Saturday, October 1, 2011

Fighting Confirmation Bias

I have already said (Here) anonymous comments will not be allowed. So don't be surprised when you comment anonymously and it doesn't get published.  People like to remain anonymous to save face in case they are wrong.   

That said, I made an exception today.  Instead of taking this guy behind the woodshed I hope everyone can learn an object lesson from it. 

Anonymous said...

Got to love a guy who thinks "value" is in financials, but think commodity plays are untouchable - it would be laughable if not so pathetic.

Say, how's list of "top 2011 investments" working out? BAC, WFC, GE, GS all hitting it out of the park? Or are they all striking out?.

You proclaimed they were significantly undervalued when they were twice their current value at the beginning of the year - talk about delusional.

Don't quit your day job...


My Observations and Comments

First it is obvious that this guy is long commodities and took exception to my idea that commodity plays are a bad idea. Secondly he insults me. Thirdly none of his comments are fact based. None of those companies were twice their current value, except BAC. 

It is an innate human tendency to ignore facts and evidence that contradict what they "believe" to be true. On the flip side, they run to facts and evidence that confirm what they "believe". This is called confirmation bias.

Fortunately the stock market is full of guys like this who cannot separate their feelings and emotions and thus their thinking is blurred (and they don't even know it). This creates opportunities everyday.  \

If you want to feel the full fury of emotion from investors just write some negative comments about a "popular" company. Similarly write something good about a "unpopular" company and you get scoffed. These people won't debate fact but instead attack your credibility. Fortunately I don't derive my self esteem from what other's think about me. In fact I could care less. 

People who have poor critical thinking will buy a stock and immediately watch the price action to see if other people agree or not. As Warren Buffett has said, "Your neither right or wrong because the crowd argrees with you, your right (or wrong) because your fact and your reasoning is right."

Fact Based Discussion

I could offer pages of facts and reasons why those financials are cheap but you could care less. You would just go back to the comfort of your newspaper that says they are all terrible. Time will tell whether or not they are good investments. Now when PBN goes down 80% in one year and there are good reasons why, don't just stick your head in the sand. 

As for my investments I would love some fact based discussion on why they are terrible investments. With BAC I recently reviewed the putback risk with rep and warranties (again) to see if I could see anything else. I have my estimate of what ultimate cost will be and strongly believe they are more than 50% on the way out. I have also commented recently on why the legal risks with respect to lawsuits will be contained. 

Commodities

As for commodities let me just say this. The S&P/TSX capped energy index (XEG) is nearly retesting 2008/2009 lows. Other material and base metals indexes have seen the floor drop out from underneath them. Is it really just fear? What are people fearful about? Europe?  Something else?

Greece is 2% of eurozone GDP and their debt ($475 billion) really isn't that much in the grand scheme of things. Greece 2 year bonds current sell with a 70% yield. If you own them you've already recorded huge losses. Now if European banks are holding those bonds on their books and not marking them down significantly that is another issue. Ireland has way, way, way, way more debt compared to irish GDP than Greece. Their 2 year bonds were selling with a 23% yield back in July and are now back below in the 8-9% range. The Irish have implemented strong austerity (living below their means). The only other problem is Portugal ($200 billion) as their short term borrowing rates are just below 20%. To make a long story short, Europe will sort this out. 

I don't believe the real story is Europe but China. That is all I will say.  People need to understand the assumptions that underpin their investment ideas. I would strongly recommend staying free and clear of commodities until the dust settles.  Odds are high that Canada will enter a significant recession. Canadian real estate will fall, particularly in Vancouver but also any local region that is highly dependant on commodites.

I hope I am wrong and yesterday Warren Buffett said he does not believe the USA will enter another recession. I sure hope he is right. 

Don't get me wrong, I don't look highly upon macro economic calls. I will not try to predict GDP next month or next year, it's useless. However macro bubbles are a different story and larger trends can be spotted. Always important have your risk radar on high alert. 

Everyone has their own investment thesis and invest accordingly. I'll end with this. If believe in peak oil, world demand for oil is growing, and oil prices are reasonable, I would seriously review your assumptions. Fight your confirmation bias and go on a treasure hunt to look for why oil prices will fall. (The same can be said for base metals and materials)


Best Regards,

Kevin


PS. - I would be willing to make a friendly bet that Warren Buffett bought another billion dollars (or more) of WFC during the third quarter. Any takers?

Disclosure - Long BAC, WFC, GE & GS

3 comments:

  1. Hi Kevin,

    The one thing that worries me about some US financials is if they have gotten into the game of credit default swaps on European debt.

    I don't have all that much concern about issues regarding the mortgages as that situation will sort outself out in the next couple of years and thereafter companies like BAC, Citi and WFC should be very profitable again.

    I just worry if they have screwed themselves into needing to be saved again by the US government.

    Thanks,

    PMREdmonton

    ReplyDelete
  2. Hi PMREdmonton,

    Thanks for the comment.

    If they own CDS's on european debt they should make a lot of money on those positions. If they sold CDS positions on european debt that is a different story. Many of the US financials have laid out their exposure to eurozone debt (gov't vs business/consumer). Overall US financials have minimal exposure.

    Secondly if you look at two year and ten year swap spreads they are quite low. Both of these have historically been quite good at predicting systemic risk and anticipating recessions. Today they are both very low and give no indication of what you are suggesting.

    On your last point about being bailed out by the US government, is interesting. First the government will do it again. I read Henry Paulson's book, On the Brink, regarding the financial panic. I have no doubt they would save them again and likely wouldn't allow a company similar to Lehman Bros to fail. Banks also have mush stronger capital levels thank in 2008. Most of the banks haven't paid much for dividends for three years. Even today WFC and JPM are still not even close to historical payout ratios and could greatly increase dividends. This capital has been accumulating for quite some time and may of the US banks have never been this well capitalized in quite a long time. All of the banks are strongly profitable. Even though BAC has recorded some big losses, the vast majority of this was impairment of goodwill and thus is a non cash charge.

    Regards,
    Kevin

    ReplyDelete
  3. As Warren Buffett has said, "Your neither right or wrong because the crowd argrees with you, your right (or wrong) because your fact and your reasoning is right."

    Warren Buffet did not say this. Ben Graham wrote this in The Intelligent Investor. Time for a re-reading...

    :P

    ReplyDelete