Tag Archives: Risk

Devil’s Advocates are Investors’ Best Friends, by Charles Hugh Smith

Posted on October 3, 2022 | Leave a comment

In my 28 years of trading, there was a time or two when a devil’s advocate would have been welcome. The problem is you never realize it until after you’ve lost a lot of money. From Charles Hugh Smith at oftwominds.com:

If those on the opposite side of the trade are viewed as threats rather than friends, it’s time to revise the analysis.

Of the many self-generated dangers investors face, few are more dangerous than confirmation bias, the comfort we experience seeking out views that confirm our own positions and our resistance to studying opposing views.

Confirmation bias is both self-evident and complex. We all understand the psychologically soothing feeling when others heartily agree with us, and the frustration, anxiety and sense of being threatened we experience when our core positions are challenged.

But there’s more to it than just that. Taking a position with conviction empowers us, for by publicly espousing a forecast, prediction or position, we’re implicitly saying, “When events show I’m right, that will show I’m smarter than the average bear.”

If we push our position and conviction to an extreme and shout it out loudly enough, we’ll attract those seeking to confirm their own biases. Confirmation bias thus generates a self-reinforcing feedback loop, as those shouting the loudest attract those who agree with them, rewarding their conviction with “likes.”

We all know the danger of marrying your position, that is, taking not just a financial stake but also an emotional stake that eventually becomes entwined with our identity. What may have started out as a calculated risk morphs into an all-or-nothing reflection of our identity. Any challenge becomes a threat to our selfhood.

Conviction is good, but a hedge and a Plan B are even better. Hedges and Plan Bs arise from a simple question: what if I’m wrong?

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Risk Accumulates Where No One Is Looking For It, by Charles Hugh Smith

Posted on March 17, 2022 | Leave a comment

You never know from where the snowflake that triggers an avalanche is going to come. From Charles Hugh Smith at oftwominds.com:

All this decay is so incremental that nobody thinks it possible that it could ever accumulate into a risk that threatens the entire system.

The funny thing about risk is the risk that everyone sees isn’t the risk that blows up the system. The mere fact that everyone is paying attention to the risk tends to defang it as everyone rushes to hedge or reduce the risk.

It’s the risk that accumulates under everyone’s radar that takes down the system. There are several dynamics driving this paradox but for now let’s look at the paradox of optimization.

The paradox of optimization is that to optimize efficiency and output (i.e. profit) resilience must be sacrificed. This leaves the system vulnerable to collapse when the system veers beyond the parameters set in stone by optimization.

Resilience is the result of a number of costly-to-maintain features. For example, redundancy: to optimize the supply chain, get rid of the higher cost suppliers and depend entirely on the lowest-cost supplier. This sole-source optimization works great until the sole-source supplier encounters a spot of bother, or one of the sole-source supplier’s component manufacturer encounters a spot of bother. By the time the entire supply chain has collapsed, it’s too late to reconfigure a factory or increase the production of marginal suppliers.

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The “Helicopter Parent” Fed and the Fatal Crash of Risk, by Charles Hugh Smith

Posted on April 13, 2021 | Leave a comment

Neither people nor markets learn or grow when they’re always bailed out of their mistakes. From Charles Hugh Smith at oftwominds.com:

All the risks generated by gambling with trillions of borrowed and leveraged dollars didn’t actually vanish; they were transferred by the Fed to the entire system.

The Federal Reserve is the nation’s Helicopter Parent, saving everyone from the consequences of their actions. We all know what happens when over-protective Helicopter Parents save their precious offspring from any opportunity to learn from mistakes and failures: they cripple their child’s ability to assess risk and learn from failure, guaranteeing fragility and catastrophically blind-to-risk decisions later in life.

Helicopter Parents generate a perfection of moral hazard, defined as there is no incentive to hedge risk because one is protected from its consequences. Moral hazard perversely increases the incentives to take on more risk because Mommy and Daddy (the Fed) will always save me / bail me out.

For example, when Mommy and Daddy make their reckless teen’s DUI charge go away, the teen’s already potent sense of godlike liberation from real-world consequences floats even higher. So next time the teen gets into his car drunk and takes his friends on a high-speed spin down Mulholland Drive, he loses control and kills everyone in the car–not just himself but those who trusted his warped sense of risk.

The Fed is the ultimate Helicopter Parent, protecting all the power players in our economy and society from the consequences of their risky actions. By crushing interest rates to near-zero, the Fed has perversely incentivized increasingly risky expansion of credit, and given the green light to there’s no limit, spend as much as you want government borrowing.

The Fed’s implicit promise to never let the stock market drop for more than a few days–the Fed Put–has incentivized every punter from billionaires to corporations to unemployed people with stimmy checks to max out their credit (or margin accounts) to increase their bets in the market casino.

The Fed has implicitly informed the bigger players that they can bet as big as they want because the Fed will always bail them out, transferring private losses to the public via Fed bailouts, lines of credit, backstops, etc.

The Fed has also signaled it will change the rules as needed to save its Players from loss. Mark-to-Market reveals the insolvency of the Players? Well, we’ll just get rid of that. All fixed! (heh)

Once the path of moral hazard has been taken, a fatal feedback loop takes hold: as reckless punters take on more risk to boost their gains, the fragility and brittleness of their positions increases geometrically. This soon endangers not just their own bets but the entire financial system, as it’s not just one punter who responds to the Fed’s Helicopter Parenting promise of no consequences for taking on more risk–every punter gets the green light to take on more risk because the Fed has our back.

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Mike Rowe: Everyone Is Essential, by John Stossel

Posted on March 4, 2021 | Leave a comment

You can’t turn life into a padded cell. From John Stossel at pjmedia.com:

AP Photo/ Evan Vucci

Politicians have too much power over our lives.

Many used the pandemic as another excuse to take more.

Early on, politicians declared that they would decide who was “essential.” Everyone else was told to stay home.

Much of the economy stopped. Millions were laid off.

Then politicians relaxed the rules for industries that they deemed “essential.”

“You can’t just call somebody essential without implicitly suggesting that half the workforce is not essential,” points out Mike Rowe, host of the surprise hit TV series, “Dirty Jobs.”

That’s a big problem, says Rowe, because people find purpose in work.

Now the Biden administration is eager to give money to people not working. It’s pushing a new stimulus package that would pay the unemployed an additional $400/week.

Since states like mine tack on as much as $500/week in unemployment benefits, many people learn that the $900/week. leaves them with more money if they don’t go back to work.

So, many don’t.

But staying home imposes costs, too. Calls to suicide hotlines are up. Domestic violence is up.

“It’s happening because people simply don’t feel valued,” says Rowe.

Politicians claim they save lives when they order businesses to close. When Governor Andrew Cuomo announced a lockdown, he said, “If everything we do saves just one life, I’ll be happy.”

Rowe mocks that in my new video this week.

“Let’s knock the speed limit down to 10 miles an hour… make cars out of rubber… make everybody wear a helmet,” he says. “Cars are a lot safer in the driveway… ships a lot safer when they don’t leave harbor, and people are safer when they sit quietly in their basements, but that’s not why cars, ships and people are on the planet.”

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Posted in Business, Civil Liberties, Collapse, Economy, Government, Philosophy, Politics, Propaganda

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The Red Flag Act, by Eric Peters

Posted on August 20, 2020 | Leave a comment

The human race never has and never will achieve “absolute safety,” and that’s a good thing. From Eric Peters at ericpetersautos.com:

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It can be hard to push back against Sickness Psychosis.

People who know it is a psychosis are social-pressured to comply with such outrages as being expected (and increasingly required) to dress up as if it were Halloween every day for reasons that are exactly the same in principle as driving their car no faster than 5 MPH with the flashers on at all times because someone fears “speeding” cars. That they might get run over – or run into – if cars were allowed to go any faster.

Such neurotics temporarily got their way more than 100 years ago, when the first cars appeared and threatened the delicate nerves of the velocity averse.

The Red Flag Acts (including the Highways and Locomotive Act of 1878) imposed a 4 MPH maximum speed limit in the country – 2 MPH in the city –   and required that the vehicle be preceded by a man walking at least 60 yards ahead of it waving a red flag to warn all in the path of the vehicle that it was coming . . . very slowly.

They got their way again in the early ‘70s, when the maximum lawful highway speed – which had risen to an alarming (to the velocity-averse) 70-75 MPH – was temporarily throttled back to 55 MPH. This was initially presented to a public terrorized by propaganda about artificial fuel scarcity as a necessary fuel conservation measure that oleaginously morphed into a saaaaaaaaaafety measure . . . very much as “flattening the curve” greasily morphed into “stopping the spread,” the latter having no end.

The common denominator being the weaponization of fear.

The difference being that the velocity averse were overruled by those who wanted to get places in hours rather than days and minutes rather than hours and – the key thing – rejected the neurotics’ assertion that their fear of movement gave them the moral right to restrict it so absurdly or even at all.

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On Reckless Exuberance, by Karen Kwiatkowski

Posted on August 15, 2020 | Leave a comment

In America’s rubber-room, zero-risk culture, there’s a lot to be said for reckless exuberance. From Karen Kwiatkowski at lewrockwell.com:

A big reason people enjoy Trump is because he seems to “have no filter.” He appears to be saying what he actually thinks, based on what he thinks he knows, regardless of the consequences. He’s kind of like a guy who tells the truth. We certainly can’t be sure, it’s unexpected in a modern President, but it’s definitely delightful.

For this, he is demonized as a liar, a fraud, an incompetent, the ultimate inappropriate man by the left progressive state media. On the right, strange code talkers like Q-Anon emerged early on to interpret this new method of communicating. Four-D chess, the mystics explain. Trump is a master, driving his opponents to derangement, and his supporters to delirium.

For all of this Trump focus, as the election looms closer, an anti-government crowd is expanding. A fundamental tear in the fabric of faith-in-government has been ripped open by Trump himself, and by pressures that go far beyond anything Trump as person or President can imagine or control.  This growing crowd, around the world and in the United States, is made up of those who are leaning into an understanding of class analysis – not the Marxist kind, but a more humanitarian and honest approach, explaining where the state actually fits into our shared modern misery.

The first eight months of 2020 shined a light on Karl Marx’s 19th century prejudices, which were actually against labor, in the sense of hard work and productive enterprise for the betterment of oneself and one’s family.  Marx was a perennially unemployed narcissist, dependent upon and simultaneously resentful of the charity of relatives and friends.  Better to create a system of a living wage delinked from actual labor value, a universal basic income by disconnected from productivity or merit, capital disassociated from market forces, and money and social status all directed by central planning intellectuals. Never worry that contempt for your benefactor might someday extend to the central state itself.

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Safety First is a Bad Ideology, by Diana W. Thomas

Posted on July 12, 2020 | 1 comment

At what point do the costs of preventing or ameliorating a risk outweigh the benefits of doing so, and does it matter if someone else is bearing the costs? From Diana W. Thomas at aier.org:

bubble wrap

When you walk out of your house, or enter the public street, you are on shared ground, a community space. During the pandemic of 2020, community spaces that are private venues, like Disney, have closed down just as often as community spaces that are public venues, like schools and playgrounds.

Public and private distinctions do not make a difference. Risk is the key factor to understanding why common spaces are closed and likely to remain so, at least in the way we were used to. In what is called the asymmetric loss function, a decision maker’s cost of a mistake in one direction is many times greater than the cost of error in the other direction.

Individuals with asymmetric loss functions are extremely risk averse when it comes to potential losses. Individuals often employ asymmetric loss functions in everyday life. For most people being 30 minutes early for a flight, for example, is much less costly than being 30 minutes late.

But, because people are different, individuals decide for themselves how late they can arrive and risk missing a flight. Things get trickier when decisions regarding risk tolerance are made for common spaces and groups, because one size doesn’t always fit all. Weighing downside risks too heavily can be socially costly, because some valuable private activities are prohibited.

Historically and across cultures, individual risk-taking is associated with growth and prosperity while minimizing risk and emphasizing potential social losses is not. In the last several decades, public tolerance of risk has shifted towards lower socially acceptable levels of risk-taking and in the long run, these changes may leave us all worse off.

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Lenin would be so proud, by Simon Black

Posted on December 5, 2018 | 1 comment

By socializing risk, in other words by making others pay for someone else’s mistakes, we make sure those risks will be taken again and again. From Simon Black at sovereignman.com:

Several years ago back in 2004-2006, if you had a pulse, you could borrow money from a bank to buy a house.

In fact, bank lending standards were so loose back then that there were some infamous cases of people who DIDN’T have a pulse who were still able to borrow money.

That’s right. Some banks were so irresponsible that they actually loaned money to dead people.

Of course, it turned out that lending money to dead people… or people with terrible credit who had a history of default, was a bad idea.

And the entire financial system almost blew up as a result of this reckless stupidity.

But then something even crazier happened: the Federal Reserve came in and bailed out all the banks with trillions of dollars of free money.

That was utterly nuts. Instead of being wiped out by their idiotic mistakes, the banks learned that they would always be bailed out no matter how stupid or greedy they acted.

The key lesson was that there would be zero consequences for bad behavior.

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Posted in Business, Capitalism, Collapse, Cronyism, Debt, Economics, Economy, Financial markets, Government, Investing, Politics

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The Market Gods Are Laughing, by Bill Bonner

Posted on July 12, 2018 | Leave a comment

Whom the market gods would destroy, they first puff up with all sorts of hubris and idiocy. From Bill Bonner at bonnerandpartners.com:

President Trump escalated the trade war yesterday, making a kamikaze attack on a vast armada of Chinese imports – $200 billion in total – headed for California.

The Chinese say they will retaliate.

Phony Wars

Last month, we opined that the trade war wouldn’t go any better than Vietnam… or Iraq… or any of the feds’ other phony wars – against drugs, poverty, or terrorists.

It will be expensive, futile… and perhaps disastrous.

But that doesn’t mean it won’t be popular. Wars give the spectators something to live for – us versus them… good guys against bad guys… winners versus losers.

Their hat size swells as their champion wallops the Chinese. Their girth shrinks as he challenges and taunts the Canadians. Their manhood grows when the enemy gives in and admits defeat.

But while this puerile entertainment is taking place in the arena, the real action is going on in the expensive skyboxes, where the elite collude against the fans.

Wars shift resources from the boring and productive win-win deals in the private sector to the magnificently absurd win-lose deals of the feds and their cronies. The only real winner is the Deep State.

Weatherman David

We saw our colleague, former U.S. budget chief under President Reagan, David Stockman, on TV yesterday. The interview was painful to watch.

He was bravely trying to explain the trade deficit and why it was caused by monetary policy, not by trade ramparts that were too low.

But the young, know-it-all newscasters were such numbskulls – so lacking in any experience, theory, or historical perspective – he might as well have been instructing a walrus on how to chew gum. The lesson was in vain.

The three TV experts saw no problem with the trade deficit… and no danger approaching from Trump’s war on it.

If there were any clouds on the horizon, they didn’t see them; if there was any thunder, they didn’t hear it; whether lightning was striking the light posts near them or not, they had no idea. They wouldn’t even look out the window.

Instead, they seemed eager to get Weatherman David out of the studio so they could go back to their bubble chatter.

They were so confident… so vain… and so dismissive of all risk…

…we thought we heard a bell ringing.

To continue reading: The Market Gods Are Laughing

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The Arithmetic of Risk, by John P. Hussman

Posted on March 5, 2018 | Leave a comment

Sooner or later Hussman’s warnings about overvalued markets and speculative manias are going to hit home. The market has been overvalued for a long time, but Hussman detects a shift in the its underlying risk dynamics. From Hussman at hussmanfunds.com:

The collapse of major bubbles is often preceded by the collapse of smaller bubbles representing ‘fringe’ speculations. Those early wipeouts are canaries in the coalmine. Once investor preferences shift from speculation toward risk-aversion, extreme valuations should not be ignored, and can suddenly matter to their full extent.

A month ago, I noted that prevailing valuation extremes implied negative total returns for the S&P 500 on 10-12 year horizon, and losses on the order of two-thirds of the market’s value over the completion of the current market cycle. With our measures of market internals constructive, on balance, we had maintained a rather neutral near-term outlook for months, despite the most extreme “overvalued, overbought, overbullish” syndromes in U.S. history. Still, I noted, “I believe that it’s essential to carry a significant safety net at present, and I’m also partial to tail-risk hedges that kick-in automatically as the market declines, rather than requiring the execution of sell orders. My impression is that the first leg down will be extremely steep, and that a subsequent bounce will encourage investors to believe the worst is over.”

On February 2nd, our measures of market internals clearly deteriorated, shifting market conditions to a combination of extreme valuations and unfavorable market internals, coming off of the most extremely overextended conditions we’ve ever observed in the historical data. At present, I view the market as a “broken parabola” – much the same as we observed for the Nikkei in 1990, the Nasdaq in 2000, or for those wishing a more recent example, Bitcoin since January.

To continue reading: The Arithmetic of Risk

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