinch of those in between,
will work optimally? The more technologies we can choose between, the more
aleatory, and the less informed is the guess we make.
I have noticed and studied one
specific consequence of that ever-widening choice of technological cocktails:
the need for cash. Mathematically, it is observable as correlation between two
coefficients: {Amortization / Revenue} on the one hand, and {Cash
& cash equivalent / Assets} on the other hand. The greater a
percentage of revenues is consumed by amortization of fixed assets, the more
cash (in proportion to total assets) businesses hold in their balance sheets. I
nailed it down statistically, and it is quite logical. The greater a palette of
choices I might have to navigate my way through, the more choices I have to
make in a unit of time, and when you need to make a lot of business choices,
cash is king, like really. Open credit lines with banks are nice, just as
crowdfunding platforms, but in the presence of significant uncertainty there is
nothing like a nice, fat bank account with plenty of liquidity at arm’s reach.
When a business holds a lot of cash
for a long time, they end up by holding a lot of the so-called ‘cash
equivalents’, i.e. a low-risk portfolio of financial securities with a
liquidity close to cash strictly spoken. Those securities are listed in some
stock market, whence an inflow of capital into the stock market from companies
holding a lot of cash just in case a breakthrough technology pokes its head
from around the corner. Quick technological change, quick enough to go past the
threshold of simple replacement (understood as straightforward shift from older
technology towards and into a newer one), generates a mounting wave of capital
placed on short-term positions in the stock market.
Those positions are short-term. In
this specific financial strategy, entrepreneurs perceive the stock market as
one of those garage-size warehouses. In such a place, you can store, for a
relatively short time, things which you don’t know exactly what to do with, yet
you feel could need them in the future. Logically, growing an occurrence of of
short-term positions in the stock market induces additional volatility. Each
marginal million of dollars pumped in the stock market via this tube is more
restless than the previous one, whence increasing propensity of the market as a
whole to panic and run in the presence of any external stressor. Joseph
Schumpeter described that: when the economy is really up to a technological
leap, it becomes overly liquid financially. The financial hormone gets piled up
in the view of going all out.
I come back to thinking about my own
strategy. Whatever kind of run we have in the stock market right now, the
coronavirus is just a trigger, and the underlying tension it triggered is
linked to technological change of apparently unseen speed and complexity.
In my portfolio, just two positions
remain positive as for their return rate: Incyte Corporation and Square Inc.
All the others have yielded to the overwhelming panic in the market. Why? I can
follow the tracks of two hypotheses. One, those companies have particularly
good fundamentals, whilst being promisingly innovative: they sort of surf
elegantly on the wave of technological change. Two, it is more aleatory. In the
times of panic such as we experience now, in any given set of listed
securities, investors flock, in a largely random way, towards some businesses,
and away from others. Mind you, those two hypotheses are mutually complementary
(or rather they are not mutually exclusive): aleatory, panicky behaviour on the
part of investors conjoins with a good mix of characteristics in specific
businesses.
Right, so I have the following
situation. In my portfolio, I have two champions of survival, as regards the
rate of return – the above-mentioned Incyte Corporation and Square Inc.
– in the presence of all them other zombies that succumbed to the surrounding panic:
First Solar Inc., Macrogenics, Norsk Hydro, SMA Solar Technology AG, Virgin
Galactic Holdings, Vivint Solar, 11Bit, Asseco Business Solutions, AMUNDI EPRA
DR (ETF Tracker), and Invesco PowerShares EQQQ Nasdaq-100 UCITS (ETF Tracker).
I keep in mind the ‘how?’ of the situation. In the case of Incyte Corporation
and Square Inc., investors are willing to pay for them more than they were
ready to pay in the past, i.e. deals on those securities tend to be closed at a
ramping up average price. As for all the others, displaying negative rates of
return, presently investors pay for them less than they used to a few days or
weeks ago. I stress once again the fact that investors pay. This is how prices
are fixed. Whichever of those securities we take, some investors keep buying.
What I can observe are two different
strategies of opening new investment positions. The first one, largely
dominating, consists in buying into cheap stuff, and forcing that stuff to go
even cheaper. The second one, clearly less frequently occurring, displays
investors opening new positions in the market at a higher price than before. I
am observing two distinct behavioural patterns, and I presume, though I am not
sure, that these two patterns of investment are correlated with the intrinsic
properties of two supposedly different sets of securities. I know that at this
point I am drifting away from the classical ‘supply – demand’ pattern of
pricing in the stock market, yet I am not drifting really far. I acknowledge
the working of Marshallian equilibrium in that price setting, I just enrich my
investigation with the assumption of diverging behavioural patterns.
In my portfolio, I hold securities
which somehow are attached to both of those behavioural patterns. I have taken
a position on other people’s possible behaviour. This is an important finding
about my own investment strategy and the ways I can possibly get better at it.
I can be successful in my investment if I make the right guess as regards the
businesses or securities that incite the pattern of behaviour manifesting in
growing price that deals get closed at. What
I can observe now, in the times of panic in the market, is a selective panic.
As a matter of fact, even before that coronavirus story went western,
securities in my portfolio were disparate in their rate of return: some of them
positive, some others negative. What has changed now is just the proportion
between the positive returns and the negative ones.
Another question comes to my mind:
when I open positions on the stock of businesses in some selected technological
fields, like solar energy, do I participate in technological change, or do I
just surf over the top of financial foam made by that change? There is that
theory, called ‘Q theory of investment’ (see for example Yoshikawa 1980[2]), developed by James Tobin and William
Brainard, and that theory claims that when I invest in the stock of listed companies,
I actually buy claims on their productive assets. In other words, yes, listed
shares are just financial instruments, but when I buy them or sell them, I, as
an investor, I develop strategies of participation in assets, not just in
equity.
When I think about my own behaviour,
as investor, I certainly can distinguish between two frames of mind: the
gambling one, and the farming one. There are moments, when I fall,
unfortunately, into a sort of frantic buying and selling, and I use just small
bits of information, and the information I use is exclusively technical, i.e.
exclusively the price curves of particular securities. This is the gambling pattern.
I do my best to weed out this pattern of behaviour in myself, as it: a) usually
makes me lose money, like really and b) is contrary to my philosophy of developing
long term strategies for my investment. On the other hand, when I am free of
that gambling frenzy, I tend to look at my investment positions in the way I
look at roses in my garden, sort of ‘What can I do to make them grow bigger and
flourish more abundantly?’. This is my farming frame of mind, it is much less
emotional than the gambling one, and I intuitively perceive it as more
functional for my long-term goals.
Good, it looks like I should give
some provisional closure and put this update online. I think that in the presence
of a hurricane, it is good to stay calm, and to meditate over the place to go
when the hurricane calms down. I guess that for the weeks to come, until I
collect my next rent and invest it in the stock market, no sudden decisions are
recommended, given the surrounding panic. I think the best I can do during
those weeks is to study the fundamentals of my present portfolio of investment
positions and draw some conclusions from it.
If you want
to contact me directly, you can mail at: goodscience@discoversocialsciences.com .
[1] Bachelier,
L. (1900). Théorie de la spéculation. In Annales scientifiques de l’École
normale supérieure (Vol. 17, pp. 21-86).
[2] Yoshikawa,
H. (1980). On the” q” Theory of Investment. The American Economic
Review, 70(4), 739-743.
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