For information edge you need expertise

 

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.

We force explanation through stories to calm our fears

[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.

Stories are important models, yet flawed.

Narratives help explain stock returns.

Narrative drives returns - even if stories do not generate measurable risk.

Investing reacts to narrative, not facts.

Is investment management a science? Use the “narrativeness” test

The change in reserve accumulation

 

We get used to an environment that may have existed for a decade and assume the recent past is the norm, yet we often find cases where recent history is the exception. Look ta the resereve accumulation around the world and we are seeing that high reserves as a means of protecting currencies after the Asian currency crisis in 1997-98 may be a thing of the past. This has implications for the dollar and for US Treasuries. There is less need for safe reserves, so this key source of demand is gone.

We are seeing significant purchases of dollar securities from foreigners, but the flows are in private equities and bonds as well as government bonds. These buyers are likely more price-sensitive and profit maximizers. This means their response to news should be stronger. Unfortunately, it is not clear who the end buyers are. This demand could come from hedge funds with offshore assets owned by US citizens. Nonetheless, dollar flows will be more news-sensitive and less stable.

Light bulbs and economists

There are many jokes about economists. I especially like President Truman’s comment about wanting a one-handed economist after hearing so many mixed opinions. While the light bulb joke is about philosophers, it could easily apply to economists or Fed officials. They will complain about what they don’t know and how hard their jobs are, yet will also redefine their goals. 

Why is it so hard to hit the 2% target? Is the new standard 3%? 

This issue seems to apply to many policy discussions. We redefine the goals we cannot reach.