A tale of logic and emotion

I guess it's been a long time since I've written anything on this blog. Admittedly, it was not because of a lack of time; but I was too confused these days to write anything sensibly. However right now at 2am in the morning, I can finally extricate myself from my predicament and analyse things in perspective. To begin, I'll start off with my favourite topic on investing.

It's always been a great pleasure to read books on Warren Buffett, especially the 2 classics by Robert Hagstrom. (I feel that Robert has done the most extensive research and analysis on Mr. Buffett) Not least because I'm a Buffett fanatic; I'm as much a cynic as well as an admirer of Mr. Buffett. But because his thinking always brings order in the midst of chaos, and reason in the face of irrational exuberance. These traits help to keep me sane for quite some time these days.

And back to ideas on investing. I'm a value investor, but I'm not a 100% value advocator. The importance of this statement is I've just identified my investment philosophy, a.k.a what are my carefully thought out investment strategies. And I don't mean trading strategies such as buying at p/e below 30, or following certain trends, or even following the Buffett Way. I mean really, what are the reasons that make me believe in this strategy I'm using, are they relevant anymore, are there logical fallacies, am I taking risks and returns which are unacceptable due to my investment philosophy. (Not due to market conditions) That's why I always find it ridiculous when people say they are playing the market. The market is one of the easiest and fastest ways for you to lose your entire fortune, so how can investing not be a serious business with an infallible investment philosphy? To ascertain whether you understand your investment philosophy, try explaining why you are most comfortable or most confident in your trading strategy to someone in 3 minutes. And 3 minutes is only for first timers, it's supposed to go down to 1.30 minutes when you are absolutely sure. But that is not all. An investment philosophy, as mentioned earlier may be extremely flawed, and it requires intelligence, humility, confidence and time to fine-tune.

I feel that just as Economics has a central problem of scarcity, the realm of investing also has its own central problem: How not to lose money. Many may be familiar but not appreciative of the 2 famous rules: Not to lose money, and never forget rule number 1. Of course, losing paper money or even real money is part and parcel of investing. But on foresight and not on hindsight, consider whether we have done everything possible to understand comfortably the companies we invest in, whether the price was really logical, and lastly whether our investment philosophies have changed. We should not blame ourselves for unexpected changes on hindsight because these are likely non-recurring.

At this point, it is important to understand the difference between an investor and a speculator. This is because I believe that investors and speculators do not mix well socially or privately, and if they ever turn out to be Siamese twins it may become a total disaster. The difference is probably best summarized by Keynes and Buffett as: Investing is the process of forecasting roughly with a margin of safety of the yield of the asset or business over its life, speculating is forecasting the psychology of the market. Benjamin Graham was more cynical in his definition: Operations not promising safety of capital and a satisfactory return are speculative. Anyway according to Keynes, investing is about fundamental analysis while speculating is about technical analysis. Maybe some of us will find Keynes' definition outrageous. But think about it; the purpose of speculation is to guess correctly so as to be rewarded quickly, afterall people don't speculate that 10 years later they have bought a winning stock. (Unless you are Nostradamus) This means a specific time frame, and of course high turnovers and precise market timings. And of course only technical analysis is concerned about predicting the time frame, where people are trying to decipher the next up and coming trend to follow so they can profit immediately. Fundamental analysis however is not about predicting the time frame, our job is to value the asset using its earnings, and finding the right price below value to earn a satisfactory return when the price meets value.

I do not believe in technical analysis for several reasons. However, my enlightenment comes from Robert's research at Santa Fe Institute. (A top-notch research institute famed for its multi-disciplinary and open-minded approach) The market is concluded to be a complex system, and the key to this system is its adaptability. Humans, alike the tissues that form part of us, adapt. And we reorganise our thoughts to correct our obvious errors in the past. (For eg, we might have heard things such as "Stocks at p/e under 30 have been winning over the past 6 months and I should have bought them") This adaptability brings about multiple degrees of thinking where we are second or even third degree guessing what our 6 billion opponents are guessing about each other. In a theoretical way the market mechanism may still bring this super complex system to an equilibrium where a winning strategy occurs, but the system on a whole is so unstable that any equilibrium last shorter than the time needed for an ordinary person to figure out. The other thing that troubles me about trends is regarding the logic of back testing. I still find it unacceptable that people inevitably manipulate variables (even unintentionally) to spot a trend. And even if we have spotted the correct trend, is that relevant anymore at this point in time? And even if the correct trend worked precisely at this point in time, can I repeat my strategy to achieve similar winnings? At the end of the day, is my investment philosophy so unstable and risky? No wonder traders make huge gains but easily lose more too. And for those who are successful, I'm not even sure whether they made money because they somehow have a prodigy to bet big on winning stakes. Of course I may be exaggerating the risks by neglecting the risk management polices (such as stop-loss positions). But what if you consistently make small losses from bad luck? Is this very much like gambling? If it were so, can you sleep well tonight by putting all your money into trading positions instead of using the fund's money?

And this is not to say fundamental analysis is the key to success either. As implied in the definition earlier, the two keys to fundamental analysis are determining the value and waiting for price to catch up to value. Tackling the second issue, if price stays depressed for a very long time, then capital gains will be reduced because of the time value of money. This is understandably frightening, but on a more logical analysis, returns come from 2 aspects: Dividends (or earnings if you own the entire company) and capital gains. Robert has shown that there is a high correlation between price and earnings over a period of time. However even when disregarding that, Mr. Buffett apparently seems unfazed by buying into private companies. These holdings have absolutely no price tags in the market, but he is happier than ever that such companies pay him such high returns because he paid such a miserable price for them since they are virgin to market IPO excitement. To the trickier first issue of valuing a company properly, this is where true education starts. To understand how a business work, how the management is running it, the financial performance of the company and lastly the value of the company, in this specific order which must not be altered, is my ultimate goal. (To fully understand, we have to ask ourselves why it should be in this order) I don't think I'm an expert in any industry or company so far, but these days i'm asking myself all sorts of questions and seeking for answers that I'm probably improving my general understanding of how businesses work.

Lastly, I've left my personal emotions to this very end. I don't think I'm living happily at all, especially I should confess that I've thought of experiencing the excitement of flying off the moving windscreen whenever I think about family problems and such. My cynicism is growing, and I'm more convinced now that unconditional love is a luxury beyond my reach. I hated the abuse when I was young, but now it makes no difference with the amount of hypocrisy from my parents. I've only told my best friend what happened since dirty linen should not be washed in public. Therefore, I've also never shared my success and sadness with anyone before; the sorrow I felt when leaving HC, the achievement when I finally played solo for NJCO in its first public concert, when I conquered lies in NS and when I lived out my bittersweet success in SMU. It is indeed a sad and lonely world out there, at least for me. But I still believe in reaching the light at the end of the tunnel, to become the beacon of light for youths.

It is in my sincerest wish to become a student of students, and a teacher of teachers for the future troubled youths.