The end of being drunk on AI?

 

There is an interesting index on token expenditures called the Silicon Data LLM Expenditure Index that measures the price of tokenization for AI. It is showing a decline as users move to cheaper models. If the price of tokens increases, demand will respond. 

Companies are now monitoring token usage and prices and ensuring that employees don’t treat tokens as a free good. This is natural behavior on the part of firms, but it also means that revenue growth for AI providers will likely slow and fall short of market expectations. 

"Look at your fish" - same with market prices

There is importance in looking closely at the things we study. There is an old parable from Samuel Scudder called "Look at your fish". The story can best be described in "The Student, the Fish, and Agassiz," a 19th-century educational parable in which Harvard professor Louis Agassiz forces a student to study a dead fish for days, using only observation and sketching, to teach that true knowledge comes from intense, firsthand examination. It emphasizes finding "general laws" through detail.

The same process can be applied to markets. We can start with price charts. Look at your charts. Look at the prices, but just don't look once; look deeply into what the markets may be saying. Then, after looking at the prices, look at the news surrounding the prices. This does not mean that everything has to have a pattern, but for any analysis, the first order of business is looking at the data. 

See before starting to analyze. 

Innovation, industrial policy and controlling the fate of nations

 

How Progress Ends: Technology, Innovation, and the Fate of Nations, by Carl Benedikt Frey, is one of the most important economic and policy books of the last year. It is especially relevant given the discussion following the Draghi Report that has influenced European thinking about the need for change and innovation. Frey makes an important argument that economic progress is a combination of innovation, which often occurs in a decentralized environment, and the implementation of scale through bureaucracy. He develops this argument through close observation of 1,000 years of history across different economic systems around the globe. Technological progress and economic growth are inevitable. There needs to be a special combination between technology and bureaucracy.

Frey draws a distinction between technological innovation that often occurs in a decentralized environment, where experimentation and exploration of new ideas take place. The technology then has to be put to use, which requires a bureaucracy or centralization to effectively employ it. Some countries did not get the technology right because bureaucracy stifled innovation. In contrast, other countries lacked technological advances but were able to grow by harnessing their bureaucracy to build on others’ innovations. 

The EU needs new technology, but that is not enough. There also needs to be a bureaucracy that not only gets out of the way but also uses its power to allow for economies of scale. 

The crowds, momentum, and risk in markets

 "These heroes of finance are like beads on a string - when one slips off, all the rest follow." - Henrik Ibsen during the early phase of the Great Depression 

An insightful comment from someone not in finance. Ibsen was mainly a playwright; however, he was aware of the goings-on in Europe and the world. We have heroes of finance, but they are not the contrarians. They are the ones leading the crowd or banging the drum to move the crowd. Everyone likes the person who reflects their thinking. I follow Bob because Bob's thinking is consistent with my view of the world. Show me the person who is thinking differently. They are the people who will move me to think better. 

Once again, our foecasting skill is poor

We try and try, but the results are always the same. We are not good forecasters. Should we stop trying to predict? That would be the obvious answer, yet anyone who invests needs to make assumptions, which are forecasts. The easy answer is to diversify, but there are assumptions about what may happen in the future. The classic 60/40 stock/bond mix will not last forever. 

Turn the loser's game into one where you can limit downside. Provide ranges and not point forecasts. The key is knowing your limitations when it comes to forecasting. If you are likely to be wrong, think in terms of probabilities. Think about the impact of being wrong and how much exposure you would like to have.

 

Industrial policy thinking is back - Not clear that this is good

 

Marketcrafters by Chris Hughes is a quick read featuring stories of individuals who used government to shape market direction. In general, the stories are positive, yet some individuals used their power to bend policy in ways that had adverse market effects. The overall theme of this book is that effective industrial policies can influence markets for positive economic outcomes, whether in housing, monetary policy, international finance, energy, or crisis response. Hughes makes the case that good policy leads to good outcomes, but he also shows that bad policy can have severe negative consequences. Hence, a new industrial policy view will not be effective in creating a better economy. My takeaway is that industrial policy should apply the precautionary principle and be careful not to bend markets to your will, because the law of unintended consequences may lead you down a path worse than a market solution.

Common knowledge problem explained by Pinker

Steven Pinker is a prolific writer on many topics, and his latest book focuses on the issue of common knowledge, When Everyone Knows That Everyone Knows... Common Knowledge and the Mysteries of Money, Power, and Everyday Life, an essential issue in information economics and game theory. Common knowledge is the shared state of understanding associated with a fact that is known by everyone, and it is assumed that everyone knows that everyone knows. This back-and-forth about what everyone knows can go on forever. It is the foundation of non-cooperative games with full information and of group decision-making. 

There can be unwritten or accepted knowledge that is common, often associated with conventional thinking or wisdom, yet, as in the story of the boy who says the emperor has no clothes, there can be a radical change in thinking when common knowledge is challenged by the truth. Assumptions about what people know and what they think others know can affect price expectations in markets and influence bubbles and their bursting. Coordination of behavior is affected by what is assumed to be common knowledge. 

There are great stories and jokes associated with common knowledge that make this a fun book to read. Still, I would have preferred Pinker to focus on specific use cases to help clarify the key problems of how knowledge and expectations are coordinated in markets.

Toynbee on history - can relate to finance

 

From Toynbee on Toynbee: A conversation between Arnold J Toynbee and GR Urban. 

...in both physical science and in the study of human affairs, the test of the difference between what is chance and what is law - regularity - is one's conception of the structure of non-human nature and the structure of human nature. 

FInance is the search for regularity

...history being the victor's propaganda.  - Urban 

A fact in history is not really something concrete like a brick or a stone, that you can pick up and handle; a fact is manmade in a sense  - it is the result of a selection from the raw material... Homo sum humanum nihil a me alienum puto - the spectator is also an actor.

In finance, we select our facts. 

...Italian philosopher Croce as saying that all history is contemporary history... every human being is situated in a point-moment of time, and he can only observe the universe from this shifting point-moment. 

Our view of finance changes with time.

History is what historians write, not what actually happened, because it is only through the cognitive process of the historian that we can read meaning into an otherwise random accumulation of facts.  - Urban 

In finance, we search for meaning through our point of view.

A very important book even for finance people - Autocracy, Inc.

 

I don't often comment on non-finance issues, but I was moved after reading Autocracy, Inc. by Anne Applebaum. This was not an emotional feeling, but anger that the autocrats of the world are forming connections to maintain their power in their respective countries. These autocratic connections are thwarting democratic movements around the globe. Applebaum provides good descriptions with substantial evidence on how dictators want to work together for their common benefit. 

The solutions to this problem are not obvious; however, there needs to be some form of international order and coordination between Western democracies to ensure that the global behavior of dictators does not rule over others. A coalition of democracies needs to actively engage in efforts to stop autocratic coordination. Obviously, this is being done, but the efforts have not been strong enough. 

Innovation and change impacts quant results

I found this table one of the most interesting for the month. Corporate behavior is all about change, innovation, and adapting to market demands. This is a constant, yet many of the models we build to describe equities are based on assumptions of stability. The first products offered by many firms are long gone, and most investors do not remember or have never encountered these products. Lego - wooden toys? McDonalds - hot dogs? Who would have guessed?

We believe that betas are stable; however, if you examine this list, firm betas will be pretty dynamic. Now it may be stable over a short-term three-year period, but if a firm is transitioning strategy, these short-term betas will also be under attack and changing radically. Modelers cannot escape the news about firms.

from @stats_feed 

 

Hofstadter's Law - applies to macro events

 

Hofstadter's Law: It always takes longer than you expect, even when you take into account Hofstadter's Law. — Douglas Hofstadter

We have written about this, yet it keeps coming up in project management. It can also come up with crises. We may identify the key issues that may cause a crisis, yet it often takes longer to reach the actual event. What has been found with Hofstadter's Law is that while the median time to get a project done is usually within expectations, there are often very long tails beyond what is typically expected.

We know that uncertainty is high and impacts investment and consumer behavior. Still, the manifestation of this uncertainty may take months to show up in asset prices and actual data. Hence, identifying an event and seeing the impact of these expectations may not coincide. Being first when making a forecast is not the same as profiting from a forecast. 

See The planning fallacy and Hofstadter's Law

Vibe or math driven markets

 

We are in a vibe-driven market. A vibe market is driven by perceptions, not expectations, tweets, policy, sound bites, and analysis. We don't have to make a judgment on the quality or type of vibe. There are both good and bad vibes. The type of vibes can change within days. It changes reactions and valuation by driving short-term moves that increase volatility. The large intra-day ranges are the result of the vibes. Traders have to "feel" the vibe and show an immediate reaction.

A vibe market is not a math-driven market. Valuation models based on quant relationships will not be effective. In a past life, we would call this market noise. Noise may not have a cause. In this case, we know the cause of the noise: short-term news that has uncertain longer-term meaning or limited context. We are seeing the impact of vibes on the poor performance of systematic traders. We expect this underperformance to continue as long as we have the vibes driving markets.

Markets are "yippy" ... the word of the week

We have a new term from President Trump to describe the markets—"yippy," not "yippee." The reality is that markets react to uncertainty. We can use the VIX as the perfect example. Volatility has declined since the extreme earlier last week, but levels are still elevated. If markets are yippy, there is a reason and it is not just unwarranted anxiety.

Time is a scarce resource

Mr. Gilder noted, “The scarcest resource is time, which always becomes scarce as other things become abundant. It is human genius that transcends the scarcity of time.” That’s economic productivity in a nutshell. - Andy Kessler WSJ 3/31/25

A variation on the time value of money, but we have to value time, and it becomes more valuable when there are more conflicts or things trying to grab our attention and time. Depending on the activity, we want time to speed up or slowdown, but unfortunately, we do not often do a good job of putting a price on time.

Future Babble - we are not good forecasters

 

Dan Gardner wrote a devastating book on the quality of forecasts, Future Babble: Why expert predictions are next to worthless, and you can do better. Can we make good predictions on the future? Gardner pours on the evidence that the answer is no, not in the least. 

Karl Popper states, "The course of human history is strongly influenced by the growth of human knowledge, but it is impossible to predict, by rational or scientific methods, the future growth of scientific knowledge." Our global and economic changes are based on changes in knowledge. Predictions about shortages are often wrong because experts do not account for technical changes. They underestimate the impact of knowledge.

It is an unpredictable world and that is especially for the experts. Experts may be good at describing the past and the present, but they do not have any edge on judging the future. At best, experts will say that we can expect more of the same. They are hard pressed to answer questions about change. 

Gardner described the difference between two forms of experts: the foxes and hedgehogs. Hedgehogs know one thing very well while the foxes are generalists. The generalists will often beat the specialists, so look to generalist thinking for predictions. 

While the author may leave the ready with a sense of hopelessness, we can control uncertainty through relying on diversification and planning for change. While we cannot make good predictions, we can always assume that the world will change. 

The laws of simplicity should be applied to quant investing

 

I finished rereading The Laws of Simplicity. It is a short book that can be finished in one sitting, yet it is full of good ideas that take some time to internalize. I try and use these concepts with all of my research, but it is not always easy. Attempts to add alpha seem to be getting more and more complex with a lot of moving parts. The idea of simplicity is to eliminate the clutter and focus on core drivers, the more that must be estimated, the more that is likely to go wrong or subject to estimation error. 

The idea of trend-following is one of the simplest strategies that works. We find that momentum also works. The idea is simple, yet implementation can grow in complexity with risk management, positioning and exception analysis. The job of the research is to ask the question, "Is this feature really needed?", or "Can this model be made simpler?". 

Below are the ten laws of simplicity by Maeda. Do a walkthrough of any model and ask if it can be adjusted to be simpler.

Follow the liberal arts to be a good analyst

Debate logic with your acquaintances, And practice rhetoric in your common talk; Use music and poetry to quicken your mind; Turn to mathematics and metaphysics when you can stomach it. 

- TheTaming of the the Shrew 

To be a good analyst you need more than just math and quant skills. You also need more that finance knowledge. You need to have a complete set of skills that mixes logic, rhetoric, and math. All have to be practiced on a regular basis to be part of your everyday thinking. 

Recorde on needing numbers

 If number be lacking 

It maketh men dumb

So that to most questions 

They must answer mum 

The Ground of Arts - Robert Recorde

Recorde invented the equal sign in the mid-16th century and was an important English mathematician. I like this quote because ti presupposes that you need to have numbers to answer most questions. He would have made a good quant today. 

A book that provides structure on cultural wars of today

 

I have been trying to better understand the cultural dynamics that have caused significant conflict in the US and beyond. As an economist, I spend my time worrying about debt, inflation, and growth, yet the news media focus is often on cultural issues as the driver of thinking.  I need a text to help navigate what is going on without the usual left or right bias. I was recommended, We Have Never Been Woke; The Cultural Contradictions of a New Elite and was surprised by the different perspective of the author.

The foundation idea is that a new “woke” elite uses the language of social justice to gain more power and status for themselves and their enhanced elite status does not translate into help for the marginalized and disadvantaged. It is a cynical perspective, yet to resonates with the simple view that most individuals are interested in their own status and power first and helping others second. 

Language can generate status and serve as an exclusionary mechanism. Status and elitism may only serve to further generate social and economic inequality. Is that always the case? Certainly not, yet the good intentions for being a social justice advocate embedded in language and symbols may also have the impact of creating more status for individuals without helping those that need it most. Musa al-Gharbi writes a book that that is richly detailed and footnoted and unfortunately, sometimes filled with jargon, yet his argument is compelling, albeit sad.

The Great River - the Tale of the Mississipppi

 

I was recently in New Orleans standing in front on the banks of the Mississippi River by Jackson Square and I was in awe of the power of this majestic river. I was watching an ocean freighter slowly moving upriver. This is a river of commerce, yet there is more to the story of this great river system. Later, poking around the library, I found The Great River: The Making and Unmaking of the Mississippi by Boyce Upholt. This is a book of history, ecology, geology, and nature as Upholt walks through the story of taming the Mississippi. From discovery to control, Upholt provides a compelling story that makes the reader want to paddle down this great river. If you have any interest in this great river, put this on your list for the year.