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August 13, 2011

If robots had souls...

Note: This article was scheduled to be published a week ago but the events of the week of August 8 kept me too busy.

The brokers with hands on their faces
If robots had souls...
I'm thinking that there must be more to life than watching a computer monitor for eight hours a day. My best deals over time have been multiyear multibaggers and you don't have to watch those minute to minute. Some of my best misses have been stocks where I was right about the business but the market lifted the stock after I had gotten tired of it. Is that better than day trading? I don't know but you have more time for other things.

If robots depend on the future being the same as the recent past, then they have a big problem. There have been some drastic upheavals in the works for several years and, in a sense, they actuated the key event this weekend (August 6, 2011). The risk free rate has been declared dead. A risk free rate no longer exists. Many of us have known that for years: the promise of getting crisp new IOUs in place of worn old IOUs doesn't improve the value of the IOU. Forty years ago Mandelbrot told investors that they were using the wrong maths. Despite the fact that now we carry super computers in our back pockets, we are still using the wrong maths. This weekend the S&P told investors that a core input the models use is fictional. Let's admit it, it's Fantasy Island.

The brokers with hands on their faces
...if robots had souls
Recent events have show that the lender of last resort is not some mythical, über-powerful government but the huddled masses of taxpayers. In Japan they have accepted 20 years of stagnation. In America they voted for change. In Europe they riot for more handouts. Japan stagnates, America evolves. Europe will blow up. The BRICs go marching on.

As I have shown before (Why Does the Average Mutual Fund Underperform? 2/20/2011), your results are not proportional to your smarts. Wealth distribution is a power function with 80% of the wealth in 20% of the hands. If you do what everyone else is doing you must wind up in the 80% that holds 20% of the wealth.

Minute to minute the world is essentially random. Quants have been able to detect minute anomalies but they are so small that to take advantage of them you either have to move at the speed of light lest they disappear or you have to use massive doses of leverage which creates risk well beyond what the wrong math tells you. The reason mega-banks can use leverage is because capitalism has become socialized. Mohnish Pabrai's method calls for big wins and small losses (The Dhandho Investor). Mega-banks, on the other hand, give the wins to the partners and the losses to the taxpayers and shareholders.

Denny Schlesinger

Why Does the Average Mutual Fund Underperform? by Denny Schlesinger
The Dhandho Investor: The Low - Risk Value Method to High Returns by Mohnish Pabrai

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