Tuesday, March 27, 2012

2nd Level Thinking in Real Life

2nd Level Thinking works in real life as well. We should not be thinking superficially and derive simplistic answers to some of the problems we face. Again in most cases, consensus would be right, and it's tempting to just follow the crowd. Sometimes, maybe average is good enough. But in other important issues, we might need to strive to be one level up.

Take my favourite topic: our kids' education. All the parents in Singapore are stuck in this crazy competition of getting into branded schools, tuition marathons and fighting to be one up against the rest. But the since every parent is doing that, no child stands out. To make things worse, parents waste money on tuition, waste time at volunteer work and every child actually has less free time, are more stressed and become less proficient in other non-academic areas: such as learning to iron, cook or fix a light bulb.

One solution to this issue is for authorities to step in as mentioned in previous posts. The nature of the game has evolved such that it is impossible for the participants (ie parents) to resolve the issue, even though everyone is just simply working in their own best interest. This is akin to asking all women to stop wearing high heels. (See this post if you don't get this.)

Well that's topic for another day.

The idea here today is to apply Second Level Thinking. Different but better. Needless to say, it cannot be just different. Some might say don't go for tuition lah, don't succumb to doing parent volunteer and support this elitist system. But then the kid loses out. So it has to be more innovative than that.

Again we ask questions such as:

1. What are the viable alternatives?
2. How can we invert and think out of the box?
3. Where are the kids today lacking?
4. What are other parents not doing enough?
5. Does my kid have a talent?

When we think through some of these answers we are effectively applying Second Level Thinking and some solutions might well be different and better.

Take question 3, what are kids today lacking? There are plenty! As alluded to above, they cannot do simple chores (Blame the Maids!). They speak less mother tongue (60% of homes are English speaking). They are exam smart not street smart. They don't see as well (a lot of kids are short-sighted).

A lot of the issues have no relevance in academics but still something to think about. The one key here: kids today speak much more English and are bad at their mother tongue.

20 years ago, English was a problem, bcos 60% of Chinese homes speak Mandarin at home. Today it is the opposite. Our Chinese kids are becoming bananas fast. Yellow on the outside, all white inside. Their command of the Chinese language is poor, and they and their parents either have no intention to do anything about it or are incapable of doing anything bcos the parents themselves don't speak good Mandarin. In fact, MOE wanted to lower the bar to satisfy some parents, only to get lambasted by the Chinese elites.

So the 2nd Level Thinking here would be to let our kids become proficient in at least 2 languages. In fact, we should let them be exposed to more if possible. Research have shown that kids can learn languages better than adults. So while we are at it, we can definitely throw in important languages like Malay, Japanese or even Spanish.

Of course language needs the environment, so if the parents cannot speak Spanish, it is hard for the child to pick it up out of the blue. But for some parents who are bilingual and speak dialects, or Malay or other 3rd languages, it might be useful to impart these to your kids.

Alas, as in stock market, people catch up to 2nd Level Thinking fast. What worked yesterday might not work today. Some parents prepared their children for Primary 1 when the kids were in K1, K2 many many years ago and those kids gained the one up against their peers during that time. But today, all parents do this and the bar is raised, to the detriment of those who cannot keep up.

Similarly, I won't be surprised that a lot of parents are making sure their kids are effectively trilingual and in the near future, we need to apply 3rd Level Thinking to gain that one up again.

Friday, March 09, 2012

Second Level Thinking

This is a phrase coined by Howard Marks in his book, "The Most Important Thing". This book is truly a rarity for investors, with both new and old concepts well thought out and written clearly. The best part: the concepts are even valid for institutional fund managers. Very rarely we find something useful both for professional and retail value investors.

So one of the most intriguing concept is this Second Level Thinking. What is this all about? Well to answer that, we first need to know what is first level thinking.

According to Howard Marks, most investors possess only first level thinking. First level thinking is obvious, superficial and consensus. Examples of first level thinking would be:

"Apple is launching iPad 3 in 2 weeks, let's buy."
"Oil just went up another 5%, airlines will be hit, sell SIA."
"WD is being hit by the Thai flood, buy Seagate."
"Toyota recalls 100,000 cars! Sell sell sell!"

Almost everyone can be a first level thinker. Just read the headlines and draw the obvious conclusion. Well, this doesn't mean that first level thinking investors doesn't make money. I can hear you shouting, "If this dumb blogger have bought Apple 2 years ago when the stock price was at $300, he would be so rich that he wouldn't be blogging now."

That is obviously true. Being consensus can still help you make money, but it may not help a lot over the long run. You might make money from Apple but you might jolly well be sucked into buying Yahoo! in 1999, or Li Ning at it's finest moment, holding the Olympic torch in 2008 or Singapore's Oceanus, the abalone story that went on fire a couple of years back. Btw all 3 examples would have burnt big holes in the investors' pockets.

First level thinking won't get you very far because everyone is doing it. It derives easy and average answers. That cannot help you generate good long term return. It is even less likely that you can beat the market.

2nd Level Thinking is complex and tedious. It is about mental aerobics, in-depth research and perhaps even long, difficult discussions with like-minded thinkers. The 2nd Level Thinker asks questions such as:

1) Does the market already know this?
2) What are all the scenarios?
3) How can one invert and think otherwise?
4) Are there comparison with other situations?
5) What is the probability that I am right and the market is wrong?

2nd Level Thinking is not just about non-consensus. It has to be non-consensus and yet correct. Different and better. It has to be two steps ahead.

A good illustration of 2nd Level Thinking would be about BP and its accident in the Gulf of Mexico. For the un-initiated, BP's off-shore oil rig exploded 2 years ago and caused the world's largest oil spill that impacted millions of humans, plants and animals in the vicinity.

For those who remember the drama, it was pretty excruciating. First we see footage of the explosion, then the spills, the poor ducks, the fishermen being interviewed and for days on end, they couldn't cap the well. Oil kept gushing out. Experts opinionated everything. How BP cut corners, how the ecosystem will be irreversibly damaged, the penalties and costs will run into billions. Meanwhile the CEO went sailing with his son and got lambasted further. Major media circus.

So the first level thinkers were like, BP is going bankrupt. Let's sell BP. Or even better, short the stock dead. Meanwhile BP's market cap halved. In absolute dollar terms, it fell roughly USD 100bn. A few years ago, that is the GDP of Singapore. Even today more than 100 countries still have GDPs lesser than USD 100bn.

So the 2nd Level thinkers would be going, "Wait a minute, 100 billion? Is that right?" When was the last big oil spill? What was the final tally for costs and penalties? Did the affected co. go bankrupt? What is the Gulf of Mexico's contribution to BP? Can BP simply ring-fence its US operations? Is bankrupting BP better or would the US Govt prefers BP to continue generating cashflow to pay the costs?

Well as it turns out, penalties and costs today cannot even hit USD 50bn. Even the amount that BP already paid out: 37bn or so, might not be fully utilized. A 2nd Level thinker at that time would also have found out that the whole US operations contributes only a third to BP and ring-fencing the whole US would have made sense if penalties and costs exceed a certain amount. Certainly BP would be worth much more alive than dead, why would the US Govt bankrupt BP?

So, when the market cap fell by USD 100bn, the market went crazy thinking BP would go bankrupt. It factored in more than the worst scenario that BP will lose its entire US operations. So it was time to buy BP back then, not sell.

Today BP's market cap is USD 150bn. So a 2nd Level thinking investor made 50% or more. Perhaps with more to come.