Disequilibrium Analysis

George Soros treats developments in financial markets as a historical process. In The Alchemy of Finance, he outlines his theory of reflexivity, discusses historical developments in markets, and describes a real time “experiment” he undertook while running the Quantum fund in the 1980s.

Markets are an ideal laboratory for testing theories: changes are expressed in quantitative terms, and the data are easily accessible.

Three of the key interrelated concepts in his framework, are anti-equilibrium, Imperfect Knowledge, and Reflexivity.


In markets, equilibrium is a very rare special case. Further, adjustments rarely lead to new equilibrium. The economy is always in adjustment.

According to George Soros:

If we want to understand the real world we must divert our gaze from a hypothetical final outcome , and concentrate our attention on the process of change that we observe all around us.

In trying to deal with macroeconomic developments, equilibrium analysis is totally inappropriate. Nothing could be further removed from reality than the assumptions that the participants base their decisions on perfect knowledge. People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations, and constantly changing outcomes. The process is reflexive.

The stock market, is of course a perfect example:

The concept of an equilibrium seems irrelevant at best and misleading at worst. The evidence shows persistent fluctuations, whatever length of time is chosen as the period of observation. Admittedly, the underlying conditions that are supposed to be reflected in stock prices are also constantly changing, but it is difficult to establish any firm relationship between changes in stock prices and changes in underlying conditions. Whatever relationship can be established has to be imputed rather than observed.

So its better to focus on nature and direction of ongoing adjustments, rather than trying to identify an equilibrium.

Imperfect Knowledge

Perhaps more problematic with an exclusive focus on rarely occurring equilibrium conditions is the assumption of perfect knowledge. Perfect knowledge is impossible. Everything is a provisional hypothesis, subject to improvement. Soros makes the bias of market participants the center part of his analysis.


In natural sciences, usually the thinking of participants and the events themselves can be separated. However, when people are involved, there is interplay between thoughts and actions. There is a partial link to Heisenberg’s uncertainty principle. The basic deductive nomological approach of science is inadequate. Use of probabilistic generalization, or some other novel scientific method is preferable.

Thinking plays a dual role. On the one hand, participants seek to understand the situation in which they participate; on the other, their understanding serves as the basis of decisions which influence the course of the events. The two roles interfere with each other.

The influence of this idea is inseparable from the theory of imperfect knowledge.

The participants’ perceptions are inherently flawed, and there is a two-way connection between flawed perceptions and the actual course of events, which results in a lack of correspondence between the two.

This two way connection is what Soros called “reflexivity.”

The thinking of participants, exactly because it is not governed by reality, is easily influenced by theories. In the field of natural phenomena, scientific method is effective only then its theories are valid, but in social political , and economic matters, theories can be effective without being valid.

Effective here, means having an impact. For example, in a bubble, the cost of capital for some companies drops to be absurdly low, relative to the risk of their respective enterprises. Consequently, some businesses that would have otherwise died, may go on to survive. (Example from two decades after the Alchemy of Finance was written: Peter Thiel mentions when being interviewed in Inside the House of Money, that Paypal did a massive capital raise right a the height of the tech bubble, even though it didn’t need the money at the time) On the flip side, a depression can be self fulfilling, if businesses are unable to refinance.

This seems to be especially true in the credit markets:

Loans are based on the lender’s estimation of the borrowers ability to service his debt. The valuation of the collateral is supposed to be independent of the act of lending; but in actual fact the act of lending can affect the value of the collateral. This is true of the individual case and of the economy as a whole. Credit expansion stimulates the economy and enhances the collateral values; the repayment or contraction of credit has a depressing influence both on the economy and on the valuation of collateral. The connection between credit and economy activity is anything but constant- for instance , credit for building a new factory has quite a different effect from credit for a leveraged buyout. This makes it difficult to quantify the connection between credit and economic activity. Yet it is a mistake to ignore it.

This is reminiscent of Hyman Minsky’s Financial Instability Hypothesis

In terms of the stock market, Soros asserts (1)Markets are always biased in one direction or another. (2) Markets can influence the events that they anticipate.

Lessons From The Landscape of History

In The Landscape of History: How Historians Map the Past, John Gaddis discusses the methods that historians use, comparing them to methods of sciences such as astronomy, paleontology, and geology. The book is a great exploration of different approaches to examining evidence.  Here are a few key lessons.

A library is better than a time machine
Unlike time travelers,  “historians have the capacity for selectivity, simultaneity, and the shifting of scale…”:
Selectivity:  Historians can select from the cacophony of events what they think is important.  They proactively impose significance on events, not the other way around.
Simultaneity they can be in several times and places at once.  By standing apart from events, historians can understand, and compare events. “…understanding implies comparison: to comprehend something is to see it in relation to other entities of the same class…”
Scale.  Historians can zoom in and out between macroscopic and microscopic levels of analysis.  As a result processes are visible to historians even if they weren’t visible to people of the age the historian studies(or a hypothetical time traveler).
Historians integrate induction and deduction
Since we’re historians, not novelists , we’re obliged to tier our narrative as closely as possible to the evidence that has survived: that’s an inductive process.  But we have no way of knowing, until we begin looking for evidence with the purposes of our narrative in mind, how much of its going to be relevant: that’s a deductive calculation. Composing the narrative will then produce places where more research is needed, and we’re back to induction again.  But that new evidence will still have to fit within the modified narrative so we’re back to deduction.  And so on until, as I earlier quoted William H. McNeill, “it feels right, and then I write it up and ship it off to the publisher.”  That’s why the distinction between induction and deduction is largely meaningless for the historian seeking to establish causation.  The verb “to fit” which implies both procedures, is much better.  Its not just tailors who look at what they have to cover, and then what they have with which to cover it, and then back and forth, again and again, until the fit is as good as its going to get.
The combination of induction and deduction is especially important in biography.
Biography, like the larger sphere of history within which it resides is at once a deductive and an inductive exercise.  Patterns of human behavior extending across time and space can alert us to the kinds of questions we should be asking about the particular individual we’re dealing with:  that’s where deduction comes in.
But these patterns alone can’t determine the answers, for it’s all to easy to to find what you’re looking for when you’ve already decided a head of time what it is.  The evidence of particular experience in biography has got to discipline what we know from collective experience: induction is how we do that.
Historians must balance the general against the particular.
Interdependent Variables
Social science is obsessed with separating out independent and dependent variables. Historians along with many scientists working outside of laboratories  view variables as interdependent.  The author calls this an ecological approach, rather than a reductionist approach.
Theories like relativity, plate tectonics, and natural selection emphasize relationships among variables, some of them continuous and others contingent.  Regularity and randomness coexist within such theories: they allow for punctuations that upset equilibria such as asteroid impacts, earthquakes, or the outbreak of new and lethal diseases.  Nor do they require singling out certain variables as more important than others.Nor do they require singling out certain variables as more important than others: what would the independent variables be for the Andromeda galaxy or the Norwegian coastline, or the Darwin finch? Reductionism in these realms is only a stepping stone towards synthesis.
Historians,however, reject the doctrine of immaculate causation, which seems to be implied in the idea that one can identify, without reference to all that has preceded it, such a thing as an independent variable.  Causes always have antecedents.  We may rank their relative significance, but we’d think it irresponsible to seek to isolate or “tease out” single causes for complex events.  We see history as proceeding instead from multiple causes and their intersections.  Interconnections matter more to us than does the enshrinement of particular variables.

Practical Philosophy: Finding Time for Deep Work


Deep Work: Rules for Focused Success in a Distracted World

Rapt: Attention and the Focused Life

The Intellectual Life: Its Spirit, Conditions, Methods


Cal Newport defines Deep Work as activities performed in a state of distraction-free concentration that push cognitive capabilities to the limit. Deep Work is essential in order to quickly master new things quickly, and to produce at an elite level in terms of both quality and speed.

Cal Newport quotes A.G. Sertillanges, a Dominican friar and professor of moral philosophy who wrote in The Intellectual Life

Men of genius themselves were great only by bringing all their power to bear on the point on which they had decided to show their full measure.

Winifred Gallagher concludes in the book Rapt: Attention and the Focused Life that management of attention is the key to improving nearly every aspect of existence. Realizing this is the easy part. The hard part is figuring out how to fit Deep Work into a busy schedule. Newport outlines 4 applicable philosophies for fitting deep work into the demands of a modern schedule.

1) The Monastic Philosophy
This is available to a limited pool of people, mainly tenured professors, and successful authors. Examples include computer scientist Donald Knuth and science fiction writer Neal Stephenson, who both go to extreme lengths to eliminate shallow tasks and communication.
2) The Bimodal Philosophy
Practically speaking, this is about taking a proper holiday, or carefully blocking off certain days for different kinds of work. It need not be long. Carl Jung, on several key occasions in the 1920s retreated to a house in the woods in order to work on writing, but spent most of his time to living a very active social life in Zurich. Adam Grant, a famous business school professor is, is very active with university responsibilities most of the time, but when working on a book, he’ll cut himself off from most office communication for 2-4 day periods.
3) The Rhythmic Philosophy
This is perhaps the most practical method for most people. Basically, it means creating a simple regular habit of deep work. Combine a simple scheduling heuristic, and an easy way to keep track.
One suggested method is to get up 90 minutes earlier and spend the extra time on deep work(this happens to be the method used by yours truly to get more reading/writing/coding done )
4) The Journalistic Philosophy
This seems like it could be combined with the rhythmic philosophy. In essence it means getting deep work in whenever you can fit it. It does require strong attention discipline(but like muscles, this can be trained). Walter Isaacson managed to write his first 800+ page book while working full time as a journalist using this method.  (us mere mortal can use noise cancelling headphones as an aid in applying the journalistic philosophy of deep work)

Newport also offers two suggestions for ramping up the amount of deep work one does.

  • Beware of distractions and looping. This is when the brain wanders into unrelated issues when it should be focused on a critical task. Newport used the example of when his brain would rehash preliminary results over and over again when he was trying to work on a proof.
  • Structure deep thinking. Identify relevant variables, define the specific next step questions, and once it is solved , consolidate the gains by reviewing the identified answer. Approach problem solving methodically.

Cialdini’s Law of Data Smog

In the classic book Influence, Robert Cialdini outlines six principles(reciprocation, liking, social proof, authority, scarcity and consistency) that represent psychological universals in persuasion. In general, all these persuasive techniques exploit people’s heuristics. The proliferation of information in this digital age means people need to rely more on heuristics than ever before. This has broad and deep consequences.

Because technology can evolve much faster than we can, our natural capacity to process information is likely to be increasingly inadequate to handle the surfeit of change, choice, and challenge that is characteristic of modern life. More and more frequently we will find ourselves in the position of the lower animals, – with a mental apparatus that is unequipped to deal thoroughly with the intricacy and richness of the outside environment. “ ­ Influence

One of the thirteen laws of Data Smog outlined by David Shena is Cialdini’s Law: Though culture moves much more swiftly than evolution, it cannot change the pace of evolution. This of course leads to a dangerous situation, where the unwary can be tricked into making dumb decisions. Worse yet are the broader societal consequences.

In the electronic age, a good lie well-told can zip around th world and back in a matter of seconds while the truth is trapped, buried under a filing cabinet full of statistics.”Data Smog

Cialdini’s follow up book, Pre-Suasion discusses how persuasiveness can be enhanced by carefully crafting what is done and said before making a request. Information overload also makes people more susceptible to the “presuasive“ techniques:

“…(1)what is more accessible in the mind becomes more probable in action, and (2)accessibility is influenced by the informational cues around us, and our raw associations to them….

In addition to its time-challenged character, other aspects of modern life undermine our ability (and motivation) to think in a fully reasoned way about even important decisions. The sheer amount of information today can be overwhelming- its complexity befuddling, its relentlessness depleting, its range distracting, and its prospects agitating. Couple those culprits with with the concentration-disrupting alerts of devices nearly everyone now carries to deliver that input, and careful assessments role as a ready decision-making corrective becomes sorely diminished. Thus a communicator who channels attention to a particular concept in order to heighten audience receptivity to a forthcoming message- via the focus-based, automatic, crudely associative mechanisms of pre-suasion- won’t have to worry much about the tactics being defeated by deliberation. The calvary of deep analysis will rarely arrive to reverse the outcome because it will rarely be summoned.”Pre-Suasion

Summon the calvalry of deep analysis

What can one do about this?” Hueristics are necessary to function in the modern world, but they must be examined from time to time. The calvary of deep analysis must be summoned for big decisions. Cialdini also recommends forceful counters assault. Recognize the tricks being employed are often enough to blunt their force, but in other cases it may be necessary to aggressively fight against the tricks. These books are a great place to start.


Why are receivables up more than sales?


“Always take a company seriously, even if its financials are knee-slapping, hoot-promoting drivel”

Kathryn Staley

I’m about halfway through The Art of Short Selling. It has some incredible short selling case studies. One accounting issue that comes up is where accounts receivables spikes without a proportionate increase in actual cash sales. Tracking the ratio between accounts receivable and sales is a way to track a pretty simple trick that company accountants can pull. The example used is that of the a corporate/government training company with a famous politician on the board. It ended badly for shareholders. This happens a lot in questionable companies getting “out over their skis.”


“Receivables can be up by more than sales for several reasons:
1. The company acquired a company, and the acquisition is not yet under control-collections do not have the same billing cycle or terms for sales, for example. If the acquisition was a large one relative to sales, the relationship of year versus year in receivables is not comparable.

2. The company is booking revenues too aggressively-for example, a three-year contract recognized at the front end, so that receivables stay high because the rate of payment is slow.

3. The company changed its credit policy to easier terms or is giving incentives for sales, thereby jeopardizing future sales.

4. The company is having trouble collecting from customers. Building accounts receivables is a cost to the company because investing in business already booked hurts cash flow. Timely collections are sensible in a growing business because growth eats money by definition.”

How companies book revenues is a particularly quarrelsome issue for analysts: There are many ways to fool around, and technology and training companies are two categories of regular abusers. Revenues booked should have a consistent relationship with collection-if a company ships now and collects in 60 days, the accounts receivable schedule should consistently mirror that policy. So rising receivables versus sales or a lengthening number of days in receivables should always trigger a question: Something has changed, it says.


If your screener sets of an alarm due to a spike in receivables relative to sales, running through this list might help you find the answer. Understanding this question gets back to the basic question: how does this company make(or fail to make) money?

One more quote to top it off:

“For the last week I’ve been carrying “The Art of Short Selling” around with me just about everywhere. Every time I get a break, I just open to a chapter. Doesn’t matter if I’ve already read it. I just read it again.”

Michael Burry(1999)

15 Signs of a Great Growth Stock

I recently reread Common Stocks and Uncommon Profits by Phil Fisher, while I was flaneuring in Morocco. Fisher held stocks for years and even decades, and focused on situations where he could get a several hundred percent gain over his holding period. His process focused on “Fifteen Points” to look for in a common stock. Not every investment was positive on every point, but good long term investments would need to exhibit many of them.

Here are my notes on the Fifteen Points.

  1. Does the company have products or services with sufficient market potential to make a possible sizable increase in sales for at least several years?

Fisher didn’t spend time on “cigar butts”- he wasn’t interested in squeezing cash out of a dying business, even though it could be lucrative for certain investors. Likewise, he acknowledges that its possible to make a quick profit from one time cost cuts in an inefficient business, although that wasn’t his niche. Notably Buffett described himself as 85% Graham and 15% Fisher, and the Fisher component arguably made him more money over the long term.

It’s important to consider what the limits of growth might be- once every potential customer has purchased once, then what? During Fisher’s time he focused on a lot of high-tech product companies. In modern times, there are a lot more service focused companies which can potentially generate recurring revenue streams.

A company with massive long term growth potential may have lumpy sales growth. Annual comparisons generally don’t mean that much, instead investors should compare multiple years.

If management is decent and lucky they might find themselves with a long run growth opportunity. If their truly good and lucky, they’ll find a way to creat it.

If a Company’s management is outstanding and the industry is subject to technological change and development research, the shrewd investor should stay alert to the possibility that management might handle company affairs to produce in the future exactly the type of sales curve that is the first step to consider in choosing an outstanding investment.

One of the key examples is Motorola.

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Short Western Union

I wrote on Seeking Alpha about the short thesis on Western Union(WU).   The company is paying $586 million settlement in which it admitted to aiding and abetting wire fraud. However  competitive decline is an even larger long term threat.  Not mentioned in the article, I was actually long the stock from 2012-2015, having bought because I thought the market overreacted to its decision to cut prices on remittances. I ultimately sold because I was disappointed with the company’s response to the technological disruption in the global remittance market.   I didn’t go short till late 2016. Its a relatively small position(about 2%), but I generally avoid shorting in size.  As this chart shows, the incumbents are losing pricing power in the remittance market:



For more details, see the full writeup.


6 Reasons Companies Fail

Dead Companies Walking, by Scott Fearon is one of the most fascinating business books I’ve ever read. The author is a talented hedge fund manager with a great track record on both the long and the short side. His ability to spot “Dead Companies Walking” is a key part of his edge.  Even for long only investors, the tales of what to avoid are valuable. The book describes 6 main reasons why companies fail:

1) Historical myopia: learning from only the recent past.

This seems to be most prevalent in cyclical industries, such as energy. The author’s formative experience was starting at a Texas bank right before the oil bust of the 1980s. People looked at charts going back only a couple decades, and assumed that prices would drop only to a certain level. Equally absurd assumptions can be applied to all sorts of metrics that people use in the investment decision making process.

2) Relying too heavily on a formula.

If a company follows a strict formula or metric, such as adding a certain number of stores annually, they can quickly find themselves making illogical decisions. Value Merchants, a retailer is an example used in this chapter.

Investors that rely too much on formulas can end up investing in zombie companies on the cusp of obsolescence. Various yellow page companies, for example, looked extremely cheap on an EBITDA basis in the early 2000s.

Relying too much on formulas an result in errors of omission. For example, investors may that relied on a strict valuation formula would have turned down Starbucks and Costco in their early days.

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Using Old Books to Exploit New Media

Trust Me, I’m Lying: Confessions of a Media Manipulator exposes the twisted incentive system that makes the media susceptible to manipulation, and the boiler room environment in which much of the “news” is manufactured. The book outlines tricks used to steal people’s time and attention. while serving some other agenda.  By understanding the logic behind business choices that the media makes, readers can better predict and anticipate actions(some might even be able to use the book to redirect, accelerate and control stories). It was written back in 2012,  but after reading, it makes sense that clickbait could help swing an election.

In the the book Ryan Holiday also hints at what gives him an intellectual edge:

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Sam the Banana Man

The Fish That Ate the Whale: The Life and Times of America’s Banana King is the biography of Sam Zemurray, known in the early days as Sam the Banana Man.  He was an Russian Immigrant turned American Banana Tycoon.

Sam’s philosophy was ” get up first, work harder, get your hands in the dirt and the blood in your eyes.”  He had an exceptional ability ability to think abstractly and to translate ideas into actions.

Here are a few highlights from his bio:

1)He built his empire by starting with bananas that were too ripe, and therefore discarded by his larger competitors:

Sam grew fixated on ripes, recognizing a product where others had seen only trash. It was the worldview of the immigrant: understanding how so-called garbage might be valued under a different name, seeing nutrition where others saw only waste. He was the son of a Russian farmer, for whom food had once been scarce enough to make even a freckled banana seem precious”

He later expanded beyond this strategy, which resembled deep value “cigar butt” investing, to build a massive fruit empire. This is one of several reasons that the Investor Field Guide compared him to Warren Buffett.

2) He was resourceful and tenacious.  He once built a long dock when he couldn’t get permit for a bridge:

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