C I O P E R S P E C T I V E S Weiss Multi-Strategy Advisers LLC. 1 An Investor’s Dilemma: Being Mindful in 2015 January 5, 2015 “Few of us ever live in the present. We are forever anticipating what is to come or remembering what has gone.” ― Louis L'Amour On a recent episode of 60 Minutes, there was a segment by Anderson Cooper on the power of mindfulness and its growing popularity in a world of technological distraction. It addressed the increasing number of scientific studies showing both the physiological and psychological benefits of mindfulness. One of the important points made in the 60 minutes segment was the distinction between meditation and mindfulness. Meditation helps you to be mindful. It allows you to understand the difference between your brain and your mind. Simply put, meditation is exercising your brain. Mindfulness, however, is awareness; simply being present and paying attention to your senses…the here and now. Meditation and mindfulness have both been a part of my daily life for the last four years and the benefits are clear to me. In my experience, when meditation and mindfulness are combined, successful results are easier to achieve. Certain common phrases athletes hear or say every day are based on the same principles of mindfulness, such as “taking it one swing at a time”, or “only worried about the game in front of us” or “the game is slowing down for him.” It’s awareness of the game at hand. Distraction, however, is the bane of awareness and technology is a major cause of distraction. Not only can technology be a cause of personal distraction, but it can also be disruptive. In 1997, Professor Clayton Christensen wrote a great book titled The Innovator's Dilemma. In the book he described the differences between "sustaining technologies" and "disruptive technologies." He described sustaining technologies as innovations that help companies make marginal improvements in their business. Disruptive technologies, on the other hand, are unexpected breakthrough innovations that force companies to rethink their existence. For example, ten years after Christensen’s book was published, Apple introduced the iPhone. Although by that point Apple had already disrupted many industries with earlier technology, the iPhone was a breakthrough innovation that accelerated the pace of disruption. The disruption caused by the iPhone is now so widespread, and happened so fast, that it is difficult to appreciate. Consider that the App store was created in July 2008, only six and a
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C I O P E R S P E C T I V E S
Weiss Multi-Strategy Advisers LLC. 1
An Investor’s Dilemma: Being Mindful in 2015
January 5, 2015
“Few of us ever live in the present. We are forever anticipating what is to come or remembering
what has gone.” ― Louis L'Amour
On a recent episode of 60 Minutes, there was a segment by Anderson Cooper on the power
of mindfulness and its growing popularity in a world of technological distraction. It addressed the
increasing number of scientific studies showing both the physiological and psychological benefits
of mindfulness. One of the important points made in the 60 minutes segment was the distinction
between meditation and mindfulness. Meditation helps you to be mindful. It allows you to
understand the difference between your brain and your mind. Simply put, meditation is exercising
your brain. Mindfulness, however, is awareness; simply being present and paying attention to your
senses…the here and now. Meditation and mindfulness have both been a part of my daily life for
the last four years and the benefits are clear to me. In my experience, when meditation and
mindfulness are combined, successful results are easier to achieve. Certain common phrases
athletes hear or say every day are based on the same principles of mindfulness, such as “taking it
one swing at a time”, or “only worried about the game in front of us” or “the game is slowing
down for him.” It’s awareness of the game at hand.
Distraction, however, is the bane of awareness and technology is a major cause of
distraction. Not only can technology be a cause of personal distraction, but it can also be
disruptive. In 1997, Professor Clayton Christensen wrote a great book titled The Innovator's
Dilemma. In the book he described the differences between "sustaining technologies" and
"disruptive technologies." He described sustaining technologies as innovations that help
companies make marginal improvements in their business. Disruptive technologies, on the other
hand, are unexpected breakthrough innovations that force companies to rethink their
existence. For example, ten years after Christensen’s book was published, Apple introduced the
iPhone. Although by that point Apple had already disrupted many industries with earlier
technology, the iPhone was a breakthrough innovation that accelerated the pace of
disruption. The disruption caused by the iPhone is now so widespread, and happened so fast, that
it is difficult to appreciate. Consider that the App store was created in July 2008, only six and a
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half years ago. In June of this year, Apple announced users had downloaded 75 billion apps to
date. And that was a 47% increase from the prior year. Think about how many apps you use
today and then think about how the word “app” did not exist just 7 years ago. The disruption
which started with iTunes in music and publishing spread across all industries and to all parts of
our life. Perhaps the easiest way to fully understand disruption and its importance is think about
how you feel when you misplace your smart phone, or when it runs out of juice. Then marvel at
our dependency on something that did not even exist until 2007.
In 2013, I wrote two articles titled Adapt or Die – An Investment World Driven by QE,
Tweets, Clouds, Robots, Singularity, and Luddites and Adapt or Die Part 2 – The Signal or the
Noise. The articles focused on the positive side of exponential innovation and how it related to
efficiency, productivity, rapid problem solving and transparency. There is no doubt exponential
innovation benefits us all, but at the same time we all need to remember that the benefits of
technology referenced by Clayton Christensen come with disruptive consequences for the
unprepared. The same holds true for the iPhone. It’s tremendous for real time information,
sharing things quickly and connecting us globally. But this technological innovation, and the
resulting life changing disruption, can lead to distraction. As the 60 Minutes segment set forth, in
the same way that mindfulness and being more present can help balance out the distractions
caused by technology, I think the time has come for investors to increase their awareness, or their
mindfulness, to navigate market disruptions. One of the dangers of investing is being prone to
recency bias; extrapolating recent trends into the future indefinitely. This is where mindfulness
becomes important. To get out of a slump in baseball, you need to take it one swing at a
time. The same holds true for investing. Take a deep breath as we prepare for the year ahead,
but be aware of what’s happening here and now. The benefits of low interest rates, inflation and
increasing multiples have helped the S&P 500 to its sixth positive total return year in a
row. However, as we exit 2014, I believe the signs of disruption have reached levels where the
probabilities are rising that 2015 may be a year titled the “Investor's Dilemma”.
“Economic forecasting is like driving a car blindfolded with directions from a passenger who is
looking out the back window” – Anonymous
Business cycles are very important to both running a business and investing. The problem
is that the forecasting of business cycles is backward looking. As a young derivatives trader at
Morgan Stanley, my first trading book was Mexico. I began running that book in October of
1994. Two months later, the peso broke its peg and the “tequila crisis” ensued. Over the course of
the next five years, I traded various emerging market books and tried to navigate the EM chaos as
it moved around the globe. I ultimately landed in Sao Paulo, Brazil and left following the
devaluation of the real in January 1999. That five year experience taught me two important
lessons. First, don’t listen to economists’ forecasts and second, the door of liquidity closes very
quickly in emerging markets as they head into a recession. Those lessons inspired me to go on to
create probabilistic models which would hopefully highlight risks of a recession in the future. I
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based these models on the same principles established by the founding father of leading
indicators, Geoffrey Moore. Moore’s work was based on economic indicators that he believed led
cycles. In emerging markets, cycles are shorter and sharper, which is why the door of liquidity
closes so quickly. This led to the decision to use asset prices as real time inputs for my
models. Right now, despite rosy forecasts in the U.S., based on what we can see out the back
window, my model (Exhibit 1, below) is telling me that the risk of recession has reached a point
similar to that of early 2007. Granted, like any probabilistic model, it is just a probability. But
based on where sentiment and positioning are in the markets as we leave 2014, ignoring the
probability seems like a bad risk to reward.
Exhibit 1
GDP Oscillator Risk of Recession (Proprietary)
Source: Bloomberg, Weiss Calculations
The model in Exhibit 1 is built around the rate of change rather than extrapolating the most
recent data. Constructing it in this fashion helped me not only in 2007 but also in 2009, around
the same time people began using the phrase "green shoots." A green shoot (or brown weed) is
just another way of looking at the second derivative. For this model I use stock prices,
commodity prices, jobless claims, household net worth and corporate profits. Although the model
has been indicating all year that growth is weakening, it’s the actual market signs themselves
confirming the model’s message that makes it more compelling. Small cap stocks have
underperformed large cap stocks. Utilities, Health Care and Consumer Staples have been three of
the top four sectors this year. From a factor basis, we saw a sharp fall in secular growth and
momentum in March and April. Global bond yields have fallen sharply. Market inflation
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expectations seen through TIPS have fallen as well. Commodities have been weak all year. The
MSCI World ex US Equity Index is down for the year and, starting in June, we began to see the
high yield market spreads bottom out and begin a march higher all the way into
December. Recently, EM sovereign debt has seen pressure as well.
“China is in the midst of a digital revolution.” – McKinsey’ & Company’s China’s Digital
Transformation: The Internet’s Impact on Productivity and Growth
Back in 2007, when the model was also flashing warnings signs, the market signals that
suggested the weakness to come were being driven by the US housing market. This year, the
underlying weakness was driven by emerging market growth and commodities. There are many
reasons for the weakness in these two areas but I believe one of the reasons is disruption from
technology. As Professor Christensen said, disruptive technologies are unexpected breakthrough
innovations. In 2007, the year the iPhone debuted, two market beliefs were driving much of the
cap ex around the world. The first was centered around Chinese infrastructure growth and the
second around peak oil. The thought at the time was that these were secular trends that would
drive investments for the foreseeable future. Long term decisions were made by both companies
and countries to benefit from these two trends. Since that time, there has been a dramatic,
abrupt shift leaving many overinvested for long term trends that changed quickly.
Exhibit 2, below, shows what’s happened to China's real estate fixed asset investment
growth rate since the peak in 2010. There are many reasons for this downshift but one of the
major reasons is the digitization of China which I highlighted in Adapt or Die Part 2 – The Signal or
the Noise – China. In their first five year plan announcement, China’s new government said the
focus was on innovation, consumption, healthcare, education, the environment and energy. This
was a change that was not expected to take place so quickly, which is why it’s had such a
disruptive impact. China’s move away from industrialization towards digitization has hurt the
growth rate for commodity demand. Exhibit 3, below, shows the same China FAI Real Estate
growth rate overlaid with iron ore and Brent crude prices. Oil prices were slow to respond but
eventually did catch up.
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Exhibit 2
China YoY Fixed Asset Investment Real Estate
Source: Bloomberg
Exhibit 3
China Real Estate Growth, Brent Crude & Iron Ore
Source: Bloomberg
"Horizontal Drilling is the real marvel of engineering and scientific innovation" - David Blackmon,
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