Injecting liquidity into the stock market is a bit like taking an aspirin when one feels sick. It lowers the fever (a short-term relief), sometimes at the expense of long-term recovery. Could it be that printing money extensively and cutting rates to low levels for too long increases market fragility as well?
Previously, Louis outlined the four asset classes that investors appear to regard as anti-fragile, now that US treasuries no longer fit the bill. With each of these four asset classes enjoying a roaring bull-run, today Louis examines the typical life cycle that lifts an asset class from unloved hell to anti-fragile heaven.
Since the 1980s, OECD government bonds have tended to be negatively correlated with equities, but during the pandemic that relationship seems to have broken down. Given that the Federal Reserve is embracing a new policy framework aimed at juicing up inflation, there are plenty of reasons to think that bonds cannot continue to play an “anti-fragile” role in portfolios. In this first installment of a two-part series looking at what…
As highlighted in Part I, we are witnessing the transition of our world from a ‘Disciplinary Society’ to a ‘Society of Control’. In Part II, we study the structural opportunity to buy the winners, i.e. the FAANMG (Facebook, Amazon, Apple, Netflix, Microsoft, Alphabet) and the likes.
A ‘Society of Control’ requires and therefore favours the mass treatment of information, and is rewarded by a multiplication effect. Today, the FAANGM provide access to computing, communication, internet, social network, gaming, film, music, and e-commerce. In other words, they all leverage the intangible part of value, i.e. information.
The three trillion-dollar hedge fund industry has spent the past decade traversing a barren desert, experiencing disappointing performance and dried up returns. An oasis, however, may be in view!
Science and philosophy have debated the significance (and even the existence) of ‘Time’ since ancient Greece. Finance, however, is the only discipline providing a market price for the uncertainty of the future, which means ‘Time’. Resultingly, it deserves a seat in the debating chamber. There are two ‘clocks’ in Finance, turning at different speeds. The first one synchronizes market trading and option values. It provides the tempo of the inherent random variability of asset prices. Only the second clock controls the directionality in ‘Space’, i.e. the expected drift of an asset. The Theory of Fragility provides the missing link between the two clocks, which reconciles most of the scientific interpretations of ‘Time’. Unlike ‘Traders’, ‘Investors’ should ignore the first clock and focus on the second
Balanced investment portfolios intuitively combine fragile assets, such as most equities, and antifragile assets, such as government bonds from developed economies or precious metals, gold or silver. However, how does one choose the right antifragile asset? The answer depends on monetary policy.
Gold is the ultimate antifragile asset. Unlike fragile assets such as equity indices, antifragile assets react positively to stress. Does it make sense to constantly hold gold in a diversified investment portfolio? ‘No’, is the answer. 50% of the time, when currencies act as stores of value, gold is a useless asset. However, the other 50% of the time, when currencies are debased, gold is a vital asset, insofar as it is the centre of pricing of all other financial assets. This paper will take the former 50% of the time to be ‘Wicksellian times’, while the latter 50% to be ‘Keynesian times’. World economies re-entered ‘Keynesian times’ on January 31st, 2019, following the monetary policy reversal of the FED. Statistics on portfolio allocation advocate a switch in these periods: from bonds to gold, from developed economy equities to emerging equities, and from cash to real estate. Gold, however, is not antifragile by nature; it has only turned antifragile since the end of the Gold Standard in 1971 because of its pricing in currencies. And currencies are fragile assets
Gold’s purchasing power has remained remarkably stable in the past 400 years, at least until the end of the Bretton Woods system in August 1971. The ensuing debasement of major currencies created a new competition between gold and currencies to attract world savings, and also between currencies themselves. This letter looks to describe the terms of the competition and identify the best moments to buy currencies rather than gold.
In our early letters on “Antifragility Revisited”, we demonstrated evidence of a linear relationship between many financial assets’ excess return and their variance at all probability levels. Such a relationship was conspicuously absent from the considerations of Modern Portfolio Theories. This required a transgression to Professor Taleb’s description of fragility and anti-fragility. But where does this relationship come from? This letter uses physics to explain the concepts of fragility and antifragility from a theoretical standpoint. Fragility and antifragility emerge as a natural consequence of market competition; they provide a financial variable which discriminates winners and losers in various market regimes. A few simple equations can be used to highlight the theory, and demonstrate how one calculates the physical variables, such as fragility. Readers who are not familiar with mathematics need not worry. The equations are even simpler than the ones used in traditional portfolio theories − that is to say, very simple!
The Theory of Financial Fragility anticipates the behaviour of financial assets in times of stress. Such anticipation not only requires a new conceptual framework regarding market arbitration, but also the help of modern physics and its understanding of energy transfers. “Introduction to Financial Entropy” and “The Energy of a Fragile Asset”, published earlier this year, dealt with the financial interpretation of various forms of energy, such as potential energy associated with expected returns, kinetic energy associated with asset variance and “uncontrollable”, “risky”, or “useless” energy associated with entropy. The Theory of Financial Fragility considers assets as species in an ecological competition vying to access the “useful” part of energy, also known as “free energy”. In other words, finance is no exception. It is governed by physical laws, and by an arbitration principle among strategies competing for survival. Understanding survival strategies is key to identifying potential winners and losers in periods of stress, and to build investment portfolios with heightened robustness. This letter focuses on the conceptual framework: the specifics of self-organized structures that ‘dissipate’ energy, such as planet Earth, living organisms, economic systems, financial markets, and many other systems that shape the evolution of mankind and, to a larger extent, the evolution of the universe, in their own way.