Saturday, January 15, 2022

Books #16: The Man Who Solved the Market

The Man Who Solved the Market is one of the best books I have read in 2021. This is the story of Jim Simons, founder of Renaissance Technologies, the world's most successful and most secretive quant fund. Even after the book is published, nobody knows exactly how Renaissance made so much money. The table below from the book says it all.

Jim Simons vs all gurus

These no.s are net of fees and the annualized returns before fees are above 50%, which means doubling the capital every 18 months or so. When so much money is being made so fast, it is no wonder the whole Renaissance team doesn't want anyone else to know the secret sauce nor are they interested in sharing. 

So we can only speculate how things actually work.

The details are scant. The book shared a couple of facts:

1. You need a lot of data for quant models to work and as such there are thousands of trades implemented at any point. Every trade is analyzed. It took decades before the team perfected their trading wins.

2. Trades at tested using mathematical / quantitative models, looking for correlations and robustness. Trades are based on math theories that may not have anything to do with economics or business fundamentals. Renaissance doesn't look for relevance or explanations.

It works because there are always anomalies that continue because humans are simply not rational. One of the most simple ones are traders and fund managers closing trades at the end of week or month, Renaissance takes advantage of that and reap the small returns by taking the other side. But most of time, according to people quoted in the book, they cannot explain fundamentally why some trades work, but that is okay.

The other revelation is that only slightly more than 50% of the trades are profitable. Although it is not stated in the book, it means that one the most important rule in trading - cutting losses, works. I learnt it while reading about the turtle traders. Their rule: as long as you cut loss at say 2% and let your profits run at double of that i.e. at 4% and above, you can win even if you only win 50% of the time. 

Besides getting the taste of the secret sauce, or rather more of a whiff of smelling it, what is also interesting is how the book weaved the whole history of the financial markets for the general reader. It talked about the turtle traders, the 1987 Oct crash, George Soros vs the Bank of England, LTCM, a few flash crashes caused by quants over the last two decades, needless to mention - the GFC and all the other important financial moments over the last 60-70 years. 

That was really just nostalgic for me and perhaps very educational for new students of finance.

It is worth noting that LTCM tried to do what Jim Simons did and blew up. So, in essence, Jim was the successful LTCM and when he succeeded, he stay hidden so that his team can continue to reap the profits from the anomalies. There is some value in maintain secrecy when you do have an edge as exemplified by Renaissance, KFC (Colonel Sanders' secret recipe), Coca Cola and famously in Japan: FANUC, the company that invented the numerical controllers for machine tools and robots.

The last bit of the book talks about how Renaissance employees managed to influence politics. Notably, one of the key staff allegedly supported Trump and got him into the Oval Office using his money and influence. It is a testament that big money is so powerful that it can decide politics and impact our lives.

Sunday, January 02, 2022

COVID-19 to Omicron: Three Years On

When the pandemic broke out in 2019, we had no idea how crazy this could get. I have always been a fairly optimistic person and I thought we should be done in 12 months, if not 18 months. The world will quickly revert to normal because humans are creatures of habit and we like to go back to our old ways of lives as soon as we can. This is why losing weight is so difficult and why we cannot really change and become something we are not. 

We are entering the third year into the pandemic now and things are not looking optimistic. New habits are now being formed which may replace old ones permanently. For instance, we may not need to meet everyone face-to-face going forward. Zoom or virtual meetings can easily become say 60% of all our meetings and old style phonecalls may still make up 20%. So the last 20% of face-to-face meetings will be saved for the most important, most precious counterparties.

The big question is whether we will still fly as we used to. When the pandemic first broke, the airline industry quickly made a prediction: we will only get back to 2019's level of passenger volume by 2025. This was based on the experience from the 9-11 attack back in 2001. At first, I didn't want to believe that. We are so used to flying, how can that be true? Three years on, it now seemed likely, or perhaps, it could take even longer, since we are still only at 40-50% of 2019's levels.

Flight traffic comparison - courtesy of Flightrader24

This does not mean we will not travel anymore. It's the same as zoom or webex. We will save up for the best. We will still travel for leisure for sure. That's the first thing Singaporeans did! We are all not in Singapore now having not being able to travel for the last two years. Business travel should revert to some kind of new normal. For some, it could one less trip per year i.e. dropping for 4 to 3. For frequent flyers, it could be 10 to 8. But I believe, over time, we will surpass the previous peak. It is just whether it's 2025 or 2030. 

It may be just numbers (of years) to most of us, but to the airline industry, it's big difference. Our beloved carrier SQ or Singapore Airlines (SIA), continues to burn around S$300m every quarter and if it is going to drag on, they will need money again (it raised S$8 billion last year). Similarly, aviation related plays will continue to be affected. It is amazing how SIA is now S$5 after a massive 50% dilution. At one point it was even close to S$6 which was just a tad away from the share price (S$6.4) before the dilution! How can the stock be diluted half revert to its old price in a matter of months, when the pandemic that caused the whole situation is still with us? Sometimes the market just doesn't make sense.

SQ continues to burn money
As such, my belief is that SQ is overvalued now, even if we actually start to recover now from COVID-19, we may not have enough margin of safety for this name. But for other SG stocks, there could be. One name that comes to mind is Jardine Cycle and Carriage, which I have also discussed previously. It has been badly hit by the pandemic and has not rebounded. Partially because it is operating in Indonesia, an emerging country will limited bargaining power for vaccines, medicines and with its domestic consumption still weak, with no recovery in sight.

Similarly, there are many recovery plays that could be interesting: restaurants, cinemas, domestic tourism names in other countries (not so much Singapore) and we should think hard to find these names. On the flipside of the coin, we should be worried about pandemic positive stocks, like zoom and other SAAS names, that had done really well. Some of them have already collapsed, but we may not see it bottoming yet because valuations are still sky high. Just look at Peleton (below), the Netflix + stationary bike manufacturer.

Peleton's share price

At the height of the pandemic, everyone wanted a Peleton bike. The market cap was a crazy US$50 billion. It has fallen 80% but still it's US$12 billion market cap, which is bigger than SQ! This is a company with no earnings, no track record, no cashflow. Just the idea that you can watch motivation exercise videos and cycle to lose weight, which was the best thing ever when everyone was stuck at home. But what happens when we can go out again?

We live in the most unusual times. The GFC created the new paradigm shift to zero interest rates which caused asset prices to inflate through the roof. Some of this huge monetary expansion finds its way to fund startups and created giants (Gojek, Tiktok etc) in the span of a few years. Then the pandemic hit and we saw how it accelerated the growth of some of these co.s but decimated segments of the old economy.

In the midst of all this, we now have real world inflation, a possible bubble of everything and potential recovery in some covid-hit names. But we have to exercise caution because all this is not going to end well. We can only diversify (not so much into cash but different holdings, perhaps even crypto - topic for another day) and hope for the best!

Happy 2022, huat ah!