Forbes / Wolfe Emerging Tech Blog: Weekly Insider (Mourn Model Makers, Volatility & Aliens Cause Global Warming)

As I always write: the only certainty is uncertainty. Paradoxically, the implied volatility today suggests that volatility will be stably-volatile for the foreseeable future (months ahead). You should expect periods of punctuated disequilibrium driven by fund redemptions in parallel with the transfer of ownership of common stock from short-term investors to long-term investors marked by high volatility and dramatic intraday reversals like yesterday.

The volatility isn’t coming from frenetic traders, but an ebb and flow of long-term investors providing liquidity to short-term investors, with the trend being exacerbated in either direction by many small daily momentum players.

Consider: yesterday closes higher. FIRST: this causes some hedge funds (without long-term lockups of capital and with monthly or quarterly LP liquidity) to decide its a good day to sell some positions to meet redemptions and hold only those positions that might pop on short-term news. SECOND: The correlated holdings overlap force other funds to sell. THIRD: Momentum investors pile on to clip a few basis points. FOURTH: Long-term, long-locked funds buy common stock from the short-term short-locked funds (because long-term capital cares less about daily or weekly price fluctuations. If meaningful mispricings exist, as they do, long-term holders will buy and plan to hold for 3 years. Mark this: The single greatest competitive advantage any fund can have is differing time horizon from a thundering herd of sellers being shepherded by short-term redemptions. As risk-guru Peter Bernstein has noted: throw away all the complex formulas, risk is not having cash when you need it.

This current environment is just this: hedge funds hanging on as long as they can, while bringing in their gross exposure because of deleveraging, cost of short borrow and redemptions. Most are unwinding (some faster than others) by size, staff or entire funds causing ownership stakes in companies (ie. “stocks”) to be transferred from short-term and momentum investors to long-term value investors.

Everyone now laments the model makers. Nassim Taleb, whose ideas I’ve pounded the table on in these columns for years has himself pounded the table on a recent Bloomberg interview calling for the heads of the academic curriculum that continue to teach erroneous ideas based on flawed assumptions of how markets or humans really work. “Messily” and “irrationally” is hard to capture mathematically—which is why finance professors and business schools still teach CAPM (capital asset pricing model), beta and other greek-letter nonsense. It’s like Charlie Munger’s story of the doctor who taught his students an incorrect procedure just because it was easy to teach.

Speaking of model makers, below as promised is the second installment of Michael Crichton’s outstanding wisdom, presented in a speech titled: “Aliens Cause Global Warming”. I first excerpt a favorite passage that relates to the current absurdity of model makers and the implausibility of linear prediction:

….Stepping back, I have to say the arrogance of the model-makers is breathtaking. There have been, in every century, scientists who say they know it all. Since climate may be a chaotic system-no one is sure-these predictions are inherently doubtful, to be polite. But more to the point, even if the models get the science spot-on, they can never get the sociology. To predict anything about the world a hundred years from now is simply absurd.

Look: If I was selling stock in a company that I told you would be profitable in 2100, would you buy it? Or would you think the idea was so crazy that it must be a scam?

Let's think back to people in 1900 in, say, New York. If they worried about people in 2000, what would they worry about? Probably: Where would people get enough horses? And what would they do about all the horseshit? Horse pollution was bad in 1900, think how much worse it would be a century later, with so many more people riding horses?

But of course, within a few years, nobody rode horses except for sport. And in 2000, France was getting 80% its power from an energy source that was unknown in 1900. Germany, Switzerland, Belgium and Japan were getting more than 30% from this source, unknown in 1900. Remember, people in 1900 didn't know what an atom was. They didn't know its structure. They also didn't know what a radio was, or an airport, or a movie, or a television, or a computer, or a cell phone, or a jet, an antibiotic, a rocket, a satellite, an MRI, ICU, IUD, IBM, IRA, ERA, EEG, EPA, IRS, DOD, PCP, HTML, internet. interferon, instant replay, remote sensing, remote control, speed dialing, gene therapy, gene splicing, genes, spot welding, heat-seeking, bipolar, prozac, leotards, lap dancing, email, tape recorder, CDs, airbags, plastic explosive, plastic, robots, cars, liposuction, transduction, superconduction, dish antennas, step aerobics, smoothies, twelve-step, ultrasound, nylon, rayon, teflon, fiber optics, carpal tunnel, laser surgery, laparoscopy, corneal transplant, kidney transplant, AIDS… None of this would have meant anything to a person in the year 1900. They wouldn't know what you are talking about.

Now. You tell me you can predict the world of 2100. Tell me it's even worth thinking about. Our models just carry the present into the future. They're bound to be wrong. Everybody who gives a moment's thought knows it.

I remind you that in the lifetime of most scientists now living, we have already had an example of dire predictions set aside by new technology. I refer to the green revolution. In 1960, Paul Ehrlich said, "The battle to feed humanity is over. In the 1970s the world will undergo famines-hundreds of millions of people are going to starve to death." Ten years later, he predicted four billion people would die during the 1980s, including 65 million Americans. The mass starvation that was predicted never occurred, and it now seems it isn't ever going to happen. Nor is the population explosion going to reach the numbers predicted even ten years ago. In 1990, climate modelers anticipated a world population of 11 billion by 2100. Today, some people think the correct number will be 7 billion and falling. But nobody knows for sure.”