Rowing forward looking backwards

I think that anyone who want to predict the future by looking into the past is playing a futile game. History at best provides us with a rough gauge of what may happen and not what will happen. Even if it does provides us with a definite what will happen, it rarely ever tells us when will it happen.

I heard on the MRT today that 'it will not rain today as it has rained yesterday'. What fallacy is that! As if there's a fixed capacity to the rain ABOVE Shenton Way. As human beings we love a good narrative , where every thing seems to have a cause. See how Sharon Stone got herself into trouble by suggesting that the terrible earthquake in China is related to the Chinese authority's treatment towards Tibet.

Furthermore we LOVE to extrapolate recent events. Sometimes it ok to extrapolate recent event, like "since loh wei's continuously gained 8 kg since oct last year, he'll probably gets heavier/fatter if he dun do anything about it." Weight change is a mostly a function of energy consumed and energy expanded, so unless i have some anomaly, it'll probably mean that i ate more than i worked for the past few months. While since i HATE to cut back intake, gotta force myself to expand more energy. Just that it's kinda hard to read and jog at the same time...Haha...

However, we also love to think in terms of trend, for example,e.g. since the company has increased sales for the past 8 years, it will increase sale next year, and probably for the next 10 years. Hey, that's how many financial analyst earn a living. Of course they will back it up with evidence of growing population, growing customer preference, etc. But if you care to look back into past analyst report, you'd find that most projections are painfully wrong. And when you back your ideas with lots of datas, tabs after tabs of spreadsheet in excel and preferably accompanied with a MBA, CFA, CPA, PhD, etc, people choose to believe that this fella knows more about the future than you. He may know more about the past than the untrained person, but does he really knows the future? who knows???

In investing and in life, we are like rowing a boat backwards away from the shore. All we have is the experience of the past to guide us, and the future is a vast unknown. How do we prepare for that? I guess i'll try by opening up my mind to more ideas, to allow people around me challange my opinions or even most precious belief, and always expect the unexpected.

p.s. i'm reading Black Swan now. Please, please read this book or the author's previous book Fooled By Randomness. It'll change the way you see the world around you...

Links
1. Preface to Fooled by randomness (free!)
2. Black Swan - Read reviews on Amazon

Turbulence and Margin of Safety

Met up with Guoyi last night and had Claypot Crab Bee Hon at Don. He’s really one of the most unique individual I know. He got the damn what the world thinks attitude which is so so rare. He gave me some insights to what Chemical Engineering is about; and my general impression is that the aim of the course is to create and design processes and equipment to mass produce experimental results.

He also gave me a refresher course on turbulence and on the significance of Reynolds number. Above a certain Reynolds number (~2400) , the flow is defined as turbulent flow. And I read on Wikipedia that (i) “Within a certain range around this point there is a region of gradual transition where the flow is neither fully laminar nor fully turbulent, and predictions of fluid behaviour can be difficult”, such that (ii) “many engineers will avoid any pipe configuration that falls within the range of Reynolds numbers from about 2000 to 3000 to ensure that the flow is either laminar or turbulent.”

Guoyi also mentioned that to many engineers, they think in terms of 10^n, ie 101 and 999 belongs in the same ‘family’. The rationale is that if you are designing processes or apparatus, it better be able to hand sufficient strain on the system to prevent catastrophe. For instance, Jun Bin told me that for the mask that is worn by fencer, it can ‘tahan’ way higher newtons of force than what normally happens during fencing.

All these examples reminds me once again on the Margin of Safety principle as expounded in “The Intelligent Investor” and practised by generations of value investor to great success. The idea is simple, only buy a security (stocks, bonds, etc) if the price is SIGNIFICANTLY LOWER than the value of the security.

“It is quite possible to decide by inspection, that a woman is old enough to vote without knowing her age, and that a man is heavier that he should be without knowing his exact weight.”
Security Analysis – Benjamin Graham


The advantages of MoS are twofold:

1) The buffer helps protect our capital.

Firstly, the value we place on the security is never exactly precise, so if you think the stock is worth $100, the ‘real’ value could be between $90 – $110. So it would be silly to buy at $95, cuz you could very well be overpaying. However, if you could buy the same thing for $70, then the $30 buffer would act as your safety net. This is exactly the same principle as applied by engineers during their design phase.

2) Margin of Safety boosts your return.
Assuming that you are right on the assessment of the value of the business at $100.
And you managed to purchase the stock at $70, with a MoS of $30.
Furthermore, the underlying business grow at 10% per annum.
And in 5 years time other investors recognise the merit of the company and bid the stock to a level that is correspondent to the business value, ie 100 x 1.10^5 = 161.

Your total return would be whopping 18% return. Way above the 10% return you would get by only assessing the value of business right and buying it at fair value.

With such brilliance and insights, its no wonder Guoyi is often flanked by girls in the school (from empirical evidences gathered by my very biased JC classmates in NUS library).

Reminiscence of a not-too-old man

Thanks Joel, for pointing out my error. Amended the previous post to what i think is a better flow of events.

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Why this post? cuz i suddenly felt that i'm the luckiest person on earth....after watching the fundraising show on tv......to anyone that i've not explicitly mentioned, you are always on my mind (to the tune of Elvis Presley song)....hahahaha...told you i'm ancient.

Had dinner with Daniel, Andrew and Damien last fri at Imperial Treasure at Taka last friday. While ordering, i asked the lady who's taking our order 'How much is the Roast Duck?', think the rest was kinda of embarassed by this question. And Daniel started laughing and buried his face behind the menu. I agree that it may not be the most appropriate qn to ask, but its just that price paid and utility must match. Daniel very nicely treated us to the meal. (but with his obscene pay cheque, i think he should too...hahaha...)

I must say that i'm a really lucky guy. Throughout my past 23 years i've been blessed with people who are caring and there to give. In primary school, i have a form teacher, Ms Chan, who truly cared. In secondary school, Mrs Razal and my awesome 3/4 class have always made me feel at home, and JSS choir helped me learn and grow . Junli and Chong Long have often

In JC, once again i'm surrounded with great people who are there to support one another. Guoyi allowed me to bug him non-stop with math questions. Jianen, Ivan and gang who helped me with physics, and the sporty bunch (Wei Tien, Arthur and such) will encourage me to run my last 2 more rounds by running with me though they have 'met their quotas'. Awesome people. Then there's the whole choir family, who gave me some of my fondest memories of my JC days.

In army, i hated BMT. I have never been able to take orders well if i can't see the rationale behind it, plus i'm really turn off by all the screaming and scolding. We are all human beings, capable of communication, why then does every sentence ends with a knn or fcuk? But when i was posted to the super ulu Sungei Gedong Camp, as an armoured engineer, my life changed. I stayed with a bunch of 'hokkien soldiers', and had a hard time adapting to the new environment. BUT they helped me get into the way to the unit, and accepted all my weirdness and pet peeves. (including wrapping my face with the green towel after they come back from their smoke break, or scolding anyone who sits on my bed before showering, or singing in the corridors...adnd the list goes on.) People like Guoyong, Daniel, Soon Lee are people you know you can TRUST if you are in a dire situation. Many times i feel that the so called less educated are of higher calibre than most uni students. They rarely overpromise, and dun bullshit others. Looking forward to meeting them again next month during ICT, yipee!

In SMU, life is GREAT! i get to study what i like, and get to stretch my mind and meet awesome people. People like Daniel, Roy, Damien, Andrew, Qinq da, Shakeeb, makes my days in school mugging an really enjoyable one. Being in E.y.E for over a year also allowed me to meet my extended family, Xin Hong, Zhao Bin, Joel (oh he say i very 'dao' in year one), Jun Bin, Jeremy, Angie, Pris and Myint. Once again they accepted me for all my quirkiness and made me feel at home.

Singing in the Alumni Choir allows me to relax and unwind every saturday. I'm so so proud of what we have achieved. It was first started of as an idea in 2002, and now we get to sing in Esplanade! Even though some of you have sang there before, but to me this was different. We are there becaused we have prepared ourselves for this opportunity for the past 3/4 years. Gotta thank Peiying for doing the thankless job of chairwoman, chee guan for brining the juniors in, for being so reliable and for being equivalent of 30 basses. Nad for enduring with my 'scooping' and wandering notes, Jie Min for being brave enough to conduct us even though i know you are not very comfortable with that. Geok for raising the spirit of the whole choir. To all my 02/03 batch pple (Jiechao, Ryan, Liping, Xiangji), we're still here and standing strong! And to all the young(er) ones, love to have you here to lower the average age of the choir, and to be so bubbly that it hard not to feel happy around you all! i'm looking forward to watch Avenue Q with u guys too!

My parents are the most wonderful people in the world! My dad, though he doesn't say cares deeply about me. His little act of kindness, like switching on the lights in the living rm if i'm not home yet or to help me iron my clothes, touched me deeply. My ever effervescent mom will always support me in whatever i do. They have unyielding faith in me and i love and respect them for all that they've done and who they are.

I once told Angie that i dun quite like human beings. But from the long long list of people i've mentioned and not mentioned, i realise that it simply isn't true. I still hate phonies and dishonest fools, but there's just so many great people out there that i cherished that i must reverse my stand. I love great people, but still hate phonies.

haha...enough ramblings for one post. may post something more intelligent soon.

Subprime, spillover and greed

I think we should reflect on Jie Chao's questions in the tagbox if you are interested in finance and the economy in general.

Here are his questions:
1. So this subprime crisis is aggravating the decline of the general US economy?
2. Am i right to say that this flood of refinancing of homes fueled the US economy some years back?
3. why does this deleveraging and foreclosures have such an ripple effect on the WORLD economy?
4. so basically the whole crisis lies in banks and financial institutions throwing out money to create a future stream of income that is in really a fat dream, right?5. therefore, it is really a false prosperity and that the seed of the crisis has long been planted when they refinance the homes?

In my opinion, I think that subprime has acted as a primer that triggered of this whole chain of event.

I'll attempt to link them up together.

Foreclosure rate increased in 2006 -->Home price decline --> Higher default rates --> Securitised assets (CDOs, MBS, etc) falls in value --> Securitised assets was held by leveraged loans (think of the 2 Bear Sterns hedge funds) --> reduced lending of banks + deleveraging of hedge fund +Reduced leveraged buyout --> CREDIT CRUNCH --> Reduced leveraged buyout + reduced economic activity (US states that can't finance public projects included)+ rising unemployment, funding problem faced by many companies --> economic slowdown/recession
(The above is my interpretation & understanding of this crises, and ideas formed from a talk i attended in SMU where an Exec Director from JPMorgan tried to explain the whole issue to us in English...please tell me if i have serious flaw(s) in the chain of reasoning)

After reading on Chaos theory, i'm damn scared to find causality between events. As human beings, we have a need to explain things in a way that make sense to us. This makes us vulnerable to flawed reasoning. However, I'll confidently pronounce that this crises is CAUSED by GREED, and no more than that. Greedy bankers and naive investors wanting to fuel the dreams of hopeful homeowners caused this debacle.

This is also partly fueled by Greenspan era of cheap money aka low interest rate, and the introduction of Adjustable-Mortgage-Rate type of loans to the US public (DBS introduced them last year too!). Furthermore, the securitized mortgages and debt were sold to yield hungry investors, say in China or other countries flushed with dollars bills from export to the US. So this US financial crises has a double whammy effect on these nations as (1) The investment that they hold has declined in value, (2) Their export will be hurt as US is the world’s largest importer.

Could we have predicted this crises and made money from it? Maybe…John Paulson made billions from it, Bill Gross side stepped it, Bill Miller stepped right into it, Countrywide financial and Bear Sterns gone down with it, JP Morgan got to buy the whole of Bear Stern on less than book value…who really knows who’s lucky who’s not.

Oh ya, by the way, Loh Wei bought shares in both JPMorgan and Countrywide last year. Some say lose some win some, but in this pair of trade, I lost more than I gained. Haha. That’s for discussion some other day.

Trying not getting killed

“We live in the trenches…we fight. We try not to be killed. Sometimes we are. That’s all.”
- Erich Maria Remarque, comment by some soldier fighting WWI

I was watching American Idol last night and was laughing my head off when the boxing guy, some trainer / motivational guru / snake oil salesman, was talked about the ‘knock off’ between the two David, he’s a whole lot of bull. I was thinking about why David Cook chose songs that were less popular. I suddenly think that it was his ‘evil ploy’ to not win the competition. Look at all the past winner, other than Carrie Underwood and Kelly Clarkson, none of the other winners continue to shine in the cut throat music industry. Maybe there’s a winner’s curse at play (literally), btw i’m not talking about the finance type of winner’s curse (will blog on this someday).

Winning in the game of investing is often about not losing in this game. Bill Gross of PIMCO shared his latest insights on his bi-monthly outlook .He shared with us PIMCO’s investment strategy since 2006 and the rationale behind it.

Essentially, it was a clearly defined 5 steps battle plan;

(1) Avoid the subprime mortgage meltdown – Mission accomplished
(2) Anticipate changes in monetary policy – Mission nearly accomplished
(3) Reinvest in high quality financial institutions which suffered impairment – Mission uncertain
(4) Ultimately invest in lower quality bonds as corporate defaults rise to peak levels – Mission for the future
(5) Be mindful at all times of the effects of a globalised economy – Mission ongoing

Gross talked about how PIMCO got to a defensive position in step 1 and 2 by purchasing long term high quality corporate bond and gave up a quite a few basis point earlier on when high yield / low risk instruments seems plentiful. However, this defensive play allowed PIMCO to “survive, and gained territory and are eager for further advances”.

Mission #4 seems to be a very interesting play. As corporate defaults rate rise to a peak, bonds would usually have higher yield to compensate for the higher risk. However, as default rate decline (since it has peaked), investors of these seemingly high risk bond would get higher yield for ‘free’.

However, Gross cautioned that RECESSION and its vicious cycle lurks around the corner. Furthermore the de-leveraging of the global economy may be lengthier and more painful than history suggests. Deflation of home prices, for instance, could once again turn the financial market upside down.

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(upnext, I will give an amateurish attempt to explain the impact of deflation of home prices)

Home equity = Fair market value – unpaid balance of the mortgage (and debt on the house).

It goes something like this, you can get home equity loan in the US. For instance, at the beginning of the year, your unpaid mortgage is $600k and market value of house is $1,000k. You can thus borrow on the 400K at a low interest rate of say 5%. So say if you borrow the whole sum, you'll get to borrow 400K and at an interest of 20K.

At the end of the year, your market value of house is $1,150k and you are allowed to borrow up to $550k, so you can pay of the interest comfortably with newly borrowed money. This could go on forever as long as the home prices in % rises faster than the interest %. This also allows you to spend like a king financed by the inflated home prices.

But now the reverse is true, interest on loans are going up as default risk has increased, and home prices have fallen as many people couldn’t keep up with their mortgages. Following from the previous example, as home prices decline, fair value = 500k and unpaid mortgage = 600k, you have a NEGATIVE home equity. You have to pay off the loan in full plus interest within short notice. So you spend less to try to pay off your debt. But the economy is softening and unemployment rising. You give up and default on your Home equity loan and even your mortgage and decide to stay on the streets. This vicious cycle goes on and on and thus wrecking havoc in the real economy.

Moral of the story for me, (1) what goes around comes back around, (2) it’s hard to be fearful when others are greedy, but we should darn well try, (3) My knowledge of such financial issues are really limited, if you find anything that’s inaccurate of plain WRONG, please tag or blast me with an email.

"Surely You're Joking, Mr. Feynman"

Richard Feynman was described as a brilliant and eccentric scientist. While reading this book, i can feel his enthusiasm for science and life radiate through the pages. And it is hard not to laugh out loud while reading some of the really hilarious stories, and yes, people do stare at you in the MRT.

A different box of tools

Feynman was a self taught mathematician. During physics class in high school, he's always up to mischief in class as he had covered all the basic physics stuff on his own. His physics teacher gave him a book "Advanced Calculus" that was meant for senior courses in college to occupy him. He learnt an operation to differentiate parameters under the integral sign (i dunno what that is?!?). This method was not very much taught in universities.

So when the brilliant mathematician at Princeton or MIT couldn't solve a 'chim' intergration, they'll bring the problem to Feynman. The 'diffentiate under integral sign' method often works. Quote from the book "So I got a great reputation for doing integrals, only because my box of tools was different from everybody else's, and they had tried all their tools on it before giving the problem to me."

It makes me wonder how often are we struggling with simple problems only because we do not know there's some fundamental tools out there that can solve it easily. Thus one of my goals for the rest of my uni days is to gather such useful tools and try to apply it actively.

The dignified professor (and that Nobel Prize)

After Feyneman got appointed as a professor at Cornell, he felt burnt out from all the preparation work in order to give good lectures. (so please appreciate all the good teachers.profs out there.) He even said the physics disgusts him a little, but he used to enjoy physics. THEN, he adopted a new attitude, he is going to play with physics, just like when he reads Arabian Nights [note to jiechao(: ] for pleasure. He shall not worry about importance or prestige or whatsoever.

Soon, he saw some guy spinning a plate in the air. And he noticed that red medallion of Cornell was going around faster the wobbling of the plate. From that, he worked out the 'wobble rate' and the 'rotation rate'. As he work out the equation for the wobble, he thought about how electron orbits start to move in relativity. He said that all this 'work' that went into the diagrams, theories and equations doesn't feel like work at all! It flowed effortlessly as he was having too much fun! Yep, he won a Nobel Prize for this theory.

How fortunate am i to be studying something i really enjoy. I just hope that everyone out there who's studying wouldn't let 'academic rigour' kills off that last bit of curiosity in us. Remember when we asked questions like 'why does the sun rise from the east?', 'why is the sea blue?', 'does the moon goes to sleep in the day?'.

Have fun learning, enjoy the process of discovering new things.

Please, please dun let that curious creature die.

The first post

Started this blog cuz a few friends (Zhao Bin, Jie Chao, and Guo Wei) asked me to start one. Xin Hong's blog offers me my weekly dose of inspiration. Thus on a smaller scale, i hope that i can provide anyone out there with something to think about. It is also an avenue for me to improve my really lousy writing skills.

I have no idea how often will i blog. But i'm quite sure that it will consists of my random musing on topics related to investing, current readings and stuff that interest me.

Why is this blog called "A different box of tools"? Cuz i'm trying to cure my 'man with hammer' ailment. Charlie Munger, "to the man with a hammer, every problem tends to look pretty much like a nail." I hope that i could counter this common problem by having different set of tools to handle different problems by borrowing from major diciplines, economics, psychology, physics, etc. So do expect pretty random posts.

On 'Chutzpah' (see link). Don't quite know what to choose as the address. As Chutzpah-unlimited is not taken, so here it is. Love this word as some of the people i admire use it frequently, Charlie Munger, Richard Feynman, etc. And i also like the sound of it too; huzt-pah (huzt sounds like hertz without the 'r').

Alright enough randomness. Next post will be about Richard Feynman - Nobel Prize winner, bongo drum player and safecraker. Hey, this guy is way more eccentric than me! yippeee!!!

I love this quote from one of his very famous lectures;

We absolutely must leave room for doubt or there is no progress and no learning. There is no learning without having to pose a question. And a question requires doubt. People search for certainty. But there is no certainty. People are terrified—how can you live and not know? It is not odd at all. You only think you know, as a matter of fact. And most of your actions are based on incomplete knowledge and you really don't know what it is all about, or what the purpose of the world is, or know a great deal of other things. It is possible to live and not know.

-"What is and What Should be the Role of Scientific Culture in Modern Society", given at the Galileo Symposium in Italy, 1964.