Ignorance is Bliss

"Ignorance is bliss. I wish I still had some."  - Adam Pascal

Sometimes while I am reading economic reports over a quiet lunch the chatter of happily ignorant people reaches me and I have to wonder what it must be like to go through life with the ignorant belief that someone, somewhere, the "theys" of modern society (I still have no idea who "they" are but apparently "they" are always looking out for everyone's best interest and will come to the rescue in our hours of need), is looking out for our well being.  There is no need to plan for retirement or worry about any future market turmoil as it will all work itself out and that magically, when it comes time to retire, the nest egg will suddenly lay itself and will produce a smooth 8% year over year return that will more than satisfy their needs.

As I am sitting at my table surrounded by economic inputs showing increasingly poor numbers that the Federal Reserve believes can be rectified with ever more debt, it is completely clear to me that this bubble that the majority of people live in will soon be popped.  Not that I am predicting a popping tomorrow or even next week as that would be absurd to place a date or time on something that is unknown but with every fiber of my body and with more than 30 years of experience under my belt it is crystal clear that the policies followed by the central bankers of the world are leading us to a bitter end.

Some of the numbers that I look at show company GAAP earnings falling more than 8% year over year while GDP growth declined 0.7% in the first quarter.  Furthermore US corporate revenues are declining while price to earnings ratios reach levels not attained outside of 1929, 2000 and 2007.  The stock bulls believe that everything will once again return to growth magically in the second half of the year but there is little evidence to show that their expectations will be met.  In the meantime citizens live like turkeys, ignorant that Thanksgiving is around the corner.

So for those of us who have lost our ignorance virginity the solution is to minimize risk or, better still, become antifragile.  In his book "Antifragile", Nassim Taleb describes that in order to benefit from the expected collapse that one's portfolio needs to be convex.  A convex portfolio has limited losses but large profits which is contrary to the current state of the market where there is minimal upside or profits with the potential for large losses, in other words concave results.  The way to detect whether your portfolio is concave or convex is to determine the acceleration of harm (or benefit).  This is critically important and will determine whether you should remain in an investment or exit.

Now not everyone is a statistical genius as he is but we can all run some simple models that can extrapolate results.  These results may not even be accurate but, assuming that you have done a half way decent job of capturing the larger variables, then changing the inputs will quickly show you whether your investment is convex or concave.  As an example if the Federal Reserve has added (which they have) $4 trillion dollars and the result is a mediocre increase in GDP then adding more debt should show limited returns.  This is called the utility function in economics where every additional dollar has less of an impact.  However, if interest rates spike then the downside to this investment is huge.  So limited upside but massive downside is a seriously concave investment and is being replicated throughout the world by all of the central bankers.  In essence they have created the mother of all concave investments.

Hopefully you have a chance to take a good rational look at your investment portfolio and ensure that it is smiling rather than frowning and if it is not then take this time to turn that frown around so that you are not let down when everything else is.  Make sense of that last sentence if you can but I am sorry to say that if you have read this far then you too have lost your ignorance so it is now time to spring into action!