Harry Newton's In Search of The Perfect Investment
Technology Investor. Harry Newton
AM EST, Wednesday, May 20, 2009. My brain
is in mulling mode. I won't make a million but I won't lose it either. I'm
looking at the contrasts (polite word) in the market -- the biggest one being
we're in a recession and the stockmarket is going up. Try this one:
ad revenue now shrinking. For
the first time since the dot-com bust, the U.S. online ad market is shrinking,
including search. That's a stunning drop in growth from a year ago, when the
market was still growing more than 20%.
The chart shows
the quarterly revenue for the big four: Google (GOOG), Yahoo (YHOO), AOL (TWX),
and Microsoft (MSFT).
here is Google's share:
If I were a
betting man, I'd say that Google's shares should be turning down any time
Madness (and maybe insanity): When the history of the early 21st
century is written, it will consist of a whole series of very dumb decisions
made under the gun of perceived (and heavily exploited) emergencies. Such
decisions include: eliminating the Glass Steagall requirement to permit commercial
banks to enter investment banking, to relax the net capital rule for investment
banks (which led to over-leveraging), invading Afghanistan and Iraq, encouraging
ethanol, bailing out the banks,, encouraging loans to deadbeats, promoting
outsourcing (and killing U.S.. manufacturers) and, most recently, running
government deficits into the ionosphere. Email me any others you can think
of. Then we can all feel depressed together.
lesson is simple: When in doubt, stay out.
lesson is more subtle: Be in doubt more often.
lesson is; Think
more. Act less.
Economist's new old book. In 2004, The Economist
published this little book.
In between updating
my dictionary and mulling the future of mankind, I've been reading it. After
all, our present mess is largely due to a handful of idiots who took gigantic
risks with other people's money in order to make themselves some short-term
Here's an excerpt
from the Shirreff's excellent Introduction (my bolding):
but boordes, Saylers but men, there be land rats, and water rats, water
theeues, and land theeues, I meane Pyrats, and then there is the perrill
of waters, windes and rockes. William Shakespeare, The Merchant of Venice,
Act I, Scene 3
first big mistake in The Merchant of Venice was to bet his whole fortune
on a fleet of ships; his second was to borrow 3,000 ducats from a single
The first rule of risk management is to identify your risk. The second is
to diversify it. Antonio broke the second rule, and his creditor Shylock
flunked the first. He found he could not take his pound of Antonio's flesh
without shedding "one drop of Christian blood": blood had not
been specified as part of the bargain.
This is an unusual example. But it illustrates how financial risk management
is just an extension of sensible prudence and forethought; to imagine what
might go wrong and to guard against it.
Modern risk management has developed mathematics and other skills to narrow
the field into bands of probabilities. It can never predict, it can only
infer what might happen.
When did modern risk management begin? It was an extraordinary collision
of extreme conditions in financial markets in the 1980s and a dramatic increase
in computer power. In the space of a few years, outcomes which could be
tested only by intuitive sketches on the back of an envelope, or worked
out after weeks of cranky iterations on a calculator, were replicable in
minutes on a desktop computer.
Monte Carlo simulations, chaos theory and neural networks have all attempted
to get closer to modeling real financial markets. Of course a model will
never be the real thing, and those who put too much faith in their
financial model will get caught out, as the boffins at Long-Term Capital
Management (a hedge fund which collapsed in 1998) spectacularly illustrated.
Ultimately, even financial firms have learned that mathematics has limited
value in calculating the probability of the most bizarre and extreme events.
As regulators and forward-thinking firms have got to grips with this problem,
they have ventured into the more uncertain territory of designing stress-tests,
imagining scenarios and occasionally playing out entire fictions of the
future. This is what makes the discipline of risk management more than just
a computer-driven exercise practiced by nerds in back offices. It challenges
the wildest imagination and the frontiers of creative genius.
Like mountain climbing, it is about minimizing danger and taking calculated
risks. Alpinists learn that principle fast or they and their friends die.
Dealing with risk in financial markets is different; the stakes are not
usually so high. And in financial markets most risktakers are risking
other people's money, not their own. That makes financial markets a
highly complex arena - far more complex, for instance, than a theatre of
war. Every trading decision may have a plethora of motives and emotions
behind it; in theory each trade adds new information, but mostly it adds
In the 21st
century, the noise from newswires, websites, radio, television and newspapers
has become so deafening that sometimes the entire world population seems
to be a single thundering herd. All humankind is focused on the troops in
Afghanistan, an earthquake in Iran, the fortunes of the Dax or the Dow,
or the earnings of IBM, which are "disappointing" because they
did not quite surpass those in the previous quarter. Like Pavlov's dogs,
we are being conditioned to salivate or recoil as massed ranks of financial
news sources pump out their messages.
risktakers have to make sense of all this garbage. And they have to combat
their own emotions, because dealing in financial markets, even on others'
behalf, is an emotional business. Even if they are not your own dreams,
you are seeing people's dreams made or unmade every day. Money, or wealth,
especially these days, is the chief means through which people hope to enhance
their lives. So the financial markets, apart from being a vital clearing
mechanism for world commerce, are places of dreams and emotions. Someone
who takes that on board will never make the mistake of believing that market
behaviour can be mimicked by maths.
Despite that caveat, a whole industry has grown up in the last 30 years
based on the idea that the behaviour of financial markets can be interpreted
and outsmarted by mathematical models. The modelmakers sell the illusion
that patterns and prices will repeat themselves. Sometimes the illusion
The endless fascination of markets is that they are always changing, as
if consciously seeking to spite human efforts to tame them. Just as fascinating
is the behaviour of the institutions that make up the markets: banks, investments
banks, insurance companies, corporate treasuries, brokers, exchanges, clearing
houses, central banks, pension funds, hedge funds, day-traders and speculators.
Like strings of mountain climbers they are keen to safeguard their own survival.
But to stay in the game they have to take risks.
financial risktaking, and the way in which institutions align themselves
to do it, is the most compelling game of all.
than risk-management successes, which are generally non-events, are the
spectacular failures. Failures tell us about the extremes of financial stress.
There are plenty of lessons to be learned from the collapses of Barings,
Metallgesellschaft, Long-Term Capital Management and other lesser blips,
many of which are analysed in this book.
Such analysis should help prevent financial institutions from making the
same mistake twice. Bus this has not always been the case, as some rather
accident-prone institutions have shown.
considers the notion that dealing with financial risk, however serious and
grown-up it seems, is nevertheless a game. It has basic rules and set pieces,
and performance that can be improved by practice. Yet most risk managers
and the institutions they work for - and indeed those who regulate them
-- do not give themselves the chance to test their skills in practice; they
are generally at the coal-face doing it for real 24 hours a day.
Learning from past mistakes is useful. Learning from mistakes that could
happen tomorrow is a crucial risk-management exercise. Yet the little scenario-building
and stress-testing that financial institutions have done so far is mostly
too abstract. They do not expose their staff in training to the kinds of
stresses that occur in live financial crises. But they could, and should,
do so at little extra cost, by playing full-blooded financial war games,
internally and even with rival institutions.
You can buy
David Shirreff's super book, Dealing with Financial Risk at the Economist's
you believe what some moron called his kid?
case you missed yesterday's wonderful Photoshop:
biggest bargain in New York is a $20 alta kaka (senior) season
pass to New York's public tennis courts. It lets you play for free. Only one
problem: When we went up there yesterday, we couldn't get a court. This confirms
Murhpy's Second Law: Just when you want to buy a second one of your favorite
thing, the manufacturer has stopped making it.
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
I make my daily column -- Monday through Friday -- freely available for three
reasons: Writing is good for sorting things out in my brain. Second, the column
is research for a book I'm writing called "In Search of the Perfect
Investment." Third, I encourage my readers to send me their ideas,
concerns and experiences. That way we can all learn together. My email address
is . You can't
click on my email address. You have to re-type it . This protects me from
software scanning the Internet for email addresses to spam. I have no role
in choosing the Google ads on this site. Thus I cannot endorse, though some
look interesting. If you click on a link, Google may send me money. Please
note I'm not suggesting you do. That money, if there is any, may help pay
Michael's business school tuition. Read more about Google AdSense,
here and here.