LifeGame

Michael Burry, Where are you? What to do in 2013... no idea, here's some guesses.

Who is Michael Burry?

In 2006 Michael Burry looked like a fool. His hedge fund (Scion Capital) had just lost 17% after posting many years of incredible returns. His investors were mad and since his fund was only 6 years old the usual "track record" wasn't in place - despite research demonstrating how there is almost zero correlation between past and future returns.

Burry was confident.

“Never before have I been so optimistic about the portfolio for a reason that has nothing to do with stocks” he said.

and

“Despite our mark to market losses, we’re short the mortgage portfolio everyone would want if they knew what they were doing.”

Ah. Yes. The sub prime mortgage crisis. It's famous, and almost financial history now. But in 2006, it was a myth. People were getting rich betting on sub prime... very rich. And doom and gloomers predicting the end of the world were losing money... a lot of money.

Michael Burry trusted what the numbers told him and mistrusted what the people told him. By looking at default rates across various mortgage tranches, it was easy to see that people who had teaser rate loans that readjusted were defaulting at much higher rates "than expected." By looking at the increase in % sub prime mortgages, especially ones at teaser rates, it was pretty easy to work out what was going to happen. That is a basic market error, and it doesn't require any kind of advanced quantitative analysis to see it. Burry would go on to make about $100 million for himself and about another $700 million for his pissed off investors...it just took another couple of years. Not bad for a doctor in training starting a hedge fund with $100k. If you're interested in this story, I highly recommend "The Big Short" and just about any other Michael Lewis book... I think I've read them all now.

His confidence here is interesting because it is forward looking. I'm sure that at the time he was feeling quite different... stressed out of his mind that he may have missed something on the one hand... frustrated to all hell that people couldn't see something that was so painfully obvious on the other. Fortunately for him,vindication came over a 2 year and not 10 year period; but I suspect he had a very safe bet in this case, and I bet the speed and magnitude of the correction surprised even him.

Seeing what others can't

We have this strange idea that people like Warren Buffett or Michael Burry possess some kind of special ability to see the future. I don't think that's it at all. What they possess is the natural disposition to be suspicious of the crowd. When everyone is doing or believing something, it is nearly impossible to defy it, even if everything inside you tells you to doso,and even if the information is plain and obvious.

There are numerous experiments where people are asked questions like "which line is the longest" as they are presented with 3 or 4 lines. It's OBVIOUS which line is longest, but by having a few confederates answer incorrectly, the actual test subject will quite frequently go with the crowd despite the answer "being obvious." That's the "they must know something I don't know" effect working it's magic. Imagine in the world of finance, where information is far less clear and stories are much more complex, and it's not just appearing stupid that is on the line, but huge amounts of real money. Also, unlike in line experiments, in finance if enough people believe it, it becomes true, even if just for a time.

Being able to say "you guys are fucking idiots, the 3rd line is shortest" and hold that position even when most people tell you you're wrong... even when teachers are giving the wrong people A's and criticizing you for being blind to what is so obvious... is what makes people contrarian. I believe this might not be a learnable thing. There might be people who just naturally say "wait a minute, why are we all running towards the cliff" instead of just charging ahead. I think there are so few of them, because in most survival cases, running with the herd saves your life and being the contrarian gets you eaten. You don't see many contrarian tuna... and that's because they get picked off and eaten.

But the world has changed and so the contrarian mutation has an advantage in a particular set of areas- finance and investing being one of them.

So What's Next?

I think about this all the time. It's so easy looking back, but what about looking forward to the new year. So I'll put my head on the chopping block a bit so we can look back at the end of the year and evaluate.

A few things stand out to me as fairly large probability problems/opportunities.

The first is US Government debt. It gets larger every year and there appears to be no incentive to reduce it. Of course, it HAS to be paid off some time, so figuring out how that might happen represents an opportunity. The problem is we've been riding that real fiscal cliff for quite some time, and could ride it a lot longer. So while you could do something like betting on dropping US Credit ratings (the world stops buying our debt), betting on sharp interest rate increases, betting on inflation (printing our way out of the problem), going long gold (I think this is a bad idea, for reasons I wrote about earlier)... the problem is time horizon. The US could run these deficits for another 50 years and so you might be right, but you might also be dead :). So I think here its about risk mitigation. I expect interest rates will go up in 2-5 years, and I expect they will go up much more than people think. We could see the return of 10%-15% mortgage rates we saw in the late 70s and into the 80s. That would be fun. Of course, if you have cash, that means that savings accounts might actually be worth having. You can either do what PIMCO did in 2011, or you can just invest in PIMCO or similar strategies.

Personal Strategy: I think I'm going to leave this one alone for now, aside from getting out of government bond funds, which I did a few months ago. I just don't know enough to bet against it, but will be looking next year.

China's Real Estate Bubble. This is well documented... just search on Google. Of course, like US debt,  it's hard to know when. Worse, the Chinese government can do all kinds of things to manage this crisis much more than the US Government can. The crash has been predicted for a few years, and it was around May that the numbers really started looking grim. If you're interested, there are some options to short Chinese real estate ProShares UltraShort FTSE China 25 and DirexionDaily China Bear3X Shares are two places to look (they are both down quite a bit this year, and looking at FXP over a 10 year horizon draws a somewhat inverse picture of the Chinese housing market). If you're really brave (i.e. much braver than me) you could directly short real estate and construction companies: here's three compared with each other. China Housing & Land Development Inc is the largest. I haven't done much research on these, so can't comment beyond the macro "China's is Overbuilt" assumption, itself questionable. Another interesting article here.

Now if you're REALLY looking for a fun project, you could go to the National Bureau of Statistics of China and grind out the monthly changes in the price index of large and small cities. It sounds like fun to me, but I'll reserve it for another day.

Personal Strategy: Similar to the US Credit Rating, there's a lot of noise here, so I'm just watching it for now. I'll probably do a deep dive on the Chinese data linked to above and that may change my mind. Unlike many people, I think that the data the Chinese government puts out is probably pretty honest.

 European Recovery. There is a lot of skepticism around Europe, especially Greece, Spain and Italy. I suspect that will continue into next year, but I am very optimistic that Europe as a "project" will continue to succeed. Why? Not because of some deep insight or analysis, but simply because people are afraid of big changes and letting the EU collapse and moving away from the Euro is about as scary as things get. Of course, it could happen, but I think it's too hard to put the shit back in the horse.

There's funds like the iShares S&P Europe 350 Index (or the VGK, same kind of thing). If you're feeling braver, you could buy shares of the National Bank of Greece, I suspect they will do quite well if Greece manages to come out of its hole. Perhaps slightly less risky is the National Bank of Ireland; both of these banks got hit pretty hard since around 2008 - yeah I know... shocking. The "big banks" including Deutsche Bank and Societe Generale are less interesting to me. I have this covered with my long position in Citibank, which hasn't paid off as well as if I had chosen Wells Fargo.

Personal Strategy: I have this indirectly through a long position in Citibank. I might go crazy and buy some Greek banking stocks over the next few months, but I need to do a bit more research first.

Gold Bubble. Probably on the "less likely" side, but I believe Gold is overpriced which sucks because buying it would be a great hedge against what I assume to be coming inflation and volatility in US currency. Of course, it's possible that Gold goes to 2000 or 3000 or 10000 an oz., but I am very doubtful here. As I said before, it's spike above platinum and the number of "we buy your gold" stores to me indicates irrational human behavior. Lots of ways to bet against gold, I am not knowledgeable enough to know how to trade commodities directly, so I just took a long position in ProShares Ultrashort Gold.

Personal Strategy: I'm long GLL right now and won't be buying gold (shares or bars) in the foreseeable future.

Tech Turnaround. It's not that tech is doing badly, but it has been very volitile. This is mostly because of the whole social/mobile thing that's going on. High profile IPOs really got crushed last year and that has scared people outof the market. Darlings like Groupon have just gotten destroyed and so social media companies have a similar reputation to .coms in 2001. They have also dragged many companies down with them including Microsoft, Intel, and HP... in fact, HP can't seem to stop the bleeding. I believe all of those companies will eventually emerge from the doom and gloom and figure it out. I wrote about that previously so I won't go into tons of detail here.

Personal Strategy: I'm long Intel and planning on buying Microsoft if it drops below 20 or so. I'll probably accumulate HP and possibly Dell as well. I'm also long Zynga, but that has been a crappy investment so far.

 

Happy new year.

Another Portfolio Update and Two Ideas

QUICK UPDATE

Despite my previous post warning to the contrary, I can't help but constantly watch and update my experimental portfolio.

Overall, the crap stocks aren't doing too badly, but that is mostly thanks to Nokia. Intel is up about 3.5%, but I think that's just noise. Until we see results from their mobile play, it's hard to tell. Also, there's still a lot of questions around the future of 'WinTel." I regret not pulling the trigger on Research in Motion, but with Nokia already in the mix, it seemed like too much piled into one sector. Besides, I think Nokia has better long term upside. I also started tracking Lexmark, but I'll talk about that another time.

Onto the ideas.

 

SHOULD GOLD REALLY COST MORE THAN PLATINUM?

I've been following gold for a while, especially since its price grew above platinum earlier this year. That is a very strange thing which lead me to understand platinum a bit better.

Platinum and Gold are about equal in rarity and quantity, but their purposes are very different. Also, Platinum is harder to find and refine. Platinum is primarily used in industry (in the manufacture of catalytic converters among other things). Gold is mostly "useless" beyond investment and adornment purposes. People use gold as a way to hedge against currency risk... among other things. Of course, most people do this by buying GLD which seems a bit silly, since a massive collapse will make selling those shares quite challenging... having 1 oz. bars might be a better bet for "Prepper" type zombie-apocalypse activities.If I thought gold was a bargain, that's probably what I would do... but I don't think it is...

There's just way too many "We Buy Your Gold" stores around... it has to be overpriced, just based on the lemming heuristic :). Everyone and their mother is sure that gold is the safe bet for the coming inflation storm (which I believe is real). However, if there is a liquidity crisis, and I don't mean a macro bank-collapse crisis, I mean when people who have GLD shares need money to pay taxes, mortgages, or twinkies or whatever, they will all have to sell AT THE SAME TIME; and that is going to be ugly - if it happens. So I think Gold might be heading for a tumble at some point in the "near" future (i.e. 1-5 years). Just look at the above drop in platinum back in 2008... people underestimate how fast and brutal that stuff can be.

Anyway, I did a bit of research and I think that buying GLL (ProShares Ultra Short Gold) might be the way to go. It's a bit more risky in that it attempts to offset changes in gold prices by a factor of 2, but the other shorting vehicles are less appealing. Here's a quick graph of Platinum (PPLT), Gold(GLD) and Gold Ultra Short(GLL) over the past few years:

Gold is just killing everything, and I'm sorry I missed that ride. Oh well. Since I have no idea when (or if) gold will drop... Gold may very well go to 2,000 or 3,000 or who knows what... I'm planning on spreading out purchases over a few months or even years.

To be clear I think there is a fair bet that currencies will continue to have problems and gold will rise to even more dizzying heights... but I'm also willing to bet that my belief here is wrong and the upside to being wrong is too much to ignore... so I am investing directly against what I think may happen.

I'm willing to bet that when something unexpected happens (Solving fiscal cliff, Europe sorts itself out, Middle East calms down) or some combination, Gold will drop pretty fast. Conversely, something like a sudden rise in interest rates might attract the greedy away from the safety (but crappy dividends) of gold and back to "other things" which could also generate a fairly quick drop. I don't really care or know what those other things are, but I see potential upside to investments like GLL. What can I say... I like to bet against things, even myself :).

 Onto #2...

 

GO MICROSOFT, GO

I am loving Microsoft right now.

I bought a Surface to see if it could replace my laptop and live up to its promises of being a sort of business iPad and it completely fails that test. There's no way my Surface replaces my laptop. It's too slow, the keyboard is weird, Windows 8 just isn't quite there. Apple hardware and software just crushes it in every way. I also love all the articles that are hyping up how awesome the iPad Mini is, how it's THE product everyone wants, while there is equal press deriding how businesses don't want Windows 8 and the Windows Phones are not setting the world on fire. In the mean time Google is putting the squeeze on as Droids continue to increase their market share and Google keeps trying to take the Office software market from Microsoft.

So why am I loving Microsoft? Because I believe that opportunities are made when expectations are either way too high, or way too low. I believe that Microsoft is a well run company that has A LOT of cash and will hopefully enter the "way too low" end of that expectation curve. They can take many swings before they are done, but I think after the next quarter of earnings (the ones that show Windows 8 "failed") they will get hammered. It's possible that this is built into their current price (which is too high for me) but I'm hoping that it's not and we could see a nice big drop after a whirlwind of bad news and downgrades from professional investors.

Microsoft is making a big push into Cloud and Mobile, neither of which has been realized on their balance sheet. Of their 16 Billion in revenue, about 9 is spread evenly between "Windows and Windows Live" and "Server and Tools" with another 5.6 from their "Business Division" and about 2 from "Entertainment and Devices." I just don't see businesses running away from MS Word, Excel, etc. just yet. I also don't see businesses running from the "Server and Tools" just because Apple makes good phones and tablets. Server software choices are expensive to change and people are lazy. Just too easy for IT managers to keep doing the same thing. Also, I think that XBOX is great and has a bright and growing future.

Thus, I suspect in a few years, Microsoft will figure out the Windows 8 thing, will figure out where computers are going and also make good inroads into both cloud computing and mobile. Of course, that might take many years... 3, 5, 7, whatever. I was around when they were johnny-come-lately to the browser war and crushed Netscape (unfairly, I might add). I'm hoping that the next 3-9 months drive a lot of irrational MSFT selling which may create a corresponding buying opportunity. Of course, having MSFT and INTC at the same time might be too many eggs in one basket, but I also think they are somewhat different bets. That being said, I think they are both well run companies that have a good future ahead of them, once their through this brutal transition period.

Anyway, those are my guesses for now.

What your Stocks Look Like Based on How Often you Look

AN APPLE A DAY

Below is a nice graph of Apple from The end of 2011 till October, 2012. It shows a nice healthy growth curve... the kind that investors drool over. Sure, there's a period of drop and stagnation, but it's nothing drastic and is overcome shortly thereafter.

Of course, such historic curves are not how people experience the emotional roller-coaster of investing.

 

ONE DAY AT A TIME

So what does stock performance look like in a more real-time experienced way?

Below is a graph of the daily changes in Apple's stock during the same period:

Looking at the information at only a daily scale creates a much more volatile looking stock when compared to the nice, smooth, ride that looking at closing price over time tells you. It's quite difficult to get a sense of whether the stock is doing well or not (of course, we know it's Apple, and we know they did well), but attempting to sum the "up" and "down" bars to get a sense of it's total performance is quite challenging.

 

A MONTHLY VIEW

Now imagine if we only looked at the data each month:

This is much more manageable from a signal to noise perspective. It's much more clear that the stock is most likely doing well. There are 6 "up" bars and 3 "down" bars in the period, but the sum of the up bars and the down bars is almost certainly positive.

Finally, here'sa single 9 month data point.

 

MORE SLICES DOES NOT MAKE MORE PIZZA

In all three cases, the sum of the gains and losses, whether daily, monthly or once, is 252.86, which represents the total gain in Apple stock during that time period.

If I have a 24" pizza and 8 hungry people, how do I feed them all? Well... I slice the pizza into multiples of 8, either 8 larger slices or 16 smaller slices. If people count the number of slices they want and the information is experienced in slices received, 16 is far better than 8. I could also not slice the pizza and let people take what they need. I could cut the pizza into 100 tiny little pieces. All of those methods will result in a different interpretation of how much pizza there is (1 slice vs. 2, lots of tiny "bites" or a giant free-for-all). However, none of this does anything to change the amount of pizza.

If you track a stock daily, or hourly, you also get lots of extra "information." Things such as Tim Cook's last speech or the FED's quantitative easing policy, distant wars, Foxconn suicides and so on. All of that news, its impact (real or imagined), and all other things are rolled up into that single data point on Oct 1st, 2012 representing a 252.86 point increase in the previous 9 month period. By the end of the 9 month period, Apple had a fantastic run, much of it attributed to the large number of products it sells at reasonably high margins. Gone from memory are the daily and hourly headlines that seemed to play such a huge role and be such vital pieces of information. Of course, I don't expect news analysts to say "yeah, Apple dropped 15 points in the last hour, but no one knows why, plus, what really matters is that they are going to sell a a lot of new iPads and Tim Cook's latest speech isn't really very important." That's not exactly a good story.

We are much more impacted by magnitude than frequency. What really stands out on that first chart is the 50 point gain and the 30 point loss. It's very easy to react to those individual events within a small time period. If I made an hourly chart, I believe the extremes would be even more pronounced (relative to the time scale). The monthly view smooths those things out and makes the ride much more moderate. The problem is that we have constant access to this information and we believe, and are told, that it makes us better decision makers; but this may not be the case.

 

DON'T THINK...ACT

I believe that our bias tends to be to over react to local events. Why? Because survival trumps understanding. If you see a lion coming it's most likely better to run than to try and work out the lion's disposition, it's intent and so on; even though running may mean you lose your meal for the day. Similarly, if you happen upon a large quantity of food, it's better to eat as much as you can immediately, rather than contemplate the dangers of being overweight or considering how you can spread the meal out over time.

Moderation and careful analysis of information is mostly applicable to modern problems. Also, abundance of choice is a somewhat new phenomenon. For most of human kind's existence, getting information was hard; choices were few. Thus, we have not developed the ability to deal with these new problems.

Even knowing the above, I find it impossible to resist looking at my own portfolio on my smart-phone many times a day. I've tried to resist and it is nearly impossible. Furthermore, no matter how much research in the field of decision making shows that more information does not lead to better decisions (i.e.people who trade actively with constant information do not beat long term trends or less frequent traders) I find it impossible to change my basic behavior.

Merry Christmas fellow humans...

How We Why

WHINING AND WHYING 

I'm thinking about why as a verb in this context. Whying is an activity that all humans engage in, and indeed, it is one of the things that defines us as humans. Anyone who has taken a road trip with a young child knows how true this is.

When we ask why, we tend to do so for many reasons, but our approaches seem to come from one of two directions.

 

TWO WHYERS

To demonstrate the different ways to why, I'll briefly discuss two ancient Greek characters: Pythagoras and Democritus.

Pythagoras is, of course, famous for the theorem that bears his name. Democritus is hardly known at all but, among other things, was one of the first people to understand the concept of the atom - that is, objects are made up of small, invisible particles.

Democritus and Pythagoras had vastly different world views. Pythagoras was, in addition to a brilliant mathematician, a staunch mystic. He believed in perfect spheres, numbers, shapes, etc. He also believed that the ultimate human endeavour was pure thinking - that is, whying within ones own mind to learn the truth of the universe. When he discovered that the square root of two was an irrational number, he tried to hide that information from people, thinking it was "dangerous" (as it violated his assumptions around the perfection of numbers). He also hid knowledge of the dodecahedron which he believed held a kind of mystic power.

Democritus, on the other hand, was a skeptic and practical experimenter. He believed the world could only be understood through observation and experiment. He didn't believe in deities (even the Gods of his time), magic, or perfection. He believed that it was inherently impossible to understand things objectively and so one must constantly challenge assumptions in order to arrive at the truth, which may not even exist in objective form.

 

WTF IS A DEMOCRITUS

Democritus is almost entirely unknown. The reason for this is that Pythagoras and his later followers including Plato were successful in burying Democritus and the followers of his methods. Eventually they ran afoul of "piety" laws and such experimental approaches disappeared. As major western religions embraced the Platonic view of the universe, the skeptical scientific method more or less disappeared in the west for approximately 2000 years; only returning in the 16th century.

That is a long time to not be whying the scientific way.

Pythagoras was whying, to be sure, but he was doing it within the limits of internal assumptions. In modern times this is called selection bias, but Pythagoras, unlike many other people, was doing it intentionally. He believed that the answers to why were located inside the mind and anything outside the mind represented a violation and corruption of an absolute internal truth. Much can be learned and understood in this way, as Pythagoras proved; but much is also lost.

I believe that the Democritian method of whying is far superior at illuminating things.

To illustrate I'll use a very simple example.

 

HOW TO STOP A CHOLERA OUTBREAK NEXT TIME YOU ARE IN 1850s LONDON

Cholera could be a major problem in 19th century London. Outbreaks could spread quickly and kill many people. Of course at that time, there was no penicillin or good understanding of microbiology. One September in 1854 Dr. John Snow (nothing to do with GRR Martin) was investigating a nasty outbreak of Cholera. Rather than using the internal why approach, thinking about what the causes might be and ruling them out, or doing research on the bodies to find "why" people are dying, he took a Democritian approach.

He mapped out the deaths on a map and looked for a pattern. He noticed that the deaths clustered around a central area and then dissipated as the distance from the point increased. He looked to see if there was anything noteworthy in that area and noticed that there was a water pump in that area. He then mapped all the other water pumps in that area to see if there was any relationship to the deaths. Sure enough, only this pump seemed to correlate with the deaths. Thus, it was likely a problem with the pump and not, say, the central water supply. By replacing the handle on the pump in question, the epidemic was stopped.

(From: The Visual Display of Quantitative Information, Tufte, Edward R., p.24)

Now... in 1854, there was no penicillin and knowledge of microbiology and infection wasn't particular advanced. Also, what causes outbreaks and disease was not very well known either and in many cases you were better off NOT going to a doctor if you valued your health. But Dr. Snow was whying in the experimental and observational way. He was trying to see what was going on and understand it as opposed to becoming obsessed with the reasons behind what was happening. He didn't need to know how microbiology works or how infections spread in the same way that Democritus didn't need to understand Quantum physics to understand the world was made up of tiny particles and was at it's core, imperfect.

It is very hard to do this kind of whying as it requires an almost relentless self-doubt and active questioning. It makes the world feel both frustrating and amazing and I'm not surprised that many people have died attempting to keep that questioning alive. The quest for truth is not always a comfortable path.

Active vs. Passive Management

WHAT IS MANAGEMENT

I've been thinking a lot about management lately, especially with regards to what it means to "manage" something. Being a good internet citizen, I looked it up on Wikipedia here.

"Management in all business and organizational activities is the act of getting people together to accomplish desired goals and objectives using available resources efficiently and effectively. Management comprises planning, organizing, staffing, leading or directing, and controlling an organization (a group of one or more people or entities) or effort for the purpose of accomplishing a goal. Resourcing encompasses the deployment and manipulation of human resources, financial resources, technological resources and natural resources."

That seems like a pretty good definition as far as describing what we traditionally think of as managers. They are people who, in contrast to NON manager, primarily exist to oversee the use of existing resources to accomplish valuable goals. Embedded in that are terms like "leadership," "vision," "strategy," and "motivation." Of course there are thousands of books on the subject which goes to one of my core assumptions that you can tell how well a subject is understood by counting the number of books that are written on the subject. The more books written, the less understood the  topic. Ok... a bit cynical.

 

MANAGERS OF RISK

This definition is also similar to the traditional role of an investment professional. Their job is to use their expertise and knowledge to provide you with the most value for your resources.

These two roles have another thing in common... their track record is fairly poor. It's a well known assumption that most projects (especially software projects) fail, in one way or another. Likewise most investors (especially active investors) fail to beat indexes like the S&P500.

Why is that?

I think it is because both investment and management have large elements of risk, and significant portions of those risks are external. Competition, macro-economic shifts, customer behavior, etc have MASSIVE impact and are both unpredictable and uncontrollable.

Turning back to management, this has lead me to think about management differently. I think the managers real job is to fundamentally understand the nature of the problem, its risk and and to systematically work to do what he or she can to reduce the risk and increase the value. I call this active management, and it is fundamentally different than the definition above.

 

ELASTIC PROBLEMS

The difference is in approach to the problem. Rather than assuming that there are fixed resources that can be applied to a limited set of problems and that those problems are well understood and those resources are static in nature; the active manager assumes no such thing. In the mind of the active manager problems are elastic in nature... they change constantly and can be manipulated to fit the circumstances. Similarly, resources can be molded and stretched to match the needs of the constantly changing problem.

This change in disposition has far reaching impact. Most of the job is not working to understand road-maps, gather accurate estimates, or clearly identify customer requirements. Instead, the active manager digs deep to understand the customer's needs and desires and, if necessary, alter and focus them. The active manager works with the developers to understand their assumptions and limits and work within or beyond them. He understands how to measure risk, but then systematically seeks to reduce or remove it. He sees problems but inverts them and turns them around to try and find another way around them - or how to turn them into a benefit. To the active manager, the world does not look like a bunch of locks where he has to find the right key; the world looks like a bunch of doors he needs to figure out how to open as fast as possible. Locks and keys are just one way.

Passive management is like taking dictation.

Active management is like playing an instrument.

 

THE INTERNAL QUESTIONING ENGINE

This kind of thinking requires a constant internal questioning mechanism. The active manager has to question everything, all the time, but without getting in the way and without being indecisive. Knowing why things are the way they are, how they could be better and what is needed are always front and center. The absence of those elements should cause concern and deep inquiry.

I'm amazed at how many people drive projects "forward" without knowing why things are the way they are. Estimation is a primary area where this happens. It normally follows this pattern:

1) Manager receives goals and value.
2) Manager gather customer needs and requirements.
3) Manager identifies resources needed to breakdown requirements into tasks and estimate them.
4) Manager creates a plan based on those estimates.

Then begins the negotiation dance where we figure out which thing we can remove to make the project fit into a timetable we like while not totally erasing the value of the goal. We selectively ignore the fact that anyone who has done software project management or development knows that those estimates all have large margins of error and those requirements will almost certainly change; or the team will blindly build according to "spec" and the wrong thing emerges. That kind of evaluation is done at "the retrospective" and has no place here at the estimation negotiation table.

 

WHY?WHY?WHY?

Why does this happen?

I think it's because the manager has not actively understood WHY the estimates are what they are... why those tasks broke down like that. What takes the longest? Which assumptions were made during the process? What was in the customer's mind when she created those requirements? What problems was the team having?

Asking a group of people "how long will this take to do" assumes a dispassionate and somewhat confrontational approach. Asking a group of people "how can we accomplish this by this point in time" assumes a collaborative challenge which people can stretch to overcome. It engages the creativity and ownership of all individuals instead of treating people like machines that spit out estimates they will then be punished with when things go south.

Starting with this mindset is essential as it embeds the manager into the process of discovery required to bring the goal and the creative making together.

This process doesn't "end" once the project "begins" either. Rather, this is embedded in the process. Risk should continuously be reduced and value continuously improved. Teams should continuously stretch their creativity to reach meaningful goals in predictable time (That's Right. Deadlines matter.) It just doesn't matter that you scored the winning touchdown 10 seconds after the game ends.Thus, understanding when the game ends is really important - hint: it's often not under the managers control to decide when the game ends... all those external forces you don't control may decide that.

 

CONSTANT DISCOMFORT

I think that a well run project should have a constant feel of discomfort and nausea. I know that sounds odd, but I think the only time things feel comfortable and smooth is when enough delusion has been ingested. Even when you are winning by a large margin and it seems like "there's no way the other team can win" a great coach will always be worried that he's missing something...that there might be some way they could come back...and, of course, there's always the next game.

The team will win some and lose some... and there will be time for celebration and reflection, but the active manager will always have that internal questioning machine humming away on the next big thing.

Update on Crap Stock Portfolio

Back on October 9th, I posted about how despite thinking that Apple (AAPL) is a great company, I wouldn't buy the stock. Furthermore, I suggested Zynga, Radioshack, and Citibank were safer buys and also mentioned Research in Motion (RIMM) and Nokia (NOAA) of all companies.

I decided to make a Google Finance Portfolio to track these things. First the graphics:

Vs. Major Indecies:

Vs. each other

Radioshack spiked for a bit and then went back down. Zynga has also kind of bumped along although I expect after their 90 million$ write down last quarter and reduction in staff (voluntary and involuntary) they may actually make money this quarter... who knows. Anyway, it's a long term bet that they can become either a successful casino or somehow figure out mobile. The former seems more likely and I suspect speculators will drive the price up if that starts to look good, at which point I'd probably bail. Then there's always acquisition, but I doubt that will happen.

Citibank did nothing until they announced they were laying off 11k workers. People hate that, investors love it. There's good reasons why, but in any case that recently bumped them up and so my writing of this blog has lucky timing for citibank returns. I still have confidence that banks will survive and thrive somehow, and I think Citibank is one of the bigger ones and therefore more likely to benefit from whatever the next big banking "strategy"might be.

It turns out the ultimate dogs, Nokia and Research in Motion, had very strong increases in the last 6 weeks. This is, again, driven by speculation and so I consider it a fake gain that is likely to drop back down again so the growth in my portfolio is luck based on the time I decided to write this update. RIMM is desperately trying to put something out that people want, but Nokia is making strong plays in Windows 8 phones as well as lower end, cheap, smartphones in secondary markets... there are a lot of people in those and they have low expectations.

As a result, my sample portfolio did not include RIMM but did include NOAA. At this point I actually believe Nokia may come back, but with the 40% gain, the stock is too overpriced to warrent an increase in position. If greed drives the speculators out and they drop 50% or so, I might pick up some more. If I was a day trader or a technical trader, I'd sell... but I'm not - so I'm waiting to see if the real value of the company goes up, which I think it can.

Return graphic here:

At a 2 month time horizon this is still all luck or noise, depending on your definition; but I actually think my position on all these stocks hasn't changed, except maybe Radioshack. I'm about the same on Apple - despite the fact that I believe they are about to have one of the best quarters that any company has ever seen in history. The iPad Mini is awesome and all the kids want one.

You can see I'm also tracking a few new stocks...not technically dogs per say, but definatelt in the dog house. I bought Intel (INTC) the other day because I suspect they will succeed in finding a great CEO and will make the transition to mobile while keeping PC domination. I think AMD has a much harder road...nothing in their restructuring plan talks about mobile which is surprising. They seem to be going the cost cutting route which seems dangerous. That could help Intel pick up more of the PC market.

I'm very skeptical about THQ as well. I suspect they will refinance their debt but their upcoming products do not seem like they will generate a billion or so in revenue which is more or less what they need right now.

Microsoft is starting to look attractive, but I suspect after 4th quarter earnings they will take a beating and the doom and gloomers will take to MSN/CNBC and push the price down to irrational levels.. or maybe something else will, who knows. But at the current value it's still too high, though I think they will somehow make it as a company

I also dumped a bunch into an S&P index fund which means that I'm investing about 4% of that in Apple by proxy (Yes, Apple is 4% of the S&P 500... amazing) along with a bunch of other biggies. I feel like it might be cheating a bit but the S&P has been pretty crappy the last couple of months and having a bunch of cash in an account seems silly to me, even if it isn't real :)... or perhaps especially because it isn't real.

I've been trying to diversify out of tech, which is what I have a more intuitive understanding for, but it's been very hard. Exceed, for example, is a Chinese Footwear manufaturer with decent earning, reasonable cash holdings and low debt. Their sales have dropped quite a bit, however, seemingly because of competition and economic slowdown in China. Nevertheless it seems quite undervalued, but I can't get enough information to make a decent decision here.

Strangely, it's incredibly fun athough I subscribe to the value investor assumption that in a short time horizon it's pretty much guesswork and in a longer time horizon companies regress to their actual value, which is subsequently very difficult to calculate since you have to make vast assumptions. So I believe it remains a game of probabilities that when your guesses are wrong or right, you minimize the loss and maximize the gain... that's why it's reasonable for me to invest in companies that I don't necessarily believe in, and avoid companies I think are great. 

Sony Games, Vita and the Future

http://kotaku.com/5933894/ Interesting interview. I understand that some things are cyclical like fashion and Italian food. I used to love text adventures and $.25 arcade games.but i wouldn't bet my billion dollar company on it. If I ask my nieces and nephews if they want a Vita or an iPad 3 I'm pretty confident I know the answer and it's not "it's a Sony." I think Sony Games has a bright future after they get clobbered for a while but I don't think it's in handhelds and I'm skeptical it's the PS4 unless the PS4 becomes a complete home entertainment appliance of some kind. Even if he's right that freemium and social are a fad... mobile and tablets are not. Some things go in cycles others go to the graveyard... and i think the graveyard has more gravity here.

Why I bought shares in Citibank, Zynga and RadioShack, avoided Apple...

READ THE NEWS, BUY APPLE.

I know. Apple (AAPL) is the smart play. Everyone owns Apple stock and everyone is getting rich. It's the talk of all the parties, there's lines out the door, the stores are packed 24/7. There are even secret APPL stock investment clubs that trade ONLY AAPL. I love Apple, own their products and believe they are one of the best companies and brands in the world - and will stay that way for to foreseeable future.They are strong and will likely get stronger. Conclusion: not buying it.

 

GIVE ME YOUR TIRED, YOUR POOR, YOUR HUDDLED MASSES

I prefer high risk nightmare dogs like Citibank, Zynga and RadioShack. Companies that I think are suffering badly in many different ways and may not even be around in 12 months. Companies that no one wants, everyone has sold and people are embarrassed to have held onto. Why would I do such a stupid thing?

 

RULES OF ENGAGEMENT

Well... here's why. My investment philosophy is like this. The whole point of buying a stock is to make money... how much? MORE than you could if you just stuck your cash in an S&P index fund and forgot about it. MOST professional institutional investors are not able to achieve this. I suspect the numbers for amateur investors is even worse (I include myself in this group). So, it's not about picking winners, it's about making money... and that requires you to think about investment as a probability game. I believe that, generally, it's more likely for a hated, forgotten and despised loser with some advantage to defy it's low expectations than a huge, public, well loved winner to beat it's ever increasing expectations.

And beating expectations is much of the battle. I'm not expecting Zynga to "beat" Apple, they don't have to... they just have to beat what people think they can achieve... and people don't think they can achieve much. But why do they think that? Does this opinion line up with the company's value and prospects relative to the odds of achieving them. This is the question that valuation needs to answer. How much is something REALLY worth and when people think it's worth less than that for irrational reasons... that's a place where you can find a potential advantage.

This creates a very contrarian philosophy. Not because I decided "I am a contrarian because that sounds cool" but rather, I'm naturally drawn to things that people run from and naturally run from things that people are drawn to. Since I resisted the urge to buy Apple,it's gone up about 40%... so, yeah, that was a "bad call." But I also didn't buy internet stocks in the 90s and avoided buying a house in the 2000s for the same reason. So I figure that makes me even :).

I STILL think Apple it's headed for a fall. How much? I have no idea. I just can't make the numbers work for Apple. It's impossible to maintain the kind of growth investors demand to keep the stock going - there's just not enough consumers, and it's just so easy for someone to release a super cheap iPad and suck away a whole bunch of market share before I'll know it happened. I suck at timing and so I'll cave at their peak and then wait too long for the recovery. I can FEEL the urge to buy Apple now, just talking about it.

Suddenly they'll miss earnings and go into free fall. Could take a quarter, could be 5 more years. Might never happen. Just my opinion.

 

DIDN'T YOU KNOW BANKS ARE SCREWED AND EVIL?

Now when I bought Citibank last year. Bank stocks were PUMMELED. Banks were evil. Banks were paying huge bonuses and had no clear reason for doing so. They were "stuffed to the gills" in bad loans. "No one knows" how deep the hole is, was in every newspaper. So people were dumping them like crazy. Before the 10 for 1 split Citi was trading at like $2-$3/share... down from about $60 in 2008. Of course, that $60 was built on lots of bad loans which they now need to absorb, and by they I mean us :). But at $2-$3/share (before split, it's around $38 now) the cash value and property holdings of the bank is almost worth more than that. Citibank has LOTS of customers... you are probably one of them.

Also, Citi is big, huge, $100 billion market cap, if they go down... OMG... it's financial armageddon part 2... they are TOO big I think. Too big to fail you might say. The odds of the Government allowing them to go totally down the drain are very small, I just don't see it.

Do I believe C is a solid company? Not particularly. Do I think that they have some kind of amazing business vision that will drive the stock back up to $60? Absolutely not. But I also think the likelihood that banking is "going away" any time soon is very small; and I think the likelihood that Citibank is going away is also small. I have a lot of faith that our government will spend whatever it takes to save them, should the need arise.  I have faith that our bankers will figure out more creative ways to stuff themselves with money... they did it before, they'll do it again.

Thus, the odds of Citibank and banking in general recovering at some point in the future to some degree above their current dog price, seems very good. When? No idea... could be years. How much? Again, no idea. But I believe more than the S&P 500 over time - hence my buy.

 

UHH... ISN'T ZYNGA GETTING SLAUGHTERED? THEY DROPPED 15% THE OTHER DAY... YOU'RE A MORON...

Perhaps, but Zynga is a different story. Governments have no problem letting tech companies die :). However, Zynga's cash reserves alone almost make it worth its $2-$3 price tag. Also, I believe that Zynga has figured out where it wants to be: mobile and gambling... and is placing lots of small side bets on other things via acquisitions and internal development. Since their questionable purchase of OMGPop, I think they've cooled down a bit.

Do I believe they are a great company with awesome vision? Not necessarily. Do I have faith in "senior management?" Not particularly. But I don't think it's horrible either - plus I'm not convinced that senior management is a huge factor in a lot of these falls and turnarounds. I do believe that they have a reasonable chance of turning around by using their stacks of money combined with streamlining the company and betting on clear goals. Also, I think the chances of on-line poker becoming legal are decent. When? No idea. But when that happens, Zynga is well positioned for a big win if it does.

Besides that, a company that has a market cap of 1.8 billion with 1.1 billion cash in the bank is attractive for acquisition. Of course, Mark Pincus owns a majority of voting shares so any buyer has to convince him, which might be difficult... so perhaps that war chest is less attractive. But if someone offered $5-$8 a share, it might be worth it. If I were a major Casino holding company I might throw some of my money at them right now.

Additionally, I have not written Zynga off as much as most investors. As little faith as I may have, I believe the hatred of the stock and management is excessive compared with the company's performance relative to the industry. Gaming companies aren't exactly setting the world on fire in the last few years.

I think the MAJOR reason that Zynga is suffering is because the flight from Web to Mobile is faster and more aggressive than anyone thought. It's not like other companies did this amazing job here and Zynga somehow screwed up... they are just bigger and more bought in to Facebook so their loss is far more visible. They IPOed right into a shitstorm from a timing perspective. I think they have a chance, and in many ways, more of a chance because they have lots of customers and lots of cash. Probability of recovery seems decent, cost of risk is very low. I believe that online poker is a potential industry.

Hated company with tons of money and employees fleeing faster than investors? I'm in.

 

RADIOSHACK... WOW. REALLY? I MEAN REALLY? THAT'S JUST STUPID.

Then there's RadioShack. OMG, I'm an idiot for buying that loser. RadioSchak? Really??? NO ONE goes there. Next year there will likely not BE a RadioShack. Best Buy is killing them in retail, they have no online presence to speak of, they have no strong strategy. Even their commercials suck. They have awkward, small, strip mall stores that no one goes to except that creepy dude that still builds robots in his mom's basement. Oh yeah, they are stuffed full of debt so I don't even have the "tons of cash" argument.

However, they do have steady sales (With dropping margins), distribution, and a good supply chain. They also have some brand recognition (thought that's fading). What's that worth? Probably not much. Will they make it? Probably not. I suspect there are very good odds they will go under next year. To save them would take some kind of miricle... what I like to call a "low probability event." However, if that event happens, I suspect it won't have a small impact. RSH is unlikely to grow by 5%-10%, it's going to disappear or skyrocket I believe and, I suspect disappearing is the much more likely scenario.

In the mean time they can bump along the bottom of the ocean for a few years. Maybe someone will acquire them. Maybe they will find a new niche by becoming a glorified smart phone/tablet reseller. Maybe geeks buying circuitboards will come back. Who knows? It's super risky. However, the cost of that risk is very low right now.

A total loser with few prospects that no one loves? I love a hail mary pass in the 4th. Buy baby!

 

CHANCE OF SUN 10%, BUT IT'LL BE SO NICE IF IT IS...

In all cases, I think the liklihood of these 3 companies outperforming the S&P in the future because of some unexpected event is greater than the probability of high visibility, sexy stocks you can talk about owning at parties will continue beat the S&P. And that's the key... beating the S&P. Most of my investment is in indexed S&P mutual funds because I suck at beating averages, just like most investors.

For me C, ZNGA and RSH represent a fun experiment in constitution and probability. Telling people "yup, I just loaded up on Radio Shack" when they are bragging about 30% returns on APPL is tough. It's even tougher when you have to tell people "Yea, I think they suck and are going to go under next year." Now you just look stupid - and maybe I am. But investing isn't about picking winners at a frequency it's about growing value faster than indexes; and to do that you need to really understand the difference between probability and frequency. I think people are underestimating the probability of these dog stocks coming back, and I am willing to bet on it.

OPTIONS, OPTIONS, OPTIONS

I don't like buying options because they are wasting assets with a fixed timeline. Also, they are confusing and math is hard. So, for me, buying hated, nearly worthless stocks that will probably disappear but might rocket back is a way of buying options while avoiding the leverage and fixed timeline that I don't like. I can own RSH until they completely disappear. It's a bit of odd rationale, but hey, I sleep better at night! 

MORE BAD IDEAS!

Other great investment ideas:

Nokia (NOK): Totally screwed- Apple and Samsung are destroying them. Lumia + Windows... long shot. Good luck with that. Glad I don't live in sweden (EDIT: Oops, Finland. Sweden is where the hot blondes are... Finland is where they make phones no one wants anymore... sorry Sweden, my bad.)

Research in Motion (RIMM): Done. No one buys Blackberries anymore. New OS? Who cares. You had your day, but it was back in 2008.

American Apparel(APP): Who? Yeah. Exactly. Look it up... it's ugly.

Happy investing :).

What Motivates Us

WHAT IS MOTIVATION
I've been interested in the research around motivation for a long time now. Yesterday I watched the documentary Happy which you can also watch on Netflix.

It wasn't really earth shattering, but I did really like the personal touches in the movie. The part about Japanese businessmen who suddenly drop dead (called Karōshi) was particularly moving.
In any case, the film does discuss motivation and results along cognitive psychological lines which is what I find the most interesting.

The major discussion point here is intrinsic vs. extrinsic motivators. Extrinsic motivators are things like money, image and status. In other words, they are rewards and value judgments that come largely from the outside. Do this and you get that.

By contrast intrinsic motivators are things like personal growth, relationships, a desire to help others. In other words things that you do "when the lights are off and no one is looking." Warren Buffett once asked "would you rather be the best investor in the world but have everyone think you are the worst investor or be the worst investor in the world and have everyone think you are the best?" The answer to that (the HONEST answer) indicates an intrinsic vs. extrinsic mindset. The same question can be applied to other topics as well. I'm assuming that Buffett believes the reason why people buy high and sell low is because they would rather have people THINK they are good investors.

AND SO I TURN TO WORK…
As a "manager" I face the problem of motivation all the time. How do you get people to "be goal focused" and "understand the problem." How do you get people to "be motivated" and "work as a team." Ironically, a lot of research has been done here, and most people know what you need. You need to make the work rewarding, you need to make the team enjoy what they are doing and feel a sense of accomplishment, you need to let people feel like they are overcoming valuable challenges and that their contribution matters. Rewards, when given, must be in line with the goals.

So why do we screw this up so much? Why is this so hard?

I think a big reason is that we short cut the motivation problem and grasp at systems and phrases to try and "solve the problem." I think there really is no short path here. You have to work with people to really understand them. You have to make sure the goals make sense to the people trying to achieve them and if they don't, you have to question whether the goals DO make sense - it's not about ramming a bunch of corporate goals down someone's throat. So that’s obvious, right?

REWARD EFFORT NOT JUST RESULTS
Intrinsic rewards are associated with overcoming challenges. To motivate in this way, we have to focus on effort and not only the result. Why? Because if you reward only successful outcomes you are encouraging people to commit to the simplest problem and then overestimate the difficulty. Solving easy problems faster "than I said I would" is how you maximize your personal reward in such a system. You also manufacture mercenaries… people who see money or title as the reason for doing anything and are trying to get as much of those things with as little effort as possible.

The other danger here is that these mercenary rewards tend to work in the short run. People will work very hard and compete with each other aggressively for extrinsic rewards like money and power. But in the long run, it’s creating an unsustainable self-destructive team or organization. I think we see some of this with companies like Enron. All that mattered was the extrinsic reward (in that case, the stock price) and so internal competition that initially drove growth quickly turned to cheating, lying, and all sorts of other long term destructive behavior because the company’s goals were not represented on intrinsic motivation.

Think of it this way... Imagine you tell your kids you will pay them 20$ for every book they read. Very quickly they will find the way to “win” is to read short, easy books. Moreover, because of the extrinsic reward focus they are learning that reading challenging and difficult books is “stupid” and a waste of time. Was that what you wanted? Of course not! Instead it's far better to pay them 20$ for the activity of reading for, say, an hour. Now they HAVE to read for an hour no matter what. They are much more likely to select books the find interesting and compelling. Better still, reward them for helping each other understand a difficult concept and use the reading activity as a means to that end.

Now you also engage the cooperation element as well. You can still use the financial reward, but in that system it is in line with the intent which is to get your kids to want to learn and read.

OWNERSHIP
Another reason for this problem is the concept of ownership. It's a well-known theory that things we make ourselves are far more valuable to us than things we acquire. Parents prominently display their child's artwork on the refrigerator  door, but are as unlikely to sell this art to other parents as they are to buy other children's artwork. If you make a plate and cup you are far more frustrated when it breaks than if you buy it. Food you cook yourself tastes, in general, better than food you buy.
Something that hides ownership in the corporate management setting is transparency. By the time work trickles down to the people doing it, the goal has gone through 3-4 levels of telephoning such that few people understand it any more. Thus when managers are asked to do something they themselves no longer have the true purpose in mind and thus are unable to communicate it to the team. This puts them in an awkward position because team members want to know what the purpose is and assume the manager must know – after all that IS their job. If they don't know, they look incompetent. This dilemma can end in the manager simply telling people "because this is what upper management wants" or some other authoritative reason. It's very unlikely that this is the desire of the people steering the company nor will it create intrinsic motivation.

Normal solutions to this problem involve "more communication" and "more oversight." The thinking is that "the machine isn't giving us what we want so we have to monitor it more closely and hit it harder." More often than not, this leads to less ownership and more confusion.

TRANSPARENT AMBIGUITY
What you really need to do is what I call "transferring the ambiguity." Most business problems are hard and ambiguous. They are distilled into theoretical solutions which are then converted into goals and, eventually, tasks. During this process, the ambiguity tends to be obscured. At many companies people working at the task level assume that “someone” knows that whatever they are working on is what the company needs. I think this is very dangerous.

It’s far better to let everyone understand the real problem “we’re facing competition and we don’t know exactly what to do” or “we’re facing a price war and think we need to reduce operation cost, or innovate, etc.” Most initiatives at companies come from some very well understood, but very ambiguous problem.

Managers often fear giving people too much ambiguity. They are worried that it will confuse and frustrate the team. They are concerned that it will shatter confidence and destroy focus.
My experience has been the opposite. Once you tell a good team that the goal is a theory that we believe will solve a stated problem (and the problem itself is only an assumption which may or may not be correct) the results are generally positive. While people DO experience the frustration and confusion, that is actually healthy. I think the reason is that now the team is motivated by overcoming a difficult problem, thinking creatively, and working together to overcome it. That is VERY different than being motivated by doing what they are told, checking off a list of boxes and then waiting for the reward.

Transparent ambiguity aligns teams to company goals. However, managers must be willing to engage in debate around both the stated problem and the assumed solution. This will likely result in modification to one or both. Once again, this is a GOOD thing because instead of the company relying on a small subset of senior “experts” it can harness the creative power of the entire organization.
Lastly, Transparent Ambiguity causes individuals to own the problem and solution. It removes authority and power as the reason for doing things and replaces it with more intrinsic motivations. It’s as if the entire company is engaging in a constant dialog around what the problems are, what the solutions are and how best to implement them.

Note that a major assumption here is that you have GOOD teams. This only works if you have people who are self-motivated, creative, open to criticism, and empathetic with others. However, I’ve also noticed that this approach reveals those qualities in people as well. I am often surprised at the creative problem solving skills and internal motivations in people that were previously buried under some kind of hierarchical structure that was limiting their role.

UNLOCK THE INTRINSIC MOTIVATION
To conclude, I think that as managers our job is to get people to feel intrinsic motivation, and also feel it myself. In essence the only difference between a manager on a team and a non-manager is what they are responsible for. In the role of “manager” I feel like my job is to make sure that the goals are well articulated, the problems well stated and the needs of the team are met. I also think it’s my job to make sure that achievements have visibility; other teams understand what we’re doing and why (to avoid duplication or trampling) and a litany of other communication and visibility tasks. My job is NOT to tell the team what to do and how to do it. I think if a team can’t figure that out and own it, I have done a poor job.

Self driving cars in Cali by 2014?

So win Google self driving car update. I love that the bill passed unanimously (still rules needed) and that Google has a blind customer and employees will be beta testers. Already working with insurance companies as well. Go Google. This is happening quite a bit faster than I expected.