Sunday, May 3, 2015

Review of State of Fear by Michael Crichton

Reading State of Fear, Michael Crichton's global warming debunking novel, made me realize how political all of his books were. His 1968 novel A Case of Need is pro-abortion. Prey is about the danger of self-reproducing technology.

Many of his books were about the awesome power of technology. People have called him "technophobic", but his own description in Andromeda Strain about the scientists is more revealing: “What they did not anticipate was the magnitude, the staggering dimensions of their error.” Jurassic Park is the same story, and the Jeff Goldblum story is maybe Crichton himself.

He once said,

"Today it is said we live in a secular society in which many people—the best people, the most enlightened people—do not believe in any religion. But I think that you cannot eliminate religion from the psyche of mankind. If you suppress it in one form, it merely re-emerges in another form. You can not believe in god, but you still have to believe in something that gives meaning to your life, and shapes your sense of the world. Such a belief is religious."
He thought that the religion had become environmentalism. But it is amazing how passe environmentalism has become over the past 20 years. Who cares about it anymore? Open borders trumps environmentalism, for example.

He gave a lecture at Caltech about the unscientific notion of "consensus" being used to sell global warming:
"Let’s be clear: the work of science has nothing whatever to do with consensus. Consensus is the business of politics. Science, on the contrary, requires only one investigator who happens to be right, which means that he or she has results that are verifiable by reference to the real world.

In science consensus is irrelevant. What is relevant is reproducible results. The greatest scientists in history are great precisely because they broke with the consensus. There is no such thing as consensus science. If it’s consensus, it isn’t science. If it’s science, it isn’t consensus. Period."
Global warming looked like a promising scam; luckily the hoax is as dead as a doornail. The elites were scheming to impose an awful taxation and regulation tyranny.


Saturday, May 2, 2015

No Evergreen Investment Strategies

It looks like the Derivatives Strategy magazine archives are gone - and with them, the Derivatives Comix that were absolutely wonderful. I had saved excerpts from three stories from back issues which, together, illustrate perfectly a point that I've made before: there are no evergreen investment strategies that will always work, and the market has been becoming more efficient over time.

One was from a 2000 issue, about how options marketmaking worked [dead link].

"Xilinx is flying. AMAT is collapsing. Foundry is up huge. These stocks are all over the place. That's how I know they're all worth nothing."

A broker-dealer comes in and sells Riley 100 December '01 calls on Nextel. "He may know something is going on, and back-dated options are dangerous,” says Riley. "I'm going to push my back-dated volatilities down a bit.” His fingers madly push at various toggle adjustments on the XTOPS system. December '01 Nextel option prices are suddenly all 1/8 to 1/4 lower than they were a few seconds ago.
Note that excellent point about volatility ~ lack of intrinsic value. Second story, from 1995-1996 [dead link].
The guy who first had the opportunity to make a lot of money doing this was Mark Rich. How did it work? I buy options. I go to this bright young dealer. He's got his options pricing model, and I want to buy a call. He gives me the price because he's got a model and he figures they're liquid instruments, and he can always buy more and more to complete the hedge.

But I'm the gorilla. So I can buy a lot of options from him and from other dealers just like him. I know one thing. Every time I buy more, it sets off a signal to buy more. It's a positive feedback loop. I'm the gorilla. I can control you. I can eventually make you buy a lot of it. If I can control the marketplace to make you buy more of it, I can dominate you because I know your recipe for replicating the options.
Third story, from 1998 issue [dead link].
But as Susquehanna has found over the years, the markets change and an interesting arbitrage technique can easily be annihilated. "Before the crash of 1987, we just ‘arbed' volatility from one strike to another,” says Yass. "But after everyone started using the Black-Scholes model, the questions became, What is the skew? What is the distribution? The next frontier is correlations.” But after that? "Who knows,” laughs Yass.
True arbitrages get harder to find. There was a time when the marketplace was full of options (stock options, convertible debt) but no general theory for pricing them.

There are no evergreen investment strategies that will always work. By the time an investment approach becomes part of the landscape, the people who were using it have generally gathered assets and are rich, fat, and lazy. The 80 year old fund managers who made it big 50 years ago by being the first people to get copies of filings dropped off at the SEC offices (once a great edge!) are not hungry enough to develop tomorrow's cutting-edge technique. This is why every generation or so there is a New School of investing that displaces the old, like succession in an ecosystem.

Friday, May 1, 2015

Tim Knight On the Startup Bubble of "Secret" and ""

Tim Knight is a bear in Palo Alto and his observations on Bubble v2 are great. This is about the Secret app that just shut down:

in exchange for 18 months of work that resulted in a completely failed endeavor, he and his buddy scored $6 million (out of which he bought himself a Ferrari), on top of whatever handsome salaries they felt they deserved.
So am I bitter about this? Well, no. Bitter isn’t the right word. I’d say I’m simply…….pissed off. Because my own high-tech start-up, Prophet, is something I worked thirteen years to build, and when I finally sold it (for all of $8 million), it was a growing, profitable firm with happy employees, fantastic products, and a very satisfied buyer. Its products are in use to this day, ten years hence. Prophet, you see, wasn’t an overly-funded clown-show where we blew through the cash and just decided we were all fuck-ups and might as well close the place down swiftly. Oh, and pocket the cash.
The quantity of these dim-witted, overly-funded outfits that are going to enter bankruptcy is going to explode over the next few years (Clinkle is bound to be a likely contender…….) was another great one that he predicted would go to zero.
So, in both a literal and figurative sense, Color has been rearranging chairs, Titanic-style.
What they did with $41 million is beyond me. Congrats to Sequoia Capital on this amazing investment.
It's too bad you can't short these startups.

Thursday, April 30, 2015

Paper: "Collective hallucinations and inefficient markets: The British Railway Mania of the 1840s"

Collective hallucinations and inefficient markets: The British Railway Mania of the 1840s [PDF] by Andrew Odlyzko

The British Railway Mania of the 1840s was by many measures the greatest technology mania in history, and its collapse was one of the greatest financial crashes. It has attracted surprisingly little scholarly interest. In particular, it has not been noted that it provides a convincing demonstration of market inefficiency. There were trustworthy quantitative measures to show investors that there would not be enough demand for railway transport to provide the expected revenues and profits. But the power of the revolutionary new technology, assisted by artful manipulation of public perception by interested parties, induced a collective hallucination that made investors ignore such considerations. They persisted in ignoring them for several years, until the lines were placed in service and the inevitable disaster struck.

Tuesday, April 28, 2015

Paper: "Identifying Overvalued Equity" and the "O-Score"

Reading a paper called Identifying Overvalued Equity by Beneish and Nichols:

"Our model is a scoring system that combines firm characteristics into an overvaluation score (O-Score) ranging from zero to five. Firms receive one point for having a high likelihood of earnings overstatement (based on the Beneish (1999)’s PROBM measure), high sales growth, low operating cash flows to total assets, an acquisition in the last five years, and unusual amounts of equity issuance in the past two years. Thus, firms with glamour characteristics, poor current operating cash flow performance, a high likelihood of earnings overstatement, a history of merger activity, and recent but excessive issuances of stock fit our profile of overvalued equity. And, we show the overvaluation is substantial; firms with O-Scores equal to five lose about a quarter of their value."
Indexing idea: use Falkenstein's low volatility approach, and also prune any firms with high O-scores or high yield debt.

Monday, April 27, 2015

Great Point By Donald Campbell On Simultaneous Invention

I've written about simultaneous invention before. This is from Donald Campbell in the book Evolutionary Epistemology, Rationality, and the Society of Knowledge (p71, 1987):

"A major empirical achievement of the sociology of science is the evidence of the ubiquity of simultaneous invention. If many scientists are trying variations on the same corpus of current scientific knowledge, and if their trials are being edited by the same stable external reality, then the selected variants are apt to be similar, the same discovery encountered independently by numerous workers. This process is no more mysterious than that all of a set of blind rats, each starting with quite different patterns of initial responses, learn the same maze pattern, under the maze's common editorship of the varied response repertoires. Their learning is actually their independent invention or discovery of the same response pattern. In doubly reflexively appropriateness, the theory of natural selection was itself multiply independently invented, not only by Wallace but by many others. Moreover, the ubiquity of independent invention in science has itself been independently discovered."
Here's a piece that Campbell wrote wrote for Interdisciplinary Collaboration: An Emerging Cognitive Science [sample PDF]:
"Rather than praying, 'May I be a competent and well-read X-ologist, may I keep up with the literature in my field,' a scholar will pray, 'Make me a novel fish-scale. Let my pattern of inevitably incomplete competence cover areas neglected by others.' Each scholar would then try to have a pattern of journal subscriptions unique to his or her department, university, or profession. Noting that the scholar and a colleague were reading the same set of journals, the scholar would feel guilty and vow to drop one of these in favor of some other. Recognizing that the interdisciplinary links in the collaborative web of knowledge are the weakest, the scholar would give up some in-group journal in favor of an out-group one. The scholar would feel guilty if he or she did not cut attendance at in-group conventions to attend relevant out-group ones, and so forth."
It's good to read widely.

Sunday, April 26, 2015

Armen Alchian, Golf, High Status Jobs, and Longevity [Also, Paper: "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process"]

The paper is "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process" [pdf] and it has some good thoughts about contracting between (or vertical integration of) oil producers, pipelines, and refineries; or of coal mines and power plants.

Appropriable quasi rents exist in specialized assets of oil refineries, pipelines, and oil fields. This leads to common ownership to remove the incentive for individuals to attempt to capture the rents of assets owned by someone else.

Suppose several oil wells are located along a separately owned pipeline that leads to a cluster of independently owned refineries with no alternative crude supply at comparable cost. Once all the assets are in place (the wells drilled and the pipeline and refineries constructed) the oil-producing properties and the refineries are specialized to the pipeline. The portion of their value above the value to the best alternative user is an appropriable specialized quasi rent. The extent of the appropriable quasi rent is limited, in part, by the costs of entry to a potential parallel pipeline developer. Since pipelines between particular oil-producing properties and particular refineries are essentially natural monopolies, the existing pipeline owner may have a significant degree of market power.

These specialized producing and refining assets are therefore "hostage" to the pipeline owner. At the "gathering end" of the pipeline, the monopsonist pipeline could and would purchase all its oil at the same well-head price regardless of the distance of the well from the refinery. This price could be as low as the marginal cost of getting oil out of the ground (or its reservation value for future use, if higher) and might not generate a return to the oil-well owner sufficient to recoup the initial investment of exploration and drilling.
Some other good examples, including mine-mouth coal plants, or specialized dies for auto manufacturers.

One of the authors was Armen Alchian who just died in 2013 at age 98. From wikipedia:
"[T]he Alchian–Allen theorem[,] colloquially known as 'ship the good apples out,' states that when output varies in quality, the lower quality output is consumed nearby while the higher quality output is shipped long distances. The reason is simple: transportation costs vary with the weight and bulk, but not the quality, of that which is transported. The added per-unit amount decreases the relative price of the higher-grade product."
Alchian's textbook Exchange and Production sounds worthwhile:
"Because of its literary quality and complexity, the textbook generally did not work with undergraduate or even M.B.A. classes."
I've been fascinated recently by the longevity of men with high-status, intellectually stimulating jobs. Charles Munger (still doing Q&A in public at 91), Judge Robert Patterson (who died last week, at 91). I'm sure it didn't hurt Armen Alchian that he lived in LA and had a flexible schedule for golfing:
"Alchian was an avid golfer throughout his lifetime. He rose very early and teed off at day break at nearby Rancho Park Golf course for an early morning round of golf. He still arrived at the office before many of his colleagues for a full day of work. When he traveled to conferences around the world, his golf clubs accompanied him. In his eighties he could look at his collection of golf score cards and describe the holes he had played on many of the courses he enjoyed."
It's sort of like how Tyler Cowen gets to eat all over the world because of economics conferences. Except a round of golf is better for you than eating deep fried chimichangas from three different street food vendors in one day.

The more, the more. If you're smart and manage to be high-status, you'll live a happier and longer life and accomplish more.