June 20, 2015

Peter Lynch was right - you can't predict the economy

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This is a quote by the famous investor Peter Lynch
I spend about 15 minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture. I also spend 15 minutes a year on where the stock market is going.
According to Peter Lynch, it's easy to overestimate the skill and wisdom of professionals who is trying to predict the economy. If an "expert" on television with a fancy job title is predicting the economy, it's easy for those who haven't studied Peter Lynch to believe the expert knows something that you and me don't understand. The truth is that the expert knows as little as everyone else does, even though many experts believe they know something. 
Peter Lynch describes it more deeply in his book One up on Wall Street. According to the book, there are 60,000 economists in the US. Many of them are employed full-time trying to forecast recessions and interest rates. If they could do it successfully twice in a row, they'd all be millionaires by now. But the truth is that they aren't. 
The idea that it's impossible to predict the economy might first sound strange. I myself had a hard time before I accepted this fact. The question is why so many experts are wasting their time, even though they are not always aware of it, while the amateurs continue to listen to them.
Because Peter Lynch is not describing exactly why in his book, I had to wait a few years to really understand why it's impossible to predict the economy. I finally found the answer in the book The signal and the noise by Nate Silver. That book includes several chapters on why so many predictions fail, including why it's impossible to predict earthquakes, why US failed to predict Pearl Harbor, and why some people didn't trust those who predicted the Hurricane Katrina. Another chapter in the book is about why it's unnecessary to listen to statements like:
  • The economy will create 150,000 jobs next month
  • GDP will grow by 3 percent next year
  • Oil will rise to $120 per barrel

The secret truth about economic forecasts
According to Nate Silver, economic forecasts are blunt instruments at best, rarely being able to anticipate economic turning points more than a few months in advance. In fact, these forecasts have failed to "predict" recessions even once they were already under way: a majority of economists didn't think we were in one when the three most recent recessions were later determined to have begun. 
Peter Lynch has the same ideas as Nate Silver. Again a quote from his book:
Nobody called to inform me of an immediate collapse in October [1987], and if all the people who claimed to have predicted it beforehand had sold out their shares, then the market would have dropped the 1,000 points much earlier due to these great crowds of informed sellers.
Every year I talk to executives of a thousand companies, and I can't avoid hearing from the various gold bugs, interest-rates disciples, Federal Reserve watchers, and fiscal mystics quoted in the newspapers. They can't predict the markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.
One of the latest examples showing how inaccurate experts are when predicting the economy is the Credit Crisis of 2008. About one year earlier, economists in the Survey of Professional Forecasters expected the economy to grow at a just slightly below average rate of 2.4 percent in 2008. And they thought there was almost no chance of a recession as severe as the one that actually hit the world in 2008 where GDP shrank by 3.3 percent. It was a scenario the economists thought would happen with a probability of just 3 percent. 
The above isn't just one case that confirms the rule. In a report with data from 1968 up until now, predictions by the Survey of Professional Forecasters for GDP fell outside the prediction interval almost half the time. So it is clear that the economists weren't unlucky - they fundamentally overestimated the reliability of their predictions.

Why is it so difficult to predict the economy? 
According to Nate Silver, economic forecasters face 3 fundamental challenges:
  1. It is very hard to determine the cause and effect from economic statistics alone. There are millions of statistical indicators in the world, and a few will happen to correlate with stock prices and GDP, even though it's just a coincidence. For example, ice cream sales and forest fires are correlated because both occur more often in the summer, but there's no causation. With so many economic variables to pick from, someone will find something that fits the past data, even though it's just a coincidence. 
  2. The economy is always changing. If the economists have predicted an upcoming recession, the government and the Federal Reserve will take steps to soften the recession. So forecasters have to predict political decisions as well as economic ones. Also, the American economy has changed from an economy dominated by manufacturing to one dominated by the service sector, which will make old models that used to work obsolete. 
  3. The data the economists have to work with isn't that good. With different governments with different policies, the past data will be subjected to these different policies, making it difficult to use old data and say that the data will be the same as today. Also, the data available may be limited. If you look at data between 1986 and 2006, which is 20 years, but the problem is that these years contained just two mild recessions.  
So what's the solution?
We know that Peter Lynch's solution is to spend about 15 minutes a year on economic analysis. Nate Silver, on the other hand, argues that if you have to listen to predictions of the economy, you should listen to the average or aggregate prediction rather than that of any one economist. These aggregate forecasts are about
  • 20 percent more accurate than the typical individual's forecast at predicting GDP
  • 10 percent better at predicting unemployment
  • 30 percent better at predicting inflation. 

May 8, 2015

2015 Update: Peak Oil - Are we there yet?

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About a year has passed since we looked at our old oil charts to see if we can see any signs of peak oil. You can see the 2014 version here. Enough talking, let's watch the charts.


The chart above displays the global oil production between 1965 and 2014. The global oil production has actually fallen from 31,682,000,000 barrels to 31,665,210,000 which is a very tiny decline. This small decline may originate from the number of conflicts that have hit several oil producing countries.
The chart that is most interesting to look at is the chart that has to do with the US oil supply. US is after all the world's largest consumer of oil. Also, a few years ago, some analysts argued that US could begin to export more oil than it consumed as a result of the new fracking sources. 


This is how the numbers have changed:
  • The production has increased from 2,737,500,000 to 3,651,095,000 barrels per year
  • The consumption has fallen from 6,898,500,000 to 6,893,755,000 barrels per year
  • The imports have decreased from 2,821,480,000 to 2,677,911,000 barrels per year
  • The exports have increased from 48,968,000 to 126,152,000 barrels per year
So we can see that US is far away from becoming a major exporter of oil. 

November 22, 2014

Peter Thiel analyzes Tesla Motors

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While Peter Thiel was born in 1967 in Germany, his family moved to California when he was young. Stanford was the school of his choice before he began trading derivatives at the Credit Suisse Group. In 1996, he founded the hedge-fund Thiel Capital Management, and he's also famous for being the first outside investor in Facebook. 

Peter Thiel has also donated $3.5 million to the Methuselah Foundation, which is a life-extension-research organization that believes humans will one day live to be 1 000 years old. One of the founders argued that the first human to live a 1 000 years is already born.

In 2005, Peter Thiel created Founders Fund, a San Francisco based venture capital fund. In the fund, you can find companies like SpaceX and Spotify. He has also written a book called Zero to One where he talks about his strategies. 

Peter Thiel is a venture capitalist (VC), who invests in new technology companies. It's generally difficult to follow the rules a VC has if you are investing in the public stock market, but I still believe you can learn something from some of the rules.

Venture capitalists aim to identify, fund, and profit from promising early-stage companies. But most of these companies will fail, and so will the fund. According to Peter Thiel, the biggest secret in venture capital is that the best investment equals or outperforms the entire rest of the fund combined. If you don't want to fail, then only invest in companies that have the potential to return the value of the entire fund. However, even if you find a successful company, you may still fail. For example, Andreessen Horowitz made a 312 times return on their investment in Instagram, but that wasn't enough to cover the rest of the fund because their investment was too small. 

Peter Thiel has two main rules
The value of a business today is the discounted sum of all money it will make in the future. That's why it may seem that new technology companies are extremely overvalued compared with older companies. For example, when Twitter went public in 2013, it was valued more than 12 times the Time's market capitalization – even though each employs a few thousand people, each gives millions of people a way to get news, and the Times earned $133 million while Twitter lost money. While investors expect Twitter to generate cash flows in the future, they don't believe in more traditional ways to read news.

Monopoly is the condition of every successful business. Under perfect competition, no company makes an economic profit. On the other hand, a monopoly owns its market, so it can set its own prices. Each monopoly is unique, but they usually share the following characteristics:
  1. Proprietary technology. It's impossible to replicate the product – like Google’s search engine. 
  2. Network effects. You have a network effect if a product is more useful as more people use it – like Facebook. 
  3. Economies of scale. The company gets stronger as it gets bigger. 
  4. Branding. Creating a strong brand is a powerful way to claim a monopoly.

Peter Thiel has seven questions he asks before he's investing in a company
  1. Can you create breakthrough technology instead of incremental improvements? As a rule of thumb, the technology must be at least 10 times better than its closest competitor. PayPal was 10 times better because it took 10 days faster to let buyers pay. Companies must strive for 10 times because smaller improvements end up meaning no improvement at all for the end user. 
  2. Is now the right time to start your particular business?
  3. Are you starting with a big share of a small market? Huge trillion-dollar markets mean ruthless, bloody competition. Facebook began with a big share of the small market "Social networks for Harvard University." The initial markets are often so small that they often don't even appear to be business opportunities at all. 
  4. Do you have the right team? One of the single clearest patterns Peter Thiel has noticed from investing in hundreds of startups is that a company does better the less it pays the CEO ($150,000 per year is enough). Real technologists wear T-shirts and jeans, so never invest in a tech CEO that wears a suit. 
  5. Do you have a way to not just create but deliver your product? Selling and delivering a product is at least as important as the product itself. 
  6. Will your market position be defensible 10 and 20 years into the future? For a company to be valuable it must grow and endure – even though many entrepreneurs focus only on short-term growth because growth is easier to measure. The most important lesson learned from Steve Jobs has nothing to do with design. The greatest thing Steve Jobs designed was a long-term vision. Many companies have failed because they didn't answer the question "What will stop China from wiping out my business?"
  7. Have you identified a unique opportunity that others don't see? Great companies have secrets: specific reasons for success that other people don't see. 

Let's apply it on Tesla Motors
The value of a business today is the discounted sum of all money it will make in the future.
Tesla's stock market value is high compared with other car manufacturers like General Motors. But that's because the investors believe more in Tesla's future profits than what they believe in the future of General Motors.

Monopoly is the condition of every successful business.
  1. Proprietary technology. It's not yet as difficult to replicate a Model S compared with what it takes to replicate Google. 
  2. Network effects. If more people drive cars from Tesla, the infrastructure around the cars (like charging stations) will improve, so more people will drive cars from Tesla because of the infrastructure. 
  3. Economies of scale. It's easier to lower the price per car if the factory is bigger, and Tesla is also building their own battery factory. 
  4. Branding.


1. Can you create breakthrough technology instead of incremental improvements?
Tesla's technology is so good that other car companies rely on it. Daimler, Mercedes-Benz, and Toyota are all using technology from Tesla. Moreover, the Model S was rated higher than any other car by Consumer Reports and the Model S became the car of the year by several magazines.

2. Is now the right time to start your particular business?
The original founders of Tesla founded the company because they saw that people were driving the hybrid Toyota Prius only because they cared about the environment and they couldn't find a true electric car. The world will also begin to run out of oil in a few years, so now is the time to sell cars not dependent on oil 

3. Are you starting with a big share of a small market?
Tesla started with the small market "high-end electric sports cars" when they designed the Tesla Roadster. They now had a little more money and a brand they could use when they designed the Model S.

4. Do you have the right team?
The current CEO of Tesla Motors, Elon Musk, described his team: "If you're at Tesla, you're choosing to be at the equivalent of Special Forces. There's the regular army, and that's fine, but if you are working at Tesla, you're choosing to step up your game." Elon Musk is also a big believer in electric cars. 

5. Do you have a way to not just create but deliver your product?
Tesla want to own the entire distribution chain where they sell and service the cars themselves without any traditional car dealer. 

6. Will your market position be defensible 10 and 20 years into the future? 
As the world is running out of oil, and Tesla believes electricity is the weapon of choice when there's no oil, there will be a big demand for electric cars in 10 and 20 years. But what about China? It's true that the Chinese are building several electric cars, but the question is how good future models are compared with a future Tesla?

7. Have you identified a unique opportunity that others don't see?
Tesla has identified that 100 percent electric cars belongs to the future. Other car companies tend to believe in hybrid cars or cars powered by fuel-cells, but Tesla will not sell any of those cars.

This article is a part of the article series Tesla Motors Stock Analysis

October 14, 2014

Somalia is back - part 2

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Almost a year ago I wrote an article with the subject that Somalia might be back in business. You can find it here: How to invest in specific countries in Africa, like Somalia and Rwanda. To summarize:
  • The economy will grow by 10 percent each year 
  • 60,000 Somali refugees return each year 
  • 350 new companies are registered each year 
  • Rents and property prices have begun to increase. In 2012, a five-bedroom rental apartment was $500 a month, today it's $4,000

Today I found a new video called "Mogadishu's face lift" (Mogadishu is the capital of Somalia and was nicknamed the most dangerous city in the world). The videos shows that Somalia has continued to improve. Let's hope this trend continues. 

October 5, 2014

The secret to who is a good trader or investor is meditation

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Two of my favorite books that are related to the stock market are Market Wizards and The New Market Wizards by Jack Schwager. What distinct these books from most other books related to the stock market is that they include chapters about psychology. If you didn't know it, it's very important to be aware of your own psychological limits if you are traveling the ups and down of the stock market. 

One of the traders interviewed in the book Market Wizards is Richard Dennis. He understood the importance of psychology if you want to become a better trader or investor. According to another book about Richard Dennis, The Complete TurtleTrader by Michael Covel, Richard Dennis never read any stock market news, such as crop reports or the latest unemployment numbers. What he read was the magazine Psychology Today to keep his emotions in check and to remind him how overrated intuition is in trading. While other traders woke up as early as possible so they had the time to read the latest news, Richard Dennis stayed in bed until the last minute before arriving to the exchange just as trading started. 

One common psychological mistake most novice traders and investors make is that they are buying stocks and other assets when "everyone" else is buying, like during the so-called tech bubble at the turn of the century. When the stock market began to fall, after the burst of the tech bubble, they who had earlier bought expensive stocks were now afraid of buying cheap stocks because everyone else was as afraid of losing more money as they were. 

Another common mistake is called confirmation bias (Wikipedia has the full list if cognitive biases). Let's say you've invested in gold. It's common that you will read information saying gold is a good investment and you confirm what you already know, but you also tend to reject all articles saying gold is a bad investment. 

So how can you control your emotions? It's super-easy to read about psychology, but it's much harder to remember and apply what you've read when you are losing all the money you've saved throughout your life. One solution to this problem can be meditation. 

According to the podcast The Tim Ferriss Show, where Tim Ferriss interviewed Joshua Waitzkin, the secret to who is a good trader or investor and who is not is actually meditation. Joshua Waitzkin is coaching the top hedge fund managers. When Tim Ferriss asked him the question "What are some habits that you've observed that you find interesting?" Joshua Waitzkin answer was: 
"First of all, meditation. Meditation is as deep and as powerful tool as I can possible describe. Maybe six or seven years ago when I was first talking about meditation with guys in the finance world it seemed like some strange thing for them to take on. But as more and more people are integrating it into the process, you wouldn't believe how many of the most powerful players in the world are meditating very deeply."

According to this Bloomberg article, hedge fund managers like Ray Dalio, Paul Tudor Jones, and Michael Novogratz, are fine-tuning their brains with meditation. But what's meditation? Meditation used to have this reputation as a hippie thing, but Samurai practiced meditation to become killers that are more effective. You've probably seen those Buddhist monks who are sitting with their legs crossed and their eyes closed. They are not praying and meditation is not a religion – what they are doing is they are trying to focus on the present. Focusing on the present is actually very difficult. Next time you are brushing your teeth, try to focus on brushing your teeth. But you will probably notice that your mind will wander away and you will think thoughts unrelated to brushing your teeth. 

If you can focus on the present, you will be able to move away from your other thoughts and make better decisions. If the stock you've bought is falling through the floor, you have to ignore your bad thoughts to not panic and try to remember the cognitive biases to not sell the stock just because it's falling.