Basic mechanics of financial bubbles (part 2)


By Francesco Caruso, MFTA, Global Asset Strategy Amber SICAV advisor

Nassim Taleb (Antifragile, *****) says that getting used to risk one can be educated in a different way of managing money. But where is the intermediate point between immunity and boiled frog syndrome?

In Antifragile Taleb says, and explains it very well, that the risk reinforces you. The Anglo-Saxon investor has a knowledge of the volatility of markets significantly higher than that of the European investor, particularly Italian ones. This is a gap to fill because the Italian investor only conceives the gain and does not understand that that time is over. This leads to a series of distortions, for example, leads managers to look for something that suits their clients, sometimes they prefer to try and avoid complaints perhaps by making a run for trends that are on the late rise and exposing the investor to the risk. Ultimately, it’s all about generating bubbles, starting from incorrect positioning and a bad perception of the market situation.

Will Bitcoins and cryptocurrencies be the next bubble?

Cryptocurrencies are a very particular tool that needs to be deeply known to understand where risk lies. However, they are completely separated from the international financial system so even if they were a bubble or cease to exist, the only ones who will be hurt are the ones who invested on them. They are not, by any chance, able to impact the international finance. It should rather be investigated why cryptocurrencies come down and rise, because they might have been favored too by the loose money of Central Banks, and if the shrinking of the cords of the pocket could also lead to shrinking liquidity cords by those investing in cryptocurrencies. We do not know. What we know is that 82% of crypto miners are in China – and maybe this is not a case. Certainly, they are vertically up and have many elements typical of a bubble, but what is missing is contagion, spread within traditional portfolios. It could come in a hurry, surely. For now, if it’s a bubble, it’s a niche bubble, and the same people who took it over will take it down. Intersting, in this regard, is the opinion of Jamie Dimon, head of JPM (

And the ISAs?

Defining ISAs (Individual Savings Accounts) a bubble seems unsafe, there is certainly a lot of heat around this new product and surely Midex has risen a lot in recent months, but it is not the first time it rises and has not reached those levels that, in my opinion, are technical levels, not even basic levels, of a bubble. If this is a bubble it is certainly not a bubble at its terminal stage, it simply does not have the features. If it were, it would mature by expanding from these levels up, it is not yet.

What to do and what does not?

First, always be vigilant and critical and understand that to survive on the markets it takes a great mental discipline: if you take risks you have to accept the volatility that can even go against you. Specialists must understand that and make their customers understand. We have markets that are at the historical lowest volatility and this means that at now there is a high level of complacency on the market or perhaps that mass mental capitulation that leads to join late to a trend has not yet happened. Usually the bubble peaks do not come in conditions of low volatility but when it is already increasing. And when I say growing volatility I mean percentage points, not zero-point. At that stage, there is no kind of defense anymore and everyone steps in because those who is left behind is seen like a fool.

But how is it possible that, for the stupid reason of not looking like a fool, people adhere to financial bubbles already in place and insists on staying just to not contradict himself?

A bubble is nothing but the effect of a sequence of assessment mistakes. And the outbreak is not determined by any fundamental cause but by any trigger. In a whole chapter of his book, Shiller queries and investigates what news led to the 1929 bubble and eventually discovered that there was none. Financial bubbles simply arise because the market has risen too much, the first sellers fall back in and latecomers are losing big sums. At that point, there is a snowball effect that drives the market down to repositioning on levels below what was the “rational” level of that market. As much the rising bubble breaks off from a correct assessment, as when it comes back, it positions below the right valuation until underestimation. We can call it “elastic effect”.

So, eyes open but also risk training, says Taleb. How do you do it?

Investors can no longer put their heads under the sand and tell their private bankers or consultants or themselves, “You have to make me earn money”. It takes a microculture of performance. Maybe people are good at earning money but they are very bad in investing them because they do not stop, not even one hour, and reflect on the causes of return on investment. Newspapers are starting to do some financial education, but we are still back in the midst of a financial culture that is indispensable to developing a culture of risk.

But this culture, how we build it? Not certainly with school that has other problems other than financial education.

We must start from the basics, perhaps from a better math culture. I often quote in my seminars the law of statistical ruin: if you have 100 and lose 50%, you go to 50, but if you have 50 and you regain the same percentage, you will have 75. If you do not control the loss you are done because the recovery becomes more and more difficult. If a bond promises 8% when all other bonds give 2%, you are not the only “wise guy” who discovered that bond. Canistracci Oil offers that performance because it is up to its neck in it and is going to fail. Yours is a very high-risk investment. But the investor, blinded by his greed and thinking he is the smartest in the market, actually falls into the trap and in the Ostrich Syndrome, who knows that the risk is there (the lion) but hides his head under the sand to avoid seeing him.

It is surprising that such dramatic phenomena are human characteristics: greed, overconfidence, perhaps even the presumption of planning everything.

I call it arrogance. No one can foresee anything. The attempt to rationalize all aspects of our lives concerns us at all levels. We believe in controlling things and in reality, things are always different from what we are expecting, especially if we talk about a mass event like the markets. Those who continuously generate secular market forecasts make me smile. It is already difficult for many people to understand the here and now. When I show long-term charts, and explain where we are, people look stunned because they did not know that they were there. Another consideration is that every investment must have a time span. Anyone who watches the markets with an idea is inevitable that it is fully catalyzed by that position and that he keeps walking from the stars to the stables, perhaps even in the same day. The last second online trader loses a lot of money just by reacting hourly, minute by minute to the volatility of his investment, and in the end, he could not even say how he lost money. Among the best investors I had, including asset managers, I put engineers, because they have a mathematical basis in their reasoning, so you can always bring them back to the reason. They often show great ability to keep their nerves steady because they know the laws of physics, math and statistics and know that sooner or later things will change.

It is to be assumed that we, as investors, suffer from the verticality of our sense of the time.

Many Oriental people have a far than zen-like approach to the markets, rather animalistic: they regard them as battlefields. Prevail or die. They have a sense of money different from us, probably because of the lack of social security networks we have. Life is an event in which you have to try and make as much money as you can because there is no one who cares about you. That is why they are so aggressive. They live with the risk. Our society has forgotten the years of battle, reaction, and risk. Now nobody takes to the streets in protest anymore. We calmly wait for the Central Bank, which is deified, to do everything in their place, and to remedy all their mistakes. It gives a human being, though powerful, a power he does not have. When talking about the Central Banks, it seems to assist to what in the classical world was the practice of prediction: they gutted animals to examine its bowels and foresee if there will be a happy harvest or not. They take the public statements, the exact words, the labial, and they tear them apart in the same way. Because we are not able to understand – or at least we do not consider it to be – and abdicate completely to judge whether a market is “investable” or not, we abandon the strategy because we are dedicated to passive tools, abandon our selection because we dedicate ourselves to ETFs. It is a continuous abdication that leads the markets to a sort of socialization of the apparently apparent returns that actually conceals all the risks we have spoken about. It is vital to continually deepen the personal financial culture, focusing on independent sources, sources that do not want to sell anything. But someone who shapes you because your best asset is also his best asset. Unfortunately, the network is a very infamous tool from this point of view, especially social networks. On the net, there are hidden numbers of incredible buffoon. Going online means exposing yourself to many risks.

I want to post a post to talk about a trader that never loses, explaining how a person can publish apparently truthful returns on Facebook, with so many extracts, bargaining results that are actually totally fake, relying on a very banal trick. So, they pretend to earn every day, every other day, and people go and fall into the net of these characters. The magic tricks of the web.

So first form a culture from independent sources.

Understand and disclose that there is no guaranteed performance. There is a point in the development of a bubble that is a kind of point of no return. The point where the private interest (or the promoter’s) and the client’s interest begin to diverge because the private knows that investing his client’s money in a certain way is exposing him to a very high risk. But he is probably driven by its own network and its own profitability structure. His remuneration is often directly linked to the volatility of his client’s investment instruments.

Will this be the case even with Mifid II?

It will always be a delicate topic because the individual’s ethics comes into play. Sometimes it is better to try not to kill the cow you are milking. It looks like a very obvious axiom, but there are still people who think that when a cow dies, you can have another right away.

It all comes down to the concept of conscience. As if the key lies there.

But it is there. That’s what makes the difference. Markets are not always the same, they are cyclical, and when difficult times come, the average investor will be either under people who have conscience or under people who have no conscience. In the second case, he will be ruined. There is a need for ethics in this area that has to be developed, but not the usual facial ethics, the real one that leads you to explain to people that reasonably more can not be done, than if you want more than maybe you are not doing the right thing, even though it would make me earn more.

How come our parents knew about these things, with the common sense or just the sense of limit they contain, and we missed them?

Because our society is centered on ego, on individualism and arrogance, on the presumption of knowing everything. Arrogance has a mathematical formula, EGO / KNOWLEDGE, the bigger the ego, and the smaller the knowledge in a field of life, the greater the arrogance. And in the financial sector arrogance leads to great losses, to ruin, to disasters.

Basic mechanics of financial bubbles (part 2) ultima modifica: 2017-09-14T12:25:12+00:00 da CP