A Canadian on Wall Street

Bruce Schneier writes about the increasingly popular phenomenon of lock-in. From a business standpoint, this probably makes sense as a certain narrow-minded strategy, but it’s interesting to see, at least in the case of Apple, how it mirrors their old attitude of not allowing clones of their hardware. In fact, the iPhone lock-in strategy is business as usual at Apple, which some people have pointed to as their strength — they are one of the premier non-open source software companies, and that vise-grip they have on development stands in sharp contrast to Microsoft, which has an equally negative view towards open source. It helps that, at least for the moment, Steve Jobs is at the helm and is in sync with the wants of the consumer public — but that situation is always tenuous, in my view. Don’t forget, not that long ago the Apple was producing G3 Cubes and wondering why people weren’t snapping them up.

Good article on the over-emphasis of recruiters on “years of experience”, from Jeff Atwood. That said, I think this applies more to industries where there are concrete measures of knowledge — success in software development stems directly from knowing how to do something versus not, so a fast learner can compensate for lack of experience. In the investing industry, fast learning may get one up to speed on possible strategies and the mechanics of investing, but I think that neither experience or a sponge-like ability to learn will make a difference in terms of actual results, since the results are highly probabilistic. As far as I’ve seen, software does not function probabilistically, so what Jeff writes makes a great deal of sense.

Actually, that title isn’t that accurate, but it sounds nice, and that’s we care about here. Obviously if we could predict the future with any accuracy, patience wouldn’t even factor in. As it stands, though, the ability to temper the natural traits of human nature is the number one priority in investing, as far as I’m concerned. I look to myself as an example of this — for the past several years my investing has been poor in the face of what, relative to the days of 2002 to 2004, is a fairly volatile market. It’s incredibly hard to stick to strategies that take ages to develop a significant margin of profit or loss, so decisive action is difficult to make.

Most recently, I made a decent profit on a front-month option play derived from an underlying stock that has had a lot of news associated with it. But the longer I held the paper profit, the more anxious I got over dips that would cut it back. There was no reason NOT to let it expire in the money, and with the lack of news, the volume was not there for significant selling. But for some odd reason I got antsy, as I do sometimes, and sold out poorly — at market price, of all things! — and though I took a profit it was soured by the poor exit that I made. Since then, more news has come out to fuel the underlying and I left a significant amount on the table — instead of a 100% return, I coulda shoulda woulda made a 300% return. Obviously this is a common regret for investors, and something that must be tempered if one is to continue investing (the natural instinct is to go back in to the same position, at a much less attractive price, much the same way people follow mutual funds that have had banner years, only to discover the fund underperforming after they put their money in). It does highlight how useful it is to be a good gambler. Poker may be the closest of the card games to the financial markets, with its multiple player psychologies/strategies and incomplete knowledge, but a lot of the techniques of gambling, like bankroll management and the ability to recognize one’s own emotional responses to success or failure and control them, are present in any form of game where money is at risk.

I guess this is just my attempt at catharsis for a newbie move. Whoever bought those options off me got a pretty nice deal.

LATER: Fund manager C Neul describes his own battle with emotion versus analysis, although not explicitly (”fretted”). The real difficulty with systems of any kind is that they generally have human overrides, i.e. people who start to see the system break down and start to change things and deviate from the original strategy. I remember an article I once read about people who were taught a specific poker strategy — the people who could stick to it with no deviation did very well, while those that insisted on overriding the strategy fared poorly or middlingly well. I don’t know if this is necessarily support for the use of systematic methods in investing — I certainly don’t adhere to anything that rigid. But it’s definitely a reminder that one must enter and exit trades with a clear idea of why you are doing so. Too often, I still have no specific entry or exit point, which may work if you have an instinctual feel for the market as some traders seem to, but it makes it very difficult to subtract emotion from the equation when you have no objective limits. I think, perhaps, that I should at least start keeping a journal of my reasons for entering and exiting positions as well as the prices I’m willing to pay and justifications for those prices, even if the justifications lie on a foundation that in itself is not absolute (i.e. discounted cash flow analysis, etc).

I find C Neul’s description of how they found a new indicator of the market direction kind of suspect, in the way that one retrofits and backtests ideas against a particular sample to use as a new indicator of future direction. Then again, I’m not a fan of any kind of technical analysis, which this clearly is. But the surety of how he describes this measure (”standard deviation of daily total returns of the index”) as a way to make predictions about future moves is what I find least appealing — for a “skeptic”, he sure seems pleased with the new measure, that happens to fit his specific sample. Still kind of amazed that professionals do this, but I suppose if everyone took my stance the shell game would fall apart.

Found this article from 2002, originally in a publication called Washington Monthly. It’s still relevant today. Admittedly, the wholesale acceptance of efficient markets theory in the body of the text is a bit questionable, but I liked this quote:

I enjoyed the sight of my fellow students, many of them aspiring Masters of the Universe, squirming in their chairs. But before long I was sharing in their cognitive dissonance. I had come to Columbia to make myself a better financial reporter. What I was learning only reinforced my growing doubts about the intellectual legitimacy of the whole enterprise. If the smartest minds on Wall Street can’t consistently beat the market, how does it help readers to pass along their stock tips?

It’s a weird edifice that has been built. Financial analysts may no longer consistently issue buy recommendations, no matter what the (dot-com) stock, but certainly the emphasis on expected earnings per share and company forecasts is something that has replaced it, in terms of the analyst influence. How many times have I see stocks rise and fall precipitously based solely on what appear to be expectations or disappointment when they remain unfulfilled? The more hyped and reported a stock — the more analyst and, thusly, media coverage — the more volatile its response to these misses (either positive or negative). With the omnipresence of business reporting, financial blogs and innumerable other sources of information and misinformation, this feedback loop obviously has to be taken more and more into account when investing. Gone are the days of a small minority of the country investing and trading on scraps of information, only a few people privy to the full dossier. Nowadays, the real difficulty with investing is filtering out all the noise.

LATER: A case in point.

LATER STILL: Interestingly enough, the article mentions the death of The Industry Standard in the dying days of the dot-com boom. Well, whaddya know, it’s back. Some coverage from the Globe on it; they’ve created a prediction market for technology related news, an area that fascinates me but which I have no facility for, as far as I can tell. There doesn’t appear to be any money at stake, so I’m doubtful of the utility of the site for some kind of “wisdom of the crowds” predictive ability.

I tried a few Intrade wagers during the French election, betting on a longshot Segolene Royal win, but no go. It’s especially interesting to me now that I’ve done a bit of reading on commodity and index futures markets and read a quote in an old book called “The Traders” by Alexander Ross (long out of print; Ross is now dead) that depicts the various personalities in the circa 1984 stock/futures scene, that implied that the futures trader quoted thought futures markets were in fact much more stable in some ways than stock markets, since there were equivalently many shorts as longs in the market and that things like the 1929 crash would not have been precipitated by a lack of buyers. I wonder if the same functioning can occur with futures markets that have the mechanics of Intrade — I haven’t looked at it closely enough but event-based contracts don’t appear to have the same kind of continuity that things like commodities and indices do, as well as going to zero or 100 at a specific point in time.

Kara Swisher had an item about Mark Zuckerberg discussing Facebook (a private company) financials on a public dial-in number, and doing it pretty much on his own.

Revenue for Facebook for 2007 will be $150 million, as has been widely reported. But for 2008, Zuckerberg projected revenue to be increased to $300 million to $350 million.

More interesting was the news that Facebook would spend $200 million next year on capital expenditures, which is a whole lot of servers.

By the way, more expenses, noted chatty Mark, those employee levels would rise to more than 1,000 in 2008 from 450 now.

And Zuckerberg also said the company’s EBITDA–earnings before interest, taxes, depreciation and amortization and a number widely used by Wall Street as an indication of operating performance–would be $50 million in 2008.

That means the company would have a negative cash flow of about $150 million (EBITDA minus CapEx), rather than break even, as it does now.

But who’s counting? Zuckerberg apparently said he did not care about maintaining EBITDA anyway.

That’s because Facebook collected $300 million in investments recently from Microsoft and other investors, which pegged the valuation of the company at $15 billion.

Sounds like a guy with a lot of hubris — I’m sure if Facebook was a public company, they would have some ridiculous market capitalization (at least late last year). I wonder what full year income for 2007 was, that’s noticeably absent from this informal report. The mention of EBITDA for 2008 but no net earnings number is kind of suspect, too. I’m guessing this is another indicator that social networking, along with Google’s admission that it hasn’t turned into much of a revenue stream, is not something that will be very easy to milk. There’s something really unattractive about mixing social aspects with marketing and advertising so bluntly, sort of like that guy that all your friends call “the car salesman” and who’s completely ingenuine about his motives in his friendships. I think people’s natural distaste for that will keep this market a lot smaller than businesses expect — call it the social networking bubble. I’m curious to know what children who grow up in this ad-heavy online environment will think; I remember media classes in my high school where students were taught how to analyze commercials for their hidden aims and such — will kids of this era need such training or will most be skeptics? Will they be more susceptible and more accepting of this kind of marketing? One thing I find interesting in all the talk about the growth of online ad markets is that no one talks about AdBlock (the Firefox plug-in that prevents various advertising from being shown in-browser) and its amazing effectiveness. Perhaps, like GMail with it’s approximately 3% capture of the market, it’s something that seems like everyone should be using if you actually use it, but if you haven’t then you just stick to the status quo (i.e. Hotmail or browsing sites with garish banner ads sandwiched between paragraphs).

As usual, another quality commentary from Sacha Peter, comparing the current purchasing power of dollars invested variously, 30 years ago. I have to admit that his systematic and well-argued attitude to financial decision-making is something I aspire to, but which I don’t think comes as naturally to me. There’s still an element of hunch that I use, and which I think everyone must in the end. It’s interesting that after however many years of study of economic factors, the “dismal science” has not really been able to establish anything approaching the laws in more physical sciences — in the absence of such knowledge, how practically can rational decision-making be applied to the economy and the markets? New forms of statistical analysis may help but perhaps there should be more effort toward, not back-testing theories and analysis, but “forward-testing” it, by letting it run for a period of time and seeing how well they perform. The problem is that 1. if successful, you would have lost the opportunity to benefit (which is a big deal in a wealth-driven industry) and 2. there is no guarantee that the theory will accord with future reality. Unlike hard science, where many laws and theories have held up long enough to be considered “true” to most, any theories on market behaviour tend to run into headwinds within a lifetime or two. (I realize I’m sort of vaguely conflating economics and markets, but you get the gist.)

Speaking of the fertile analogical ground between people and corporations, Derek DeCloet applies the analogy to Microsoft. Microsoft’s offer for Yahoo does seem a bit like the latest in an undignified series of moves by an older man — the comb-over, the “hip clothes” — all intended to sell itself as the younger, faster, fitter, healthier man it used to be. It might work for a while, but perhaps corporations shouldn’t strive so hard to become new, the way some old people are content to be old, with all that entails. Then again, there are companies like IBM, Monsanto, Procter and Gamble, etc, who have been around for at least a half century now and don’t seem to be going away. No doubt the sped up timeline of technology-focused companies is causing some of the stress, but I think this might be a case of an older corporation trying too hard to enter new markets and losing focus on any core competency. I suppose there aren’t that many companies that are having their prime moneymaker so vigorously (and laterally) attacked, what with the operating system losing a lot of its importance in terms of application platform.