#5 - The Uncertainty Of Rallies and Trolleys
On the anatomy of a market rally, cash flow statements, trolley problems, tacit knowledge and the Rashomon Effect
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This week we have a diverse set of articles for you that try to make some sense of the uncertain world we are currently living in. If you continue receiving this email in your Promotions tab, we request you to move one email in your Inbox and mark it with a Star. This reduces the uncertainty associated with not finding this newsletter in the inbox.
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Uncertainty is everywhere.
Events that were not anticipated are happening around the world like the irrational behavior of stock markets while the economy continues to plunge into a recession, changing geopolitical dynamics in Asia, Big Tech pivoting their strategies which we explored last week amidst an invisible microscopic organism that can potentially threaten our lives. These uncertain events also end up having unseen second-order consequences.
In this week’s edition, we explore topics that help us understand this uncertainty like -
Analyzing the US stock market rally
Dissecting cash flow statements
Poker and Life
Flaws in thought experiments
Tacit Knowledge vs Deliberate Practice
Liverpool’s EPL Victory
Analyzing The Stock Market Rally - Howard Marks Memo
Read the article here
The world is combating the greatest pandemic in a century and the worst economic contraction of the last 80+ years. And yet the stock market was able to compile a record advance and nearly recapture an all-time high at a time when the economy was humming, the outlook was rosy, and the risk of a pandemic hadn’t registered. How could that be?
Howard Marks writes that people are finding more things to take positively like credence in the Fed’s ability to bring an economic recovery, rising optimism on vaccine tests and treatments, monetary and fiscal actions of the Fed reinforcing a positive belief, low interest rates, behavioral factors like fear of missing out, etc.
Marks writes that the most optimistic psychology is always applied when things are thought to be going well, compounding and exaggerating the positives, and the most depressed psychology is applied when things are going poorly, compounding the negatives. This guarantees that extreme highs and lows will always be the eventual result in cycles, not the exception. The powerful rally we’ve seen has been built on optimism; has incorporated positive expectations and overlooked potential negatives; and has been driven largely by the Fed’s injections of liquidity and the Treasury’s stimulus payments, which investors assume will bridge to a fundamental recovery and be free from highly negative second-order consequences. The fundamental outlook may be positive on balance, but with listed security prices where they are, the odds aren’t in investors’ favor.
Cash(flow) Is King
Read the article here
The cash flow statement is the most important financial statement in a company’s books. It shows us how much cash a business generates, where management spends the cash, and how much they actually receive on their revenues. It shows us a company’s cash-generating power, not its financial engineering pedigree. There are few ways companies can spend cash - either buyback stock, issue dividends, acquire a business, reinvest in their own business or pay down debt.
The examples provided in the article gives us a rich insight on how not all cash that gets reported is equal. By focusing on the cash flow statement, we’re also able to determine if growth is value creative or destructive.
So if you do believe your stocks are rising despite weak results, have a closer look at the cash flow statements in the annual reports.
Life Is Like A Game Of Poker!
Read the article here
Poker is a game of incomplete information where you can make the best decision and still lose or make a horrible mistake and get lucky. In life, we can often get away with conflating the two. Things go well, and we take credit. Things go poorly, and we blame the world.
Poker teaches a central lesson that chance is just chance - neither good nor bad. Without us to supply meaning, it’s simple noise. The cards don’t know or care who you are. They have no concept of fairness. They are just dealt — and we are left to deal with the fallout, to interpret the noise. And so, the most we can do is learn to set aside what we can do nothing about and, instead, focus on controlling what we can.
Poker forces you to confront the difference to realize that, no matter your skill, luck is a powerful friend and foe, both at the table and away from it.
So what do you think separates luck and skill?
Are Thought Experiments Flawed?
Read the article here
Thought experiments are short hypothetical scenarios designed to probe or persuade on a point of ethical principle. Most famous (or infamous) among these are ‘trolley problems’ – thought experiments about the permissibility of causing the death of a smaller number of people to save a larger number from a runaway trolley (or train). There are two ways to look at thought experiments - a scientific way and a way that appeals to imagination. Thought experiments are highly fallible, and we should be circumspect about using them to provide insights into real-world ethical problems.
If thought experiments are considered scientific, they would inherit the methodological challenges of internal and external validity. An alternate view of thought experiments is considering them as persuasive fictions. Things presented in fiction are simple and distorted. Responsible thinking requires calibrating our levels of credence to the reliability of our intellectual tools. Thought experiments, clearly, are not reliable tools but in the absence of better tools, they remain our best tools for ethical thinking.
Here is a modern version of the trolley experiment faced by governments few months ago.
(Source: via Whatsapp)
Tacit Knowledge vs Deliberate Practice
Read the article here
Tacit knowledge is knowledge that cannot be captured through words alone like riding a bicycle. Tacit knowledge instruction happens through things like imitation, emulation, and apprenticeship. You learn by copying what the master does, blindly, until you internalize the principles behind the actions. Tacit knowledge is important for knowledge work. It is difficult to make tacit knowledge explicit.
A common myth is that deliberate practice can help build tacit knowledge. Deliberate practice is possible only in domains with a long history of well-established pedagogy like music, math and chess. The process of learning tacit knowledge involves - you find a master, you work under them for a few years, and you learn the ropes through emulation, feedback, and osmosis — not through deliberate practice.
Liverpool - Champions of English Premier League
Read the article here
Liverpool winning the English Premier League is a story of patience, grit and perseverance. When Jurgen Klopp was named as the manager, little was he sure that his team would be the earliest and the latest champions in history: winning it with seven games to go but crowned on 25 June.
Miguel Delaney writes that Coutinho’s departure from the club was a key turning point as it helped Klopp reshape the team by adding defensive composure to the chaos wrought by their attack, by adding patience to their pace. Liverpool has shown patience, persistence, power and control at different points in different matches which justifies their dominance in the toughest football leagues.
Jurgen Klopp has reminded Liverpool what it takes to win titles and become champions in ways they have never seen before.
This is what sums up the inherent nature of uncertainty, as who would have predicted five years back that Liverpool would dominate and win the title in the most emphatic manner possible in such a competitive league. I am sure even the most devout Scouser would have never predicted such a victory.
Mental Model For The Week - Rashomon Effect
This is derived from the film titled Rashomon by Akira Kurosawa. In the film, four people give drastically different accounts of a scene they all observed where Kurosawa used the cinematic elements of perception and subjectivity to present conflicting versions of the same event through different characters in the storyline.
Situations where we get two accounts of the same event, but the versions are dramatically different because they’re informed by different facts and perspectives.
This makes truthseeking difficult.
The lesson here is we should not be overconfident about one version of the truth, especially the one we believe in. A healthy skeptical attitude and having an open mind to look at another version of the ‘truth’ helps in evaluating powerful contradicting arguments.
Book Recommendation For The Week - The Death Of Expertise By Tom Nichols
Expertise is an intangible but recognizable combination of education, talent, experience and peer affirmation. This book describes the role and the value which experts can provide in a democracy and how a widening gap between experts and laypeople is a threat to the current democratic world.
You may view a brief summary here.
You can purchase the book here.
Podcast Recommendation For The Week - Chamath Palihapitiya on Investing Through The Crisis
Chamath is a venture capitalist and the CEO of Social Capital.
In this interview, Chamath speaks about key guidelines for investing, views on Bitcoin, looking at things that don’t change over time and things that need to change, how the economy might recover post the pandemic and some suggestions for the global economy.
You can view a summary of the show here and listen to the entire podcast episode here.
Afterthought
True happiness is to enjoy the present, without anxious dependence upon the future, not to amuse ourselves with either hopes or fears but to rest satisfied with what we have, which is sufficient, for he that is so wants nothing. The greatest blessings of mankind are within us and within our reach. A wise man is content with his lot, whatever it may be, without wishing for what he has not.
-Seneca
That wraps up this week’s edition of The Curious Cat.
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