Losses hurt twice as much
October 10, 2017

Mint - Blain's Morning Porridge

Roughly speaking, losses hurt about twice as much as gains make you feel good

For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…

Great to see Richard Thaler win the Nobel prize for Economics – as an observer of irrational markets for the last 30-plus years I'm delighted to see the guru of irrational behaviour win the award. Thaler is famed for his pithy observations on how RATEX assumptions (rational expectations) fail because of bias in the way economic players act. His "nudge" concept – gently guiding economic players towards rational choices - has become an operational discipline in its own right.  

But it got me thinking about markets. A degree of irrationality is, perhaps, a good thing. As more and more of the markets are now run by algorithm-crunching computers and automated stock trackers – where will the irrationality to fuel volatility come from? Volatility is a good thing – but if it's crushed out by genuinely rational robots then perhaps markets are heading for a long somnambulant slumber with zero price move entropy. That really would be a disaster – if every market player was entirely rational then what chance of alpha returns? 

And less market entropy is a bad thing. We'd be kidding ourselves if we think algorithms are really perfect. They may be more "rational" – whatever that means - but there will be cumulative system error that will, long-term, make them unsustainable, downright wrong and require reset.

The story of markets is about surprises, mistakes and shocked realization as the downright blooming obvious becomes blindingly apparent… Which is rather of the moment, this being the 10th anniversary of the Global Financial Crisis that began in 2007. I wonder when we'll wake up to a crisis saying: "It was all the computers' fault! How could we be so stupid?" Because we are…

Life as an irrational economic actor is simply more fun. If I'd always done the right thing… well I wouldn't be here today if I had! And talking of irrational markets. what have we got for today? Yesterday was thin due to the US holiday – but add Turkey to the list of potential trouble spots, and factor in the news El Norte Koreans are planning another firework launch. 

It's not worth saying anything about Brexit. I've been through a messy divorce and all the signs are there. Stop trying to be nice. Walk away. Meanwhile, and completely unconnected, I can't believe we're apparently going to close the factories making Typhoon fighters and mothball the Royal Marines' amphibious landing ships… just saying…

Catalunya looks interesting. the Spanish have wisely left it up to the rebels to make the next move – to declare independence or not in the face of an increasingly divided region (in terms of the numbers of didn't vote, who wish to remain in Spain, corporates fleeing, and the threat of non-recognition). There aren't any signs of compromise between Barca and Madrid - this is the way modern democracy achieves its goals… stifle dissent by not responding. Force the other side to drive the narrative. Markets don't seem much bothered as Spain and Catalan assets have stabilized.

Mo-the-Tash (E -Erian) is on the wires warning "only a major shock like North Korea or a police mistake [like US taxes perhaps] could hurt stocks". He sees a policy mistake at the Federal Reserve as a risk, but I suspect markets will be utterly discombobulated if government fails to deliver growth and the current "recovery" peters out into a new recession.

One piece of news on Bloomberg was the European Central Bank saying it may require 51 of the 111 biggest banks in Europe to add yet more capital to "test their resilience to hypothetical interest-rate shocks". Is that a subtle message about what's likely to come? They were analysing a number of shock scenarios – including a 200 basis points base rate hike. Banks judged to be well prepared for interest rate shocks could actually see their Pillar 2 capital requirement decline, but those judged "not-so-good" will see capital needs rise. Interestingly, the assumptions all assume "rational" depositor behaviour if rates rise.

And let me remind readers of yet another Blain trading mantra: The only thing worse than a bank with too little capital, is one with too much.

Meanwhile, I was out yesterday, but colleagues have left a succession of e-notes highlighting a worrying trend at high levels – for example the burst at the top end of the London housing market where nothing in the obscenely wealthy end is selling, or the fact a Francis Bacon painting failed to meet its reserve at auction. Or how about private aircraft prices down 16 percent over the past year?

What does that mean? Do the mega-rich know something we don't? If the world is really on the edge of a massive synchronized economic recovery, surely that's going to create a new slew of wealth, and if so, why aren't the wealthy anticipating it?

Or, it might be opportunity. Private aircraft prices have fallen 35 percent in the last three years. That means they sound cheap. and if growth is happening. are they going to be back in demand and what price makes sense...? (Or is the private jet end of the market just broken?)

Back to the day job.

Bill Blain

Head of Capital Markets/Alternative Assets





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Mint - Blain's Morning Porridge

Roughly speaking, losses hurt about twice as much as gains make you feel good

For the avoidance of doubt – the Morning Porridge is unrestricted market commentary, it is not investment advice…

Great to see Richard Thaler win the Nobel prize for Economics – as an observer of irrational markets for the last 30-plus years I'm delighted to see the guru of irrational behaviour win the award. Thaler is famed for his pithy observations on how RATEX assumptions (rational expectations) fail because of bias in the way economic players act. His "nudge" concept – gently guiding economic players towards rational choices - has become an operational discipline in its own right.  

But it got me thinking about markets. A degree of irrationality is, perhaps, a good thing. As more and more of the markets are now run by algorithm-crunching computers and automated stock trackers – where will the irrationality to fuel volatility come from? Volatility is a good thing – but if it's crushed out by genuinely rational robots then perhaps markets are heading for a long somnambulant slumber with zero price move entropy. That really would be a disaster – if every market player was entirely rational then what chance of alpha returns? 

And less market entropy is a bad thing. We'd be kidding ourselves if we think algorithms are really perfect. They may be more "rational" – whatever that means - but there will be cumulative system error that will, long-term, make them unsustainable, downright wrong and require reset.

The story of markets is about surprises, mistakes and shocked realization as the downright blooming obvious becomes blindingly apparent… Which is rather of the moment, this being the 10th anniversary of the Global Financial Crisis that began in 2007. I wonder when we'll wake up to a crisis saying: "It was all the computers' fault! How could we be so stupid?" Because we are…

Life as an irrational economic actor is simply more fun. If I'd always done the right thing… well I wouldn't be here today if I had! And talking of irrational markets. what have we got for today? Yesterday was thin due to the US holiday – but add Turkey to the list of potential trouble spots, and factor in the news El Norte Koreans are planning another firework launch. 

It's not worth saying anything about Brexit. I've been through a messy divorce and all the signs are there. Stop trying to be nice. Walk away. Meanwhile, and completely unconnected, I can't believe we're apparently going to close the factories making Typhoon fighters and mothball the Royal Marines' amphibious landing ships… just saying…

Catalunya looks interesting. the Spanish have wisely left it up to the rebels to make the next move – to declare independence or not in the face of an increasingly divided region (in terms of the numbers of didn't vote, who wish to remain in Spain, corporates fleeing, and the threat of non-recognition). There aren't any signs of compromise between Barca and Madrid - this is the way modern democracy achieves its goals… stifle dissent by not responding. Force the other side to drive the narrative. Markets don't seem much bothered as Spain and Catalan assets have stabilized.

Mo-the-Tash (E -Erian) is on the wires warning "only a major shock like North Korea or a police mistake [like US taxes perhaps] could hurt stocks". He sees a policy mistake at the Federal Reserve as a risk, but I suspect markets will be utterly discombobulated if government fails to deliver growth and the current "recovery" peters out into a new recession.

One piece of news on Bloomberg was the European Central Bank saying it may require 51 of the 111 biggest banks in Europe to add yet more capital to "test their resilience to hypothetical interest-rate shocks". Is that a subtle message about what's likely to come? They were analysing a number of shock scenarios – including a 200 basis points base rate hike. Banks judged to be well prepared for interest rate shocks could actually see their Pillar 2 capital requirement decline, but those judged "not-so-good" will see capital needs rise. Interestingly, the assumptions all assume "rational" depositor behaviour if rates rise.

And let me remind readers of yet another Blain trading mantra: The only thing worse than a bank with too little capital, is one with too much.

Meanwhile, I was out yesterday, but colleagues have left a succession of e-notes highlighting a worrying trend at high levels – for example the burst at the top end of the London housing market where nothing in the obscenely wealthy end is selling, or the fact a Francis Bacon painting failed to meet its reserve at auction. Or how about private aircraft prices down 16 percent over the past year?

What does that mean? Do the mega-rich know something we don't? If the world is really on the edge of a massive synchronized economic recovery, surely that's going to create a new slew of wealth, and if so, why aren't the wealthy anticipating it?

Or, it might be opportunity. Private aircraft prices have fallen 35 percent in the last three years. That means they sound cheap. and if growth is happening. are they going to be back in demand and what price makes sense...? (Or is the private jet end of the market just broken?)

Back to the day job.

Bill Blain

Head of Capital Markets/Alternative Assets



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