Certainty vs Likelihood

Anxiety is a permanent condition that drives stress. Without anxiety, we might make significant errors of excess and with too much anxiety, we might make significant errors or caution. While these issues are challenging, they are not nearly as difficult as the related unconscious behaviors.

In the investing arena there are many uncertainties. I discovered during the Great Tech Bubble of 1999-2000 that clients wanted certainty. When my clients who were business savvy asked about stock market conditions, I provided the pros and cons of why I thought it was a dangerous environment but declared that it was not certain. Almost to a person, these people fired me. When my clients whom I did not perceive to be savvy asked about conditions, I told them to go back to their lives, that it was dangerous and we were taking care of their funds. Almost to a person, these people stayed.

As a reflected on this divergence, I thought about being a passenger on an airplane. If the pilot came on the intercom and told us that we were entering a storm system, that it was likely that we would emerge alive but yet there remained a small chance that the plane would crash, I would be panic stricken. I'm actually looking for the pilot to lie to me - to make that high likelihood of safety into a certainty of safety in order to calm my anxiety over flying 32,000 feet in the air in a small metal tube. I discovered that clients wanted me to make a likelihood into certainty. That's actually part of what they pay for.

The problem is that when you begin by lying to others, you end by lying to yourself. By indicating certainty to others, that behavior can gradually lead to a sense that certainty is achievable instead of degrees of likelihood. There is no certainty in any markets. However, this knowledge is only relevant as far as the research process allows. If the certainty bias against anxiety runs rampant, it will then create additional delusions of overconfidence and confirmation biases.

Reasoning is critical, but rationality is limited in markets where empiricism is a careful constraint.

Relying On The Kindness of Strangers? QT's fickle ways

As the famous play conveys, relying on the kindness of strangers is not a good strategy for living. However, during good times, such as Fed monetary easing coupled with Quantitative Easing, the kindness of strangers becomes almost compelling in its success. At times, borrowing or gambling yourself rich becomes a reality and "monkey see, monkey do" sets in.

As tightening becomes a reality, any strategy that relies on the kindness of strangers - such as the greater Fool approach or borrowed money - becomes dangerous. As a result, significant downturns have occurred in the housing and auto industry. At the same time, crypto and SPACs have taken significant hits. As the phase 1 of tightening turns to phase 2 of pausing, more problems in these kindnesses are likely to surface.

Who's gigging whom?

In Texas, the fans of Texas A&M are well-known for their sports yell of "Gig 'em Aggies!" The term is borrowed from the world of hunting frogs or fish as a form of spearing the prey with a "gig." But the term's usage is increasingly heard as we discuss the "gig economy," meaning a series of short-term jobs or engagements.

When I first learned about Uber and noticed the price and experience advantage over taxicabs, I went home and began the process of selling my cars. The economics made sense. Since I drove my car less than 5% of the time, ride share made sense. Further, there was labor as people between jobs or who needed additional income or flexibility could earn money. It all confirmed the beauty of capitalism's decentralized usage of excess capacity.

Recognizing that no clear competitive moats existed, I avoided any investments in Uber or its competitor Lyft. Then, as usual, the California government entered the space to save the poor labor market. Rather than address the bad business behaviors (such as not forwarding tips to the drivers - which was a major issue), California's legislators focused on creating full-time jobs. Another example of needed governance being misapplied. 

The result is chaotic. Without going into all of the details, the companies are now forced to some bizarre pricing models. When I looked at pricing to ride to DFW this morning, Uber was at $35 and Lyft was over $80. Two weeks again, it was the exact opposite. Of course, if the prices were similar, these companies would be accused of price fixing. Worse yet unsustainable losses at the parent level are occurring

Uber posted a $1.3 billion loss over the first nine months of the year, bringing the firm’s loss to $30.3 billion going back to 2015. Though Uber shares are down 40% since their spring 2019 IPO, the company remains valued at $54 billion. Lyft has similarly ugly results. The markets are pricing that a way to allow rational platform and labor competition will develop. Short of smart regulation or Lyft collapsing, I don't see it.

How Quickly is the Recession on the Way?

If it's not already here, a recession is clearly on the way. A recession is at least two consecutive quarters of a drop in GDP. Of course, GDP is composed of volume and price. It appears to me that volume is already in decline, but price is increasing at a rate that disguises the underlying recessionary trend.

The Fed's commitment here is strong, but the journey is nearly impossible in the short run. Consumer balance sheets are so strong and desires to consume so high that I seriously doubt that 10% interest rates would stop them. So, the slowing must come from somewhere else. Perhaps it will simply take the reverse effect of what kept the economy going during the pandemic - a wealth effect. 

By driving rates higher, stock and bond markets have immediately responded with the worst combined drop since 1932. However, the other more important asset has yet to drop - real estate. Real estate is a backward looking asset class. As a result, it only drops when enough people are forced to sell and the lack of buyers reveals a new set of appraised values. With the lock in long term rates at such low levels, it is unlikely that the recent purchasers are going to be selling. 

So, if the reverse of the wealth effect - call it the poverty effect - needs to occur before the economy really slows down, the Fed will be in hiking mode for some time here - barring a "break" like occurred recently the British pension schemes.

This Time Is Different?

"This time is different" are reputed to be the most dangerous four words for investors. Yet, the past three years have certainly made an argument for their usage. 

One of the many remarkable patterns that I see currently is the attempt for the Fed to slow down the economy while consumers have strong balance sheets. In the past, the Fed has attempted to slow things down (e.g. 1999 and 2007) when spending and speculating have been running hot with a consumer whose balance sheet was weakened with debt. By "tightening," the Fed has been able to slow the economy dramatically due to the drop in asset values, the loss of cyclical jobs and a drop in consumer demand. But this time looks different.

For example, in reviewing AutoNation's (AN) financials, I have been amazed to see how AN has fared. In the midst of this tightening, the volume of cars sold has dropped by roughly 20%, but the price increases have offset this loss. These price increases have occurred even as AN is selling cars with missing chips. Even more, these price increases are based on financing with rising interest rates. At this point in a "tightening" cycle, AN would be marking down cars to clear them from the lot as consumers would step back. It appears that no amount of pressure is reducing this demand.

From where I sit, the "this time is different" dynamic is rooted in delayed gratification. People who have suppressed shopping and traveling desires for three years are simply responding differently. During the pandemic, it appears that people not only missed hanging out with friends and family, but they also missed the joys of new stuff, of new vistas and of new experiences. If that is so, the Fed is fighting a demand drive with more psychological force than previously experienced. In fact, the closest analogy may be the euphoria of post-war spending.

Recession Ahead: Necessary or Not?

Chairman of the Fed Jerome Powell has transitioned from calling inflation "transitory" to no longer transitory. Both positions were accurate at their respective times. This inflation is not driven by an excess of demand, but by COVID-related supply chain issues. It was logical that as COVID receded supply chains would open up effectively, but that has not occurred due to three factors: 1) chip shortages require longer start up periods, 2) the Chinese reverted to COVID policies in light of their zero tolerance policy and 3) the Russian invasion of the Ukraine. So inflation will last for sometime, but is not driven by an excess of consumer demand. Given that the Fed understands this, why would the Fed push ahead aggressively with rate increases? In a word - expectations.

The Fed is responding to concerns that a temporary set of supply chain issues becomes a permanent mindset for producers and consumers. The Fed always uses a blunt instrument. In 1999, the Fed could have used stock market specific tools to deal with the Internet Bubble, but chose instead to raise rates which punished the entire economy. Today, the Fed looks to apply the same punishment to slow the entire economy down to the speed of the supply chain's average production ability. This will certainly create a drop in demand by creating a drop in employment. However, that will quickly lead to a recession while not necessarily fading inflation until these three aforementioned factors abate. Ironically, if the Fed were to not act at all, the economy may more quickly resolve these issues with funding for increased production but at the risk of inflation expectations hardening.

Self-serving Bias in Driving

Owning Berkshire Hathaway (BRK) means taking a sizeable position in automobile insurance through BRK's ownership of GEICO. The possibility of self-driving cars concerned me because it seemed that car insurance would be radically changed or even eliminated. However, as I reflect more deeply, automobile insurance is likely to stay as well as become a critical participant in the adoption of the technology. 

Self-driving cars concern most of the people I talk with, but I find myself eagerly awaiting their arrival. Initially, I viewed this difference as based in my dislike for driving. Again, further reflection revealed a superficial analysis. The reality goes back to studies from decades ago that showed drivers, on average, viewed themselves as better than average drivers. I thought to myself, "am I better or worse than other drivers on average?" At first, I reflected on my age and my aptitudes and concluded that I had better than average possibilities. But further analysis revealed my propensity to talk on the phone, work on my computer and change cassette tapes while driving. Those patterns were rooted in my overconfidence on the road - making me a worse than average driver. That's when I gave up, for the most part, driving.

A friend of mine says "we are all the center of our own universe" which is the root of our self-serving bias. It's weird to have such a maladaptive mechanism that would cause us to overestimate ourselves in a setup for worse outcomes. I've come to believe that this self-serving bias feels so good in its "rose colored glasses" effect that we are all wearing those glasses. Self-serving biases are a kind of first generation augmented reality glasses that can also be called "the Lake Wobegone effect," "the overconfidence bias" and even "free will." I used to think it populated more with men, but now I think it's topical and affects everyone after talking with mothers and fathers about their children.

The beauty of insurance companies is their focus on statistical analyses. Insurance companies are the likely proponents of self-driving technologies because they will reveal the statistical advantages of self-driving. There is no question that self-driving cars have and will have a lower likelihood of accidents, but people will be reluctant to embrace that improvement as long as they maintain the bias that their own capacities will cause them to defeat these odds. It will require the insurance company's pricing mechanisms to shape the consumer's sense of paying a higher price for the "right" to beat the odds.