An interesting chart from Apricitas Economics on the employment changes in the arts since the introduction of ChatGPT. Live arts are showing job gains, but digital arts are showing significant employment declines. AI’s impact may come in unexpected places and shift job dynamics, with some winners and others losing out.
It is striking that the Fed admitted it made a mistake. Michelle Bowman gave a speech in London that should raise some eyebrows. Note that the speech was given outside the country. The key findings are listed below, but most surprising is that the review suggests a risk-averse culture among regulators. Better to do nothing than take some action. The bank regulation is done at the regional bank level. For all the speeches and economic research that is done at the regional Fed level, shouldn’t they get this right? It is not clear that centralization would be better, but this is interesting food for thought.
Now, the question is what will Governor Bowman do about this?
An investor can generate returns based on their knowledge. The knowledge used creates an information edge that may allow you to earn a higher return than the market portfolio. To determine an information edge, ask what your level of knowledge is about a topic or firm. We focus on tacit knowledge, the expertise from practice and experience. There is ubiquitous tacit knowledge available to most, and specialist tacit knowledge focused on a much smaller set of individuals.
Ubiquitous tacit knowledge exists in a number of degrees. We can start with beer-mat knowledge, which is a simple description. For example, the Fed controls monetary policy. There is popular knowledge, which you may read in a newspaper, and primary-source knowledge that may come from research analysts and academic articles. These are all fine, but they will not create an edge.
Specialist tacit knowledge can come in two forms: interactional expertise, which shows you can critically evaluate information and use it, and contributory knowledge, which shows mastery and the ability to use that knowledge to develop unique thinking.
If you want to know whether you have an edge, then ask what your level of knowledge is. If you don’t have a specialist’s level of knowledge, you are unlikely to have a chance of beating the market.
[T]o trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none … The cause-creating drive is thus conditioned and excited by the feeling of fear.
- Nietzsche hat tip top fs.blog.com
The unknown requires clear understanding, even of complex situations. We want to find causes for everything. If we have an explanation for the unknown, there is comfort and power. One creates sensemaking by substituting discontinuous concepts for continuous perceptions. Investors like a clear cause-and-effect flow.
What is the story here? And what will happen next? We use stories to make sense and to justify decisions or positions. Yet stories are often simplifications that make life easier and are not always the best tool for understanding a complex world.
Surprise, there is more than one type:
Better risk management requires mindful organizing that creates high-reliability organizations. Mindful organizing develops decision-making processes to protect against high volatility, chaotic markets, and surprises.
This post synthesizes the key points of Managing the Unexpected: Sustained Performance in a Complex World by Karl Weick and Kathleen Sutcliffe.
The mindful organization focuses on the firm’s coordination problem. The core problem of any firm, and its reason for existence, is to coordinate activities to increase efficiency and lower costs. Yet coordination is not easy. There is good and bad coordination. According to Barry Turner, “organizations achieve a minimal level of coordination by persuading their decision-makers to agree that they will all neglect the same kinds of consideration when they make decisions.”
A good organization can adapt to surprises and be resilient. A highly resilient organization (HRO) should act through what the authors classify by the simple acronym FSORE: failure, simplification, operations, resilience, and expertise.
Mindful organizations look for continuity with a specific focus on some key principles:
Adaptive managing from Gary Klein should follow the simple format - STICC:
Investors within organizations often face the garbage can model of decision-making. Decisions are made in a chaotic environment where goals are unclear, and participation in the process is fluid. There is often organized anarchy. Problems arise and need attention. They could be random. Solutions may or may not exist when the problem appears. The participants that may help with the decision may shift, and the choices that need to be made, when and how much, are often unclear.
Within this model, resolution is needed quickly but is not always clear. Oversight is difficult because it is not always clear who is in charge of the decision. There is often an issue with flight. Decisions are delayed or abandoned as priorities shift. The garbage can model differs from rational decision-making, yet it more closely reflects reality.
In a chaotic environment, decision-making is not optimal; anarchy is present. Hence, investors have to break the cycle of decision-making and focus on process. One simple approach is to use models that rationalize decisions, but sometimes choices are unique and require decisions outside a model. Organizations must become process-oriented to avoid these issues.
So what is your process? Does the organization follow it? Is there clear responsibility for who has to decide? Are preferences clear? There should be a linear sequence of actions that lead to a decision, not all information and choices coming at the same time.
“Partial knowledge is more often victorious than full knowledge: it conceives things that are simpler than they are and therefore makes its opinion easier to grasp and more persuasive." - Nietzche
"History will justify anything. It teaches precisely nothing, for it contains everything and furnishes examples of everything."
- Paul Valery
Storytellers are model builders. There is a need to describe the causal basis of experiences. A stream of events needs some causal explanation or sense-making that is realistic and comprehensible. A story will use stylized facts to support an argument, but stories are not the same as models. It is a process of causal inference that is not always based on empirical testing from large samples of data.
Stories are especially important when data are limited or uncertainty is high. In environments of radical uncertainty or complexity, a story or narrative is a useful tool for describing the environment and making sense of causal relationships.
Organizations use stories to help explain their actions. The story will serve as a model for how an organization behaves. Nevertheless, these stories focus on certain mythical themes: rationality, hierarchy, individual leader significance, and historical efficiency.
The story can be flawed, so investors must question the underlying assumptions behind any story, no different from how model assumptions are reviewed and tested. Stories should be reviewed through a rigorous process to avoid flawed logic based on partial knowledge.
We can think of intelligence in two components. Both are needed to be an effective trader or investor. First, an intelligent person needs to effectively adapt to an environment. Managing the environment requires resources, so an individual must know how to use them. It requires knowledge about the world and the ability to make decisions. Second, people need to interpret experiences within an environment. The skill to provide meaning and learn. Experiential learning links these two forms of intelligence.
Intelligence is about adaptation, which may involve low intellect, where success is obtained through limited effort and causal understanding, or high intellect, which is associated with a need to understand the causal structure.
This leads to three forms of intellectual adaptation: rules and heuristics. The second is harder because rules may not work, especially in dynamic environments. The second is imitation, where one actor follows another’s success. The third mechanism is selection, which reproduces attributes associated with prior success and eliminates those associated with failure. Yet, controlling or managing the investment environment is difficult.
Success in controlling an environment is limited because history is complex and stochastically uncertain, and outcomes depend on the sequence of choices that lead to a specific action. Success depends on the sample of experiences and the sample of outcomes.
Intelligent investing is more than applying models; it is an attempt to control a complex environment that requires understanding, action, and learning.
There is consternation in the bond markets that may be unwarranted. Rates are higher, and the sell-off has been strong, but we are returning to the normality seen before the GFC. Was the post-GFC period normal, or is the current environment, with a positive real rate, an inflation premium, and a term premium, the norm?
I would argue that the current environment is a return to normality, and the low interest rates during the QE period were abnormal. The Fed and the Us Treasury cannot be in a continual mode of amping up the economy. There has to be a focus on inflation and controlling credit excesses. Of course, there is a threat of recession, and people will be in need, but the labor market is close to full employment, and inflation is well above target.
Should we expect lower bond yields, or is the market just reflecting reality?
An important news article states that Euronext is open to a merger with Deutsche Börse, which would be an important step in the one-European-exchange move to unify rules and regulations for stock trading; that is the hope. One of the most urgent and important discussions about competition in EU integration is reducing bottlenecks in capital markets. The EU has been a laggard in venture capital and private equity funding. New companies look to the US for capital. The disperse set f stock marklets redcues liqudity and makes any listing more expesneive in Europe. A consolidated exchange environment should allow for better listings, more liquidity, and lower operating costs across European markets.
It is early to say whether there will be any merger announcement, yet a discussion is a good first step.
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“Amateurs go broke taking large losses; professionals go broke taking small profits.”
Bill Eckhardt
Bill Eckhardt is one of Chicago’s true trading legends. He may not be as well-known as others, but through the turtle bet, he helped launch an industry called managed futures.
His short phrase is packed with information and rivals the classic phrase “you never go broke taking a profit,” an old financial proverb with an unknown exact origin, though often attributed to the legendary financier Bernard Baruch. It is also included in the book Reminiscences of a Stock Operator about the speculator Jesse Livermore.
Eckhardt is from the trend school, and if you don’t know when a trend will end, it is best to just hold your positions and not take profits early. Of course, you have to take losses quickly.
