| Latest Forum Topics / User Research/Opinions |
 Post Reply
|
|
?Wealth Effect? a Black Cat?
|
|
|
Pinnacle
Master |
15-Nov-2007 00:53
|
|
x 0
x 0 Alert Admin |
Phillip Securities Research Nassim Nicholas Taleb, in his prologue of The Black Swan, offers an explanation about our world?s obsession with what is normal and that we neglect ?outliers? so much by our media (as in newspapers, TV, books), research and studies (e.g. bell curve, statistics) and more, leading to ?inability to predict history? because of the ?inability to predict outliers?. In today?s investing situation, we have become complacent that 4 or 5 (if you include the AFC in 1997, chart above) catastrophic events on the investment calendar of just 25 years were ALLOWED to wipe billions off the market cap of listed companies because we could not predict history. 4 or 5 out of 25 (if one could mix occasions with years), you are staring at as much as 25% outliers. Graphically if you squeezed this into a bell curve, you would get more of a pumpkin curve than a bell curve. Nassim attributed our complacency to our world?s unfair system of reward and punishment. He assumes, by way of an 9/11 example, a courageous and intelligent legislator, who somehow managed to enact a law on September 10 (one day before that fateful day), imposing locked cockpit doors. As a result, the planes did not hit the WTC and therefore there was no 9/11. Would this legislator have been rewarded? Most unlikely. Instead, one could think of many negative things that could have happened to him. The airlines would have hated him (cost, disruption) or he would have lost his job (tourism panicked). No one or very few would have appreciated something that did not happen. An important lesson to take away is that usually the impact of a crash is significant (otherwise one would not call it a crash) and it is therefore logical to further research and REWARD so as to predict history more accurately. The more likely people to succeed predicting history include people like Nassim or Benoit Mandelbrot (person Nassim dedicates his book, The Black Swan, to) - the chaos people, I mean. There is nothing strange about what the media can pull out of its bag of tricks when markets react badly. With the sub-prime issues in the US and the bad reaction from the financial markets, stories galore have emerged of the US going into a recession for sure. Celebrated names are quoted making calls for a recession or a severe slowdown. Next they will ?defrost? the Munger?s wealth effect remarks of a few seasons ago. To survive in this industry, I have learned to leave my brain at home when I go to the office. Let?s tackle the wealth effect from my desktop at home, with reason. A write-off or charge or loss provision is a not a cash flow item. When Merrill or Citigroup invest in a CDO, they pay for it. The seller banks the money. Merrill or Citigroup write their investment in their books. The payment by them is a cash flow item. The receipt by the seller is a cash flow item. If, for some reason, the seller decides not to bank the sale proceeds but he BURNS the money instead. There is a negative wealth effect. Money has disappeared from the system. But a write-off ? NO! If Merrill or Citigroup looks at the P&L account (includes the write-off) and not the cash flow statement to make firing decisions, will this create a wealth effect? It depends who they fire. By sacking the CEO will most probably not cause any wealth effect. First you hire a replacement. Second it may even improve the situation if the ousted CEO, with his golden handshake, decides to hire some people to run his entrepreneurial ideas. Now, assuming some other-ranked people got the sack but these could be cancelled out if the axed CEO hires these people for his entrepreneurial pursuits. We can argue till the markets resume their bull run. I believe we should monitor the banks if they should start to cut credit lines. If this does not happen, the economy will carry on growing, given the accommodative FED approach. China did not have a recession for a long time because they do not cut credit lines. Increase reserve ratio, yes, but they do not cut off the lines. This is the secret formula. I think many will be wrong this time or the people, who use the wealth effect to talk down the economy, will also get it wrong. Money supply dictates that there will be no recession in the US. Money has been created eleven months ago. If you don?t want the money, someone else would. As long as the banks don?t pull the plug, life goes on. George W Bush is right, this time. He said that if the US could come back from 9/11 (end of recession when it happened), then it should do likewise today. This fits the ?outliers? theory but because he is Bush, few believe. I might also add that the US recovered previously from 1987 (Black Monday), 1998 (LTC) or 1988/89 when a thousand financial institutions closed shop and so it should take the sub-prime ?excuse? and rebound strongly. Reward or punishment or I could just blame the media but one suspects that you can wish IT into an outlier for it to/not to happen with little reason. I could argue the Wealth Effect into a ?Black Cat? theory ? i.e. superstition. |
| Useful To Me Not Useful To Me | |