Decline and Fall

So far in my journey as a student of investing, I have gravitated towards the strategy of buying stakes in good businesses at reasonable prices. Execution of this strategy often involves investing in these great businesses when they are going through a period short term turmoil. This sounds simple enough. 

Although it sounds simple, it is quite challenging in practice. Investor's typically study a business' history and forecast its future. Evaluating historical track records is undoubtably a crucial part of analyzing  a business and is helpful for developing conviction in investment ideas. However, historical greatness does not imply future success. So, when great businesses sell-off, you run the risk of buying optically cheap businesses where the silent creep of impending doom has set in and the sell-off is, in fact, appropriate.

To learn how to avoid making such mistakes, I have read Jim Collins' How The Mighty Fall, which presents institutional decline as a staged disease. Collins develops a framework for identifying great companies, which are on the path of decline and fall. Here are my notes on Collins' framework.

Stage 1: Hubris Born of Success

For Collins, this stage is characterized by a change in the internal orientation of the company from an emphasis on understanding why you adhere to certain practices, to simply insisting that they are best. This in turn might mean that management stops focussing on the core business, failing to renew obsessively. Thus, the primary flywheel is neglected. 

Stage 2: Undisciplined Pursuit of More

Contrary to popular belief, not a lack of innovation, but overreach is the more common cause of decline, particularly for great businesses. This is for two reasons. First, when hubris kicks in, bravado (not insight and understanding) starts to drive decisions. Second, when businesses start to pursue new projects outside their circle of competence without the right people, they are forced to institute bureaucratic processes. Collins would say a culture of bureaucratic mediocrity replaces a culture of disciplined excellence.

Stage 3: Denial of Risk and Peril

This follows from stages 1 & 2. Management starts to "discount negative data, amplify positive data, and put a positive spin on ambiguous data". The last of these three is perhaps most dangerous. In stage 2, businesses take undisciplined risks. In stage 3, leaders fail (i) to cut losses when the facts change and (ii) to maintain a sharp focus on customer loyalty and stakeholder engagement.

Stage 4: Grasping for Salvation

Companies may stumble towards the end in stops-and-starts. Along the way, there are always moments of exuberant hope. A charismatic visionary, bold and revolutionary bets, that much-mentioned hoped-for-blockbuster. People become so desperate to avoid the worst outcome that they cling to the few straws (frayed as they may be) of hope. However, as is the case with a critical patient, the next speed bump is only too often around right around the corner. As goes the discerning Buffetism, turnarounds seldom turn. 

Stage 5: Capitulation to Irrelevance or Death

In Stages 1-4 organizations burn through cash. By stage 5 they are mere shadows of their former selves.

I find this this framework super useful. But, as a rookie, small investor who is not privy to the internal workings of a business and cannot meet management, I am faced with a practical issue: how do I determine if the silent creep of impending doom has set in? Collins' book suggests the following markers which one can look out for in company presentations and transcripts.

• Good decisions are attributed primarily to skill, and bad ones to luck
• Management exudes a know-it-all attitude
• M&A inconsistent with core business and values
• Personal interests are placed above organizational interests
• Management bets the ranch on grand visions and complete overhauls as opposed to taking a build, test and grow approach. 
• Hype about the future and insufficient focus on risks
• Constant reorganization and chronic restructuring
• Leadership churn
• ALSO: Watch out after a legendary leader steps away

Simple things matter

No one wanted the pandemic. It is, nevertheless, an opportunity to learn. In this post, I will reflect on one of my most important learnings from this experience: simple things matter.

There is a lot of angst around covid. Some simply seem not to care; others have fully holed themselves in. My approach is simple. We must endeavor to lead near-normal lives whilst doing simple things (following good hygiene and some social distancing) to contain the spread. Indeed, having spent a quarter on the UChicago campus, I can say with some degree of conviction that small measures can go a long way. If people wear masks, use hand sanitizer, and form well-defined social bubbles, we can not only contain covid, but can also lead fairly, albeit not entirely, normal lives while we are at it!

I see parallels to this in investing, which too is all about responsible risk-taking. Doing seemingly simple things like focusing on the long term, limiting oneself to one's sphere of knowledge, and emphasizing management quality can help avoid blowups, the equivalent of a covid outbreak perhaps. This is a lot of the job done! Indeed, as Howard Marks says, "If we avoid the losers, the winners take care of themselves." The reverse of this logic also holds true: if we fail to do the small things right, we are more likely to have a covid outbreak, or make a terrible investment. And a single blowup can negate the effects of several good decisions.

It's all about the little big things!

Betting on humankind

As the 2020 saga is coming to a close, I want to take a quick look at the world's scorecard:

Deaths? MILLIONS extra

GDP? DOWN

Mental health? SCREWED 

World? SHUT the hell DOWN

2020 was a bummer year for the world. Full stop!—no ifs, no buts. 

As the 2020-saga comes to a close, however, it seems the covid-saga is, at long last, near the beginning of its end too. I think the world is ready (almost!) to let out a muted "Phew": the economy has not been decimated, mortality has fallen, vaccines are being rolled out...there is light at the end of this dark tunnel. 

In March, fear engulfed the world. Now, our lips are poised, tongues are ready for that collective sigh of relief and sense of having made it out of the woods. We have shown great resilience and displayed a capacity to cope with and adapt to unforeseen and highly undesirable situations. Perhaps the age-old adage "this too shall pass" is indeed accurate. Humankind has survived two pandemics, two world wars, and a great deal more. The full weight of human history points in one direction: Betting on humankind is wise.

Time has a way...

To use the title of Aswath Damodaran's book on corporate valuation, investment decisions should be based on a combination of "Narrative and Numbers". In order to start developing an understanding of the numbers side, I recently took a super interesting Coursera course on financial accounting!

Near the start of the course I realized that non-cash items such as depreciation, amortization, and bad debt expense add artistic elements into accounting. Managers can legally get creative with accounting? What? My reaction exactly: the thought that the numbers published in an annual report present a twist on reality (and not reality itself) worries me.

But as I went through the course, I realized that this is partly because the future reality is unknowable till it happens. More importantly, I learned that provided the books are not cooked, time has a way of revealing and ironing out adventurous, aggressive accounting; if you don't account for non-cash items sufficiently, you will have to take write downs on assets in the future. (And similarly if you are too conservative, the expenses booked today will reduce future expenses.) Time just has a way...

So what did I take away? There are three things that were reinforced for me: 

• Time has a way of setting things right.
• One must carefully evaluate a long term track record. 
• You have to trust that the managers' interest is aligned with yours.

Invest with the Dao

I recently took a course on Daoist Thoughts. Daoism, for those who don't know, is a thought-process which emphasizes the importance of leading a simple life in harmony with nature, and not resisting the dao (the way of nature). The concept at the heart of Daoism is wuwei: action in inaction. This is somewhat like the idea of Going with the flow and involves taking only those actions, which are suited to the circumstances.

With the summary out of the way, I can get to the connection between Daoism and investing, which I wished to highlight. In the manuals on wisdom produced by Daoists, we are repeatedly told that rather than impose a plan or model on a situation, we should let others act frantically, and then lightly adjust ourselves as we see the direction that matters have evolved in. Investing is, above all, a test of our equanimity. So, it seems to me, that we investors must master the art of wuwei; the idea of achieving the greatest effects by a wise strategic passivity is at the heart of long-term investing. Hence the Mungerism: The big money is not in the buying and selling, but in the waiting. 

Dead Companies Walking

In Fortress Balance Sheets I said that I had exited my investment in Aston Martin at a 42.5% loss and I quoted one of my favourite adages: "When you don't get what you want, you get experience." Back then I had - and I still have - every intention of making this experience count. My Aston Martin foray made me very curious about business failure so I kept asking myself: why do some corporations seem to last forever, whilst others struggle to stay alive?

If we avoid the losers, the winners will take care of themselves.  -H. Marks 

In that spirit, I went on to read Scott Fearon's Dead Companies Walking, which is chock-full with anecdotes and insights acquired over an investment career spanning more than three decades. Fearon identifies six company leadership mistakes, which help him spot losers. In this post I want to touch on each of these fatal management errors:

1. They learned only from the recent past. 

We frequently - usually unwittingly - learn from the recent past rather than the entirety of history. This is somewhat analogous to relying on anecdotes in lieu of base rates (if you know the first thing about probability, you know that this is a recipe for disaster!). Business leaders, as well as investors, must guard against myopic vision, for it leads to error. Fearon also applies this to individuals': A successful track record and a degree from a good school...can create a kind of historical myopia, a mistaken belief that one's past successes guarantee similar results in the future. 

2. They relied too heavily on a formula for success.

Using a formula without thoughtfully considering its limitations and relevance to the situation at hand is a fool's errand. Maslow explained the law of the golden hammer best: I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail. It is also important to remember that a formula can be plain wrong even if it appears to have worked for a period of time. In fact, a formula is most dangerous when it has worked for a long time, because we have a tendency to forget that it is not gospelspeak. I would love to have a foolproof formula for success (who wouldn't!!!), but I'm not sure one exists.

3. They misread or alienated their customers.

The classic product-market-fit problem has wrecked countless companies. There is at least one of two key things at work in almost every case: (i) the product is targeted at the management, instead of the consumer; (ii) management failed to account for the way in which people in the real world actually behave. REMEMBER: A truly valuable company is one that provides a product or service, which possesses significant value in the eyes of its target customer.

4. They fell victim to mania.

Largely self explanatory... If management bets the ranch on the latest cool thing, they will almost certainly lose the ranch. Instead of bold bets, you want companies to invest in new initiatives and ideas by making small, calculated bets, which can be scaled up if and when they yield promising results. If this is done well and the organisation learns from past mistakes, this will allow the company to go from strength to strength and move forward (with caution!).

5. They failed to adapt to tectonic shifts in their industries.

When the entire industry changes and a business fails to adapt, the entity must die. This is because no business can outlive its utility; fewer customers will inevitably (at least eventually) mean that the corporation will be deprived of the lifeblood of any business: revenue growth. I would go so far as to say that tectonic shifts in their industries, which materially alter the economics of doing business can undo even the most nimble, well run company. Hence the sage Buffetism: turnarounds seldom turn.

6. They were physically or emotionally removed from their companies' operations.

This post is all about leaders' mistakes which can destroy a business. To me it is blindingly obvious that management matters!!! It is no surprise then, that this error rounds-off Fearon's list of fatal mistakes. If management is not actively engaged with trying to understand the business and getting a feel for its pulse, how can they steer the company in the right direction? In case you didn't realise, that was a rhetorical question: they can't!

For me, Fearon's book is a guide for becoming better at avoiding disastrous losers and maybe benefiting from their often self-inflicted and predictable deaths. I would unreservedly recommend this book to all other aspiring investors!

"Firefighting" by Ben Bernanke, Timothy Geithner, and Henry Paulson

JFK once said "The Chinese use two brush strokes to write the word 'crisis.' One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger - but recognize the opportunity." For an investor, crises are an opportunity to buy into good businesses at reasonable - or at least not ridiculous - prices. That is why, after three years of struggling to find opportunities, I made more investments over the last month than I had made over the last five years. Vladimir Lenin supposedly said that there are some decades when nothing happens, and some weeks when decades happen. From my experience with this crisis, the first of my still-short investment journey, I have learned that in times of crisis, lots happens - or at least, for an investor, a lot (of buying) should happen! 

When you are choosing to invest at a time of crisis, you are catching a falling knife. You do this because you believe the world will bounce back, because it always does. Indeed, human inventiveness, solidarity, and our sheer will to 'live to fight another day' have always come to the rescue. But, it is important to note that this recovery is aided by the tireless work of policymakers, who seek to limit the damage caused by the fire (crisis) at hand. It is important to understand this damage control aspect of crises.

So during the ongoing COVID-19 crisis, I decided to read Firefighting, a page-turner which tells the story of the 2007-2009 Great Financial Crisis from the perspective of the three fire-chiefs who spearheaded the United States government's response. As something of a neo-classicist myself, I found it tempting to cry moral hazard on many instances while I was reading the book; however, I am nevertheless fascinated by the success of the unprecedented measures taken (and arguably needed) to contain the crisis and right the economy. 

I am fascinated by the way in which greed and fear, and exuberance and panic result in credit cycles. That is why I have thoroughly enjoyed reading Galbraith's A Short History of Financial Euphoria and Krugman's The Return of Depression Economics, and watching HBO's Panic: The Untold Story of the 2008 Financial Crisis. And that is also why I have loved learning from Firefighting. Buffett said "[Firefighting's] cautions for the future should be required reading for all policy makers". They should be required reading for all investors too!

When I read, I like to pick out nuggets of wisdom, quotations that beautifully state or explain a seemingly basic, but in fact profound truth. So, here are a few of my favourite quotations from Firefighting (I promise you being this selective was far from easy - in fact it was pretty damn tough):

Financial Crises will never be a thing of the past. Long periods of stability can create overconfidence that breeds instability. We are later told: The enemy is forgetting. 

Risk, like love, tends to find a way. 

Bad news about one segment of the housing market [created] the E.coli effect, where rumours about a few incidents of tainted hamburger frighten consumers into abandoning all meat rather than trying to figure out which meat...is actually tainted. So, as the authors later note, investors began to shun entire classes of financial products, whether they were contaminated with subprime or not, which depressed prices and made them even more toxic. It was as if avoiding meat caused E.coli to spread. 

Every banker knows that if he has to prove that he is worthy of credit, however good may be his arguments, in fact his credit is gone. 

If you've got a squirt gun in your pocket, you may have to take it out. If you've got a bazooka, and people know you've got it, you may not have to take it out. 

Capitalism without bankruptcy is like Christianity without hell. 

Capital cushions can seem safe and adequate until suddenly they aren't. 

We spend a lot of time looking for systemic risk, but it tends to find us.

Learnings from Robert Caro's "Working"

Robert Caro is known for his biographies of political figures such as Robert Moses and Lyndon Johnson. Caro's epic biographies are renowned because of his forensic research process and relentless pursuit of facts. Caro's latest book, 'Working', is an autobiographical text that allows us to gain insight into the methodology of the world's greatest biographer. As an aspiring investor, who is just beginning to realise the importance of meticulous research, I wish to reflect on how some of my key learnings from 'Working' can be applied in the investing world.

Make sure to be thorough
Caro received one piece of advice when he became an investigative journalist: "Turn every page. Never assume anything. Turn every goddamned page." Ever since, this philosophy has been the cornerstone of his research process; a relentless pursuit of the truth underpins Caro's writing.

The more facts you accumulate, the closer you come to whatever the truth is. And finding facts...takes time. Truth takes time. 

A relentless pursuit of facts is of immense importance in investing because it can enable better decisions. However, I must add a caveat. While the past is undoubtably important, investing is less about the past and more about the inherently uncertain future. Thus, it is necessary to accept some uncertainty, provided you understand the limitations of what you know. This is because if you spend your whole life researching, continuously deferring action, you will never make a single investment.

Thought precedes communication
Caro's Princeton professor once told him to "Stop thinking with [his] fingers". I would want to supplement that phrase with another: Stop thinking with your lips. I am targeting both learnings mostly at myself (the lord knows I need to hear them on repeat!).

I can't start writing a book until I've thought it through and can see it whole in my mind. So before I start writing, I boil the book down into three paragraphs, or two, or one - that's when it comes into view.

You only have to watch CNBC's Squawk Box or Closing Bell to know that these tenets would be applicable in the investing world too. Indeed, we seem to suffer from an irresistible urge to quickly publicise our baseless, speculative thinking on the direction in which the market will move next, and to offer instant, frequently-dubious explanations for recent market movements. I know from experience how tempting it is to write without due consideration and speak without proper reflection. This is why I intend to learn from Caro's rigorous process in which thought precedes communication.

Talk to the people that matter
Caro's research relied heavily on being able to speak to people for long periods of time. During these interviews, Caro always asked questions like "What did you see? What did you hear?" They are unusual questions, but they are useful ones; they allow you to learn more about the atmosphere and setting in which an event occurred. In addition, he urges the interviewers to let the interviewees (and not themselves!) fill moments of silence. That way, you might just "find out things from them that maybe they didn't even realise they knew". 

You have to keep going back to important people - people who were important not necessarily because of their status but because of what they saw.

When you become a stockholder in a business, you make the active choice to own a part of it. Before making such a big decision, you have to be sure that you understand the business you are buying into. Therefore, it is important to speak with managers and employees - particularly those employees who are on the frontline - because they are important people. They should know the business better than anyone else, and speaking with them should allow an investor to have a deeper understanding of said business.

'Working' is undoubtably one of my new favourite books. For me, it is the ultimate guidebook on effective research. It should be required reading for all researchers.

Learnings from Stephen Schwarzman's "What it Takes"

Stephen Schwarzman's autobiography details his extraordinary journey of building one of the world's largest asset-management companies. His anecdotes, insights, and values are deeply inspiring for an aspiring investor like me, and I have really enjoyed reading this book. In this post I will briefly note some of my most important learnings, which I hope to take forward with me.

• Entrepreneurship is psychologically and financially demanding. Even when you have a unique idea and are blessed with fortuitous timing, you have to "bludgeon it into existence". If you are dedicating your life to something, it better be worth it: go big or go home.

• Ask for help and seek advice. Don't hesitate to knock on the doors of the people you admire. The odds are that they will be happy to guide you - and maybe, just maybe, you'll find a lifelong friend.

• Relationships and reputations are invaluable. Do whatever it takes to build and maintain them.

• Help others by solving their problems. All acts of kindness (big or small, random or not) go a long way. When you help someone, they remember. This is why listening to others' problems, and trying to solve them is a great way to win friends.

• Information is money. This was why Schwarzman once told an interviewer "I want to be a telephone switchboard, taking information from countless feeds, sorting it, and sending it back out into the world."

• "The harder the problem, the more limited the competition." If you can build a reputation for solving tough problems, people will actively seek you out - and pay you handsomely.

• Work in a team. Scwarzman puts it best: No one person, however smart, can solve every problem. But an army of smart people talking candidly with one another will.

• "There are no brave, old people in finance." As you learn from your mistakes and failures you have to develop a healthy dose of skepticism along the way; otherwise, you won't survive in finance.

• Take a moment. "Take a breath, slow it down, and relax [your] shoulders until [your] breaths [are] long and deep." This works particularly well because "people [are] always happy to let [you] have that extra moment". It "even reassures them" and makes them "more eager to hear what [you have] to say once [you are] ready."

Hail Cash, for Cash is King!

In Fortress Balance Sheets, I talked about how my Aston Martin adventure has taught me that leverage is "the most dangerous gift in finance". In this unusual crisis, however, I am learning not only about the perils of leverage, but also the importance of cash. 

I now realise that it is valuable to have what may, in the normal course, be considered an obscene amount of excess cash. Several companies (e.g. Booking Holdings, which owns OTA Booking.com) are likely to see their revenues hit zero (note that this did not happen even in GFC). Such firms will still incur fixed costs as well as those variable costs, which cannot be cut quickly. So, firms will lose a lot of money. A strong net-cash balance sheet position allows a firm to comfortably weather this storm, without being forced to permanently dilute equity holders. And, perhaps most importantly, having an abundance of cash heading into a downturn can allow a firm to invest aggressively for the long-term at a time when a lot of other firms are fighting for survival. This is why, Facebook's USD 50 billion cash pile no longer seems excessive when you consider that the firm could potentially lose 25 billion this year alone.

Cash piles that seemed ridiculous only three months ago now seem anything but; so-called "excess" cash is now evidence of management's prudence. 

Fortress Balance Sheets

The most dangerous gift in finance is leverage. Over the last five years, I have frequently read, heard, or written words to the following effect: 

Excessive debt is a red flag. On the stock market, credit yields fantastic results if you are right, but produces equally destructive, leveraged losses if you get it wrong. So, leverage magnifies upside; BUT, it also magnifies downside.

Amidst the coronavirus turmoil, I have finally learned this from a first-hand experience as I have exited my investment in Aston Martin (at a notable 42.5% loss). One of my favourite adages says "When you don't get what you want, you get experience". And I have every intention of making this experience count. So, in this post, I will detail my experience and reflect on what I have learned.

Aston Martin Lagonda - the journey

My investment thesis was simple and I still believe each of the following is true.

- AML is a heritage brand with a notable following.
- Company has invested in good products, and is launching one new car per year.

- Exclusive specials, F1 participation, and mid-engine cars will elevate the brand.

- SUV (the DBX) broadens appeal, and should increase volumes.

Then why exit? One word: LEVERAGE. 

Aston Martin is a highly levered company (even after factoring in a recent rescue investment by Lawrence Stroll and the upcoming rights issue). When I invested in AML, I was aware that leverage magnifies the upside and the downside; but, I was mostly focussed on the upside, because the stock had been cratering, and the company looked incredibly attractive. 

However, despite believing in the long-term story, I am unsure whether Aston can survive amidst the challenging climate of the covid-19 induced economic disruption. As it shuts factories, revenues will fall, losses will grow, and the business will be pushed closer to the brink of default and bankruptcy. Equity holders can potentially get wiped in such a scenario. This is why I chose to sell my shares in AML and invest the proceeds in a compelling business with a far stronger balance sheet.

So what lesson did I learn from this experience?

You need a FORTRESS BALANCE SHEET, because it can allow a firm to weather a storm. I have taken an edited excerpt from a previous post to explain my thinking in more detail.

Risk = (Hazard x Vulnerability)/Capacity to Cope. This allows us to distinguish between a hazard or bad event and the factors that determine the level of risk posed by this event. A strong company, by which I mean one that is not using performance enhancing drugs (leverage), has a higher capacity to cope with a bad event, and may even be less vulnerable to a bad financial event. And, because bad things happen to good companies (all the time) a fortress balance sheet is non-negotiable.

I once said, "Predicting rain doesn't count, but carrying a coat does". To me, maintaining a fortress balance sheet is the equivalent of carrying a coat. In fact, a strong balance sheet is more than just a protective coat; it is also a weapon. A company which has a strong balance sheet will likely outlast a levered competitor and so will benefit from the levered company's demise. Furthermore, having cash on hand (or at least favourable access to capital markets) can allow firms to strategically acquire businesses that are on sale. So, a fortress balance sheet allows companies to bounce back stronger than they were before the crisis.

As a result of this experience, I am particularly sensitive to the importance of a solid balance sheet. I hope never to repeat my mistake of investing in a highly levered business. In good times I might end up seeming a stubborn fool; but, when the tide goes out (for it inevitably will), I don't want to be caught swimming naked.

And the crisis came.

This post has been a long time coming (the terrible pun was, of course, intended!).

"Sooner or later, bubbles always burst."

Last year, a good friend generously gifted me a copy of The Return of Depression Economics by Paul Krugman. In his accompanying note he reflected on the ‘historical insight and broader application’ captured in this marvellous book. Well, I’ve finally got around to reading it, and I couldn’t have put it better myself; the book is quite simply chock-full of ‘historical insight and broader application’.

In my post, I will attempt to capture some general principles and recurring themes pertaining to financial markets and investing. I will inevitably do Krugman’s rattling good book a disservice; but here goes…

#1 We keep reinventing the wheel.

People in finance keep on reinventing the wheel. I think there might be a pattern here: repackaging leads to enlivening – and a deathly ignition. We renamed the ‘third world’ as ‘emerging markets’ to make it sound more attractive to invest in. And we renamed ‘junk bonds’ as ‘high yield bonds’ for the same reason. And because words have power this rebranding drove up the relevant assets’ prices. The problem is that “the good opinion of markets can be fickle” because “today’s good press doesn’t insulate you from tomorrow’s crisis of confidence”. When tides turned, the former was – at least partly – responsible for the Asian crisis, and the latter ended badly in the US in 1989. People invent new, fancy jargon, hailing a good idea as the new genius rainmaker, only to rediscover that credit is credit – and risk is risk – regardless of what it is called. Similar things have happened repeatedly in history, and there is no doubt they will happen again.

#2 Moral hazard abounds.

“Modern nations...cannot find it in their hearts to let widows and orphans lose their life savings simply because they put them in the wrong bank, just as they cannot bring themselves to stand aside when the raging river sweeps away houses foolishly built in the floodplain”. This creates the expectation that governments will guarantee depositors’ money, and creates a situation of moral hazard. This sets in motion an obscene chain of events, which guarantee that the government will ultimately have to deliver on this promise, whether explicit or implicit.

#3 Bad things happen to good economies (all the time).

Risk = (Hazard x Vulnerability)/Capacity to Cope. Or at least, that’s what I was taught. Why is this relevant? Well, it distinguishes between a hazard or bad event and the factors that determine the level of risk posed by this event. A strong economy, by which I mean a fundamentally sound economy (and not one that is on a euphoric credit-binge, or which is overwhelmed by a false sense of indestructibility), has a higher capacity to cope with a bad event, and may even be less vulnerable to a bad financial event. However, if the event is significant enough, in terms of magnitude, then it can still wreak an incredible amount of havoc. This is why “bad things can happen to good economies”.

#4 Be wary when people say this time is different. It rarely ever is.

Just when a recession starts seeming like an impossibility, that is when it is most likely to strike “out of a clear blue sky”. As I mentioned in my post based on A Short History of Financial Euphoria, a sense of progress brings a (justified) sense of optimism. And then, even the most sensible investors (quite literally) sell their brains, unable to take a long view when everyone around them is getting rich. What once started as insightful optimism is transformed into mania – or as Krugman puts it, “hype springs eternal, and people [become] willing to suspend their rational faculties”. This is when people, having forsaken reason, start spouting nonsensical explanations for why this time is different. At this point, there is too much money chasing too few deals. Well, that is when you know a crisis is coming. Reality, time and time again, has shown that “all financial crises tend to bear a family resemblance to one another”.

#5 Because believing makes it so.

If people expect a recession and so consume less, other people earn less. So, they may be unable to make interest payments on existing debt, let alone borrow more money. And because one person’s spending is another person’s income, this would have a ripple effect. This deleveraging is part of the credit cycle. 

Similarly, a loss of investor confidence, results in falling asset prices, and falling liquidity. As losses mount, confidence falls further, and all the air can go out of the bubble. This can be particularly acute due to margin lending. The quantitative strength of the feedback loop matters.

This is why Krugman explains how there are panics and then there are panics. Sometimes a panic is just a panic: an irrational reaction on the part of investors that is not justified by actual news. Much more important…however, are panics that, whatever sets them off, validate themselves – because the panic itself makes panic justified. He later goes on to reiterate that “When an economy is vulnerable to self-validating panics, believing makes it so”.

#6 Permabears all over the place!

Paul Samuelson once quipped that declines in U.S stock prices had correctly predicted nine of the last five American recessions. I personally like to replace ‘declines in U.S stock prices’ with another phrase: ‘so-called experts’. You might think that this must make people risk-conscious – and if you do, you would be wrong. Because “ever since the 1930s there have been people predicting a new depression any day now; sensible observers have learned not to take such warnings seriously”.

Not only do permanently bearish, ominous statements become impotent, they also lead to bad decisions. People might justify being a permabear by saying “better safe than sorry” but, in the long run, they will just be left feeling stupid – and sorry. That is not to say that we should be blindly optimistic. Quite the opposite: investors must seek to be optimistic whilst approaching everything with a healthy dose of skepticism.

Expert Opinions: Signals vs. Noise

Today, when I read the news or browse through social media, I notice a deluge of confident expert opinions and ‘scientistic’ forecasts (too readily) available in our information age.

This is why I am fascinated by the reliability — or lack thereof! — of expert opinions and forecasts. This interest was further developed through my IB Theory of Knowledge presentation, which explored the extent to which it’s possible to make reliable economic predictions. I learned that we frequently derive false security from precise numerical forecasts, which are often based on data that can be conveniently measured rather than the most important parameters (which might be difficult or even impossible to measure).

Hayek’s speech titled ‘The Pretence of Knowledge’ further led me to conclude that economists can make directional predictions, not precise forecasts. Hans Rosling’s Factfulness even describes a quiz in which chimpanzees outperformed so-called experts. I learned that forecasts reported in the media are often made by overconfident pseudo-scholars — and even when made by a genuine scholar, forecasts are still bound by any model's limitations.

Yet thoughtfully developed predictive forecasts remain important for effective decision-making, which (particularly in the investing world) requires an implicit consideration of a necessarily uncertain future. Experts’ analytical, frequently imaginative statements about the future are powerful tools that allow us to build models and glimpse through a translucent lens into a potential future.

During my exploratory journey in the world of value investing, I have learned that investing requires us to distinguish meaningful signals from the cacophony, generated by experts and media pundits and amplified by social media, surrounding the global economy. I am certain that our ability to separate the wheat from the chaff — or, more appropriately, the signals from the noise — is what will determine whether or not we are able to generate alpha over a long period of time. 

As I once said Leave it to the Experts (Don't)!!!

Howard Marks' Latest Memo: You Bet!

I have read pretty much all of Marks' memos, and this one is one of the best yet. The key implication for (equity) investors, if I understand correctly, is that a great businesses can be a poor investment at the wrong price, whilst a terrible business can be a great investment at the right price. Instead of trying to identify winners, we must seek to identify - and capitalise on - 'mispricings'.