The Irrational Investor


The Irrational Investor


Giffen Goods, Tulips and Bears Oh My!

By Douglas Borthwick & Frank T. Troise

We were both fortunate to go to some of the more prestigious undergraduate and graduate universities in the world.  We both had a focus in Economics and Finance and somehow managed to graduate.

Underlying that education were some basic assumptions:

·         The risk free rate

·         The role of a fiduciary

·         Free markets

Yet, as we look at today’s market, and the factors underlying it, we have come to realize that viewing the markets through the lens of a rational investor today, is in fact, the least rational thing to do.  This market is being driven by central bank policies that make a mockery of valuation, pricing, and exit strategies.

A few decades ago we held a belief that equity markets in developed market economies rose and fell in accordance with company profits and earnings.  The stock market was looked on as a separate entity from the economy. It could rise when the economy fell and vice versa. Today the stock market is seen as a proxy for economic growth. A higher equity market is highlighted as a sign of economic strength.

This conclusion harkens back to some of the basics of what we were taught regarding valuation and pricing.  An equity’s price is, or should be, a function of its underlying cash flows (earnings/dividends), and some “goodwill” thrown in for added measure.  Valuation was discounted using the risk free rate, which is/was a government interest rate determined by the free market.

This couldn’t be further from the truth today. Today’s higher equity prices come as a direct result of corporate buy backs and extremely low interest rates that are not set by the market, but rather forced lower by Central Banks as they nationalize their relative Sovereign, Mortgage and Corporate Fixed Income markets through quantitative easing.

These lowered interest rates serve two purposes.  They increase the Net Present Value of equities as the discount rate is adjusted lower, and they encourage companies with listed equities to issue bonds at low rates in order to buy their own stock back in the market.

In the old days, bonds rose when stocks fell.  Bonds rose as Central Banks cut rates to stimulate the economy.  The slowing economy would have been evident in a lower stock market.  In times of expansion, portfolios would be overweight equities relative to fixed income. In times of contraction, equities would be underweight relative to fixed income. 

These days it is best to be overweight both equities and bonds… With the crowded popular notion that Central Banks will not step away from quantitative easing because the consequence would be economic contraction. It sounds like the Central Bank mandate has shifted from employment and inflation to keeping equities bid… Otherwise known as the FED Put.

This creates a unique fiduciary dilemma.  Using some very basic math, one could easily rationalize that the DJIA today should be somewhere between 24,000 to 28,000 (depending on what equity return assumption you use in 2007/2008 and then project that forward).  As the world’s pensioners calculated their financial plan in the midst of the Great Recession, their savings were slowly and methodically whittled away.  What is their option today?  They have no choice but to follow the central banks, and double down on risk.

How does Wall Street reconcile to that?  It doesn’t and it fights strongly to have the fiduciary standard removed from its responsibility.  This simple irony is at the core of the pension dilemma facing the world today as individuals and sovereigns realize their financial shortfall(s).

Rather than pontificate on the merits of what we learned at school, we have decided to change our perspective to that of the irrational investor.  What would we do if we had no education, no valuation expertise, no fiduciary responsibility to anyone, and simply succumbed to the tulip mania we are all seeing today?

We are confident in our assumption that current markets show similarities to the Tulip heights of March of 1637, will be met with doubt by many in the investing community.  However we believe we are merely stating what most investment professionals already acknowledge behind closed doors.

We believe that what we are witnessing across global markets is the manifestation of what Scottish economist Sir Robert Giffen aptly described in the late 1800’s as “Giffen Goods”.  The definition of a Giffen good is here:

A Giffen good is a good for which demand increases as the price increases, and falls when the price decreases. A Giffen good has an upward-sloping demand curve, which is contrary to the fundamental law of demand which states that quantity demanded for a product falls as the price increases, resulting in a downward slope for the demand curve. A Giffen good is typically an inferior product that does not have easily available substitutes, as a result of which the income effect dominates the substitution effect.


Could we categorize Sovereign Debt as Giffen goods?

There are nowadays so few AAA rated Sovereign debt instruments that their lack of substitutes, in combination with quantitative easing has resulted in them being well overpriced relative to where they would be in a regular free market.

What should we do to become irrational?  To be a successful irrational investor is a process that involves several steps:

Step #1: Forget prudent man/fiduciary protocol.  To become a successful irrational investor, one must renege on any common-sense you initially portrayed to clients.  That won’t work today.  Abdicate any responsibility to your clients and, if possible, have them indemnify you for any of your future decisions.  Of note the recent lobbying efforts by Wall Street to Treasury/DOL on any fiduciary definition/responsibility.

Step #2Hit the pain point: Baby Boomers.  Their retirement expectations are bankrupt and are only now beginning to see the dilemma they are in.  Once they have given you a free legal pass to their portfolios, you can double down.  Why?  They are already so far behind the retirement curve they are desperate.  If they ask for traditional MPT/efficient market logic, then pass on them as client accounts.  Mathematically you cannot win that battle.

Step #3: Forgot about valuation/pricing.  This is all about momentum.  There is no true “risk free rate” today underpinning any valuation/pricing analysis.  Throw that out.  It is all central bank driven and governments are buying everything.  What’s another way to look at valuation?  The central banks are nationalizing the debt and equity markets.  What does this mean for passive investing?  It is the cheapest way for you to rationally implement an irrational investment strategy. 

Step #4: Forget about true labor growth.  While it may look like there are jobs, the underlying numbers are BAD.  No real productivity growth since WWII and wage growth that barely keeps up with inflation.  Remember, technology is deflationary.  Uber has driverless cars; do you really think you are safe?

Step #5: Go Russia/China. Why? Everyone else is building walls and going isolationist/nationalist.  Who benefits the most?  Russia and China.  Stable governments execute trade deals, and the rest of the “modern” world has forgotten this.  Look no further than the oil in Africa deals both Russia and China have negotiated.

Step #6: Go infrastructure.  The USA has so far decided to forego negative rates.  Instead, they appear ready to issue more debt to build infrastructure.  Whether to build a wall, new roads or new bridges, significant infrastructure spend is coming to the US.

Finally, while we wrote this post as a tongue-in-cheek exercise, we found ourselves nervously laughing.  Why?  We both have young children and our kids are beginning to understand the world’s problems in their social studies classes.  But who cares?  Our children will commit us to a Florida retirement community and pay for our health care as we watch the rising waters from global warming approach our beachfront condominiums.


About the Authors

Doug Borthwick is a Managing Director and the Head of Foreign Exchange at Chapledaine FX, a Tullet Prebon Company.  Mr. Borthwick has served as the Managing Director of Chapdelaine FX, a division of Tullett Prebon since its inception in October, 2012. His business serves institutional investors and global financial institutions, providing electronic and voice enabled trade execution in foreign exchange; combined with market moving commentary.

Douglas was formerly a Managing Director and the Head of Research and Trading at Faros Trading LLC. He spent 10 years with Morgan Stanley in New York and London managing the Asian NDF and the G20 deliverable forwards desks. Douglas also ran Proprietary Trading with Merrill Lynch and ran the Latin American FX trading desk at Standard Chartered Bank. Douglas was a member of Institutional Investor ranked teams in both US and Latin American Economics at Lehman Brothers.

Douglas is regularly interviewed on Bloomberg, CNBC and the WSJ, with his opinions often sought by institutional investors.  Douglas holds a BS in Economics from Carnegie Mellon University and an MBA from Yale's School of Management.


Frank T. Troise is a Managing Director and the Head of Digital Distribution and Communications (Asia) for Leonteq Securities (Singapore) Pte. Ltd. (member of the Leonteq AG group SIX: LEON).  He is responsible for digital distribution and communications across Asia for Leonteq’s three main businesses in Asia: Structured Solutions, Platform Partners, and Pension Solutions. 



The information presented in this article/post is provided “as-is” with no warranties, and confers no rights.  The information contained, and any opinions or views expressed, in this article/post are not intended to be, and do not constitute, investment research, recommendation or advice on any securities, investment products and/or instrument or to participate in any particular investment strategy.  This article/post has not been reviewed by, and does not reflect or represent the opinions or views of, Chapledaine FX, Tullet Prebon, or Leonteq.  Unless expressly stated, it is or represents solely the opinions or views of the author(s).


A FinTech Parable


A FinTech Parable

My daughter (14) asked me the other day: “Dad, what is Fintech?”

I struggled for a second as I pondered the best way to encapsulate the Fintech phenomenon, and then it hit me:

Forrest Gump.

“Fintech is like a box of chocolates sweetheart.  Each new company is a different flavor.  Payments are milk chocolate, robo-advice is dark chocolate, trading is white chocolate, and so on.  People in Fintech spend a LOT of time debating whose chocolate is better, but they are missing the bigger point.”

“What’s that?” she replied

“The price of sugar.  At the end of the day it all boils down to that”

“Who controls the sugar?”

“The banks.  That’s why they have to be there”

“But, you are missing one thing Dad,” she noted

“What’s that kiddo?”

“Who owns the box?”

“That’s easy.  That’s China”

“Sounds to me that’s who your friends in Fintech need to make friends with,” and with that she was done.


The Insolvency of Robo-Advice


The Insolvency of Robo-Advice

Stockholm syndrome: A psychological phenomenon described in 1973 in which hostages express empathy and sympathy and have positive feelings towards their captors, sometimes to the point of defending and identifying with the captors.

It’s an age old question:  “How much should I have in stocks?”

An equally old trick to answer it was to reply with the following:

“100 minus your age is how much you should have in stocks.”

So if you were 60 years old, you should have 40% in stocks.

It’s a pretty simple quick-fix to address a rather complex portfolio optimization problem.  It is also actually quite accurate.

The PhDs reading this post this might be frustrated, but this quick fix (100 minus your age) will be more than mathematically sufficient.

Why?  Because there is a larger inherent mathematical irony that no one wants to talk about:  8% returns may be gone forever.  Warren Buffett has said this at many Berkshire Hathaway annual meetings, and McKinsey just highlighted this in their latest paper (Click here to read it).

What McKinsey has said is that decades of actuarial tables used in calculating what a fiduciary/prudent man would do when investing are now no longer viable.  Previously used 8% US stock returns may now be between 4.00%-6.50%.  US bond yields, previously assumed at 5.00%, may now be between 0.00% to 2.00%.

That’s a significant change of expectations.  Let me give you an example from another perspective.

Several years ago, I did a segment on CNBC (click here to see it) wherein I showed that the Dow Jones Industrial Average would need to be over 23,000 for pensioners to break even.  That was several years ago…look at the DJIA now.  Are we even close?

How did I arrive at this?  I took the market levels (high and low) from 2007 and extrapolated them out using an 8% equity return.

That is what everyone did with their financial planner/broker/wealth advisor then in 2007.  Obviously the math did not work, nor did the markets cooperate.

And what have we done today?

We have programmed the robo-advisors to do the same calculation.  The robos are using the exact same actuarial tables with the same expected market returns.

What does that mean for pensioners?  By default, they will allocate a large portion of their portfolio (remember, it is 100 minus your age) to very low yielding bonds.  The remainder will be in low return equities.

These are the same low yielding bonds that almost guarantee they cannot live on their pension distributions. Simply put, the interest rates are too low and they will spend their retirement faster than they expected.

Yet the robo-advisor will calmly and accurately drive them to that outcome.  And, they will do it for very low fees.

So the pensioner, will slowly and methodically be driven to insolvency.

The young millennials get hit twice.  One, by the actual lower market returns achieved, and two as society taxes them more, and saddles them with more debt, to make up for the pension shortfalls.

What should the robo-advisor do, or have done?  It should tell its users to save more, work longer, and cut costs.

But, which robo-advisor tells you to not invest?

One last question for you to solve as you consider the above: What do you think the quick answer should be now?  Is it “100 minus your age?” or is it something lower? Maybe 70?  Let me know what you calculate.

In the interim, we can watch the robo-advisors economically and efficiently drive the pensioners in our global society to almost certain insolvency.





The Fin-Tech Fallacy


The Fin-Tech Fallacy

You call it procrastination? I call it thinking
Aaron Sorkin

As the public markets trade sideways, investors have worked themselves into a frenzy over “FinTech”. The FinTech assumption is that financial institutions are absolutely incapable of innovation, and are being mercilessly out-maneuvered by young innovators and disruptors.

Or are they?

Let me challenge the current euphoria, and use the innovators own material as a basis for comparison.

Case in point: original thinking.

TED talks recently had a fantastic talk about “The surprising habits of original thinkers” by Adam Grant. The link to it can be found by clicking here or below:

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In it, Grant highlights three key facets to original thinking and “Originals”:

  1. They procrastinate
  2. They feel fear and doubt
  3. They have lots of bad ideas


Let’s look at this via a well-known example. Apple launched a unique GUI with the first Mac. Great product. Great advertising. Great buzz. But no commercial viability.

Microsoft watched and carefully followed Grant’s paradigm of original thinking. From that came Windows and Bill Gates ...the wealthiest man in the world.

As Grant says: “Different and Better”.

Who learned from that? Steve Jobs.

The next time, Jobs applied his creativity differently, pragmatically and ultimately succeeded. Look no further than Apple’s market capitalization today.

As we look at FinTech, and overlay original thinking, the fallacy lay in several key themes:

  1. Are any of the technologies truly unique?
  2. Is there any viable path to profitability?
  3. Does it have the balance sheet to withstand regulatory scrutiny?


Or, is the FinTech reality one simple truth: lower prices/costs.
Challenge me. Take a hard look at each FinTech vertical: Peer-to-peer, crowdfunding, robo-advice, block chain, etc. Show me one that negates the three themes that I have highlighted.
Or, is the FinTech reality about cheap human capital, iterating in isolation, whilst the financial institutions wait, and then do something different and better?

…I think you know the answer.

In the weeks and months ahead, I look forward to sharing with you the success stories of the improvers as they simply make things different and better.


Frank Troise is one of South East Asia's leading voices on FinTech. He is a Managing Director and Head of Digital Distribution (Asia) for Leonteq (SWX: LEON)  He is an active advisor to many of Asia’s leading financial firms, management consulting firms, technology companies, venture capital funds, hedge funds, and start-ups. 




Nyquil Market Musings


Nyquil Market Musings

Been fighting a nasty cold this past week, so forgive the quick bullets. But here’s what’s resonated with me these past few weeks (watch my latest CNBC appearance):

  • China stated lower growth, US stated higher rates…why is anyone surprised about the market’s reaction?
  • Oil at these levels is historically stimulative…where’s the bid (or demand)?  With a "2" handle it gets interesting.
  • Nastiest FinTech quote of the week: “Robo-advisors are “SaS” models…Should ‘a Sold”. Ouch.
  • Harvard 5-year case study in the making on reserve management: Buy treasuries when yields are high and when your currency is strong. Sell treasuries when yields are lower and your currency is weaker. Then watch everyone vilify you. Who we talking about? China.
  • Another funny quote: “Why don’t we hear anymore buzz and PR about P2P debt?”…”Maybe ‘cause they are making money…
  • The Standard Oil Trade of the Month: Buy Fracker High Yield. Who is buying? PE. Who is the $$ behind the PE? You guessed it. Classic JD Rockefeller playbook. My production costs are lower than yours…
  • Compare China to Canada, South Africa, Japan, and Australia. Who really devalued?
  • Amazing watching Japan preaching to China about capital controls.
  • Low oil targeted three problems: Iran, Putin, and alternative energy. When does Putin get upset? When the dollar weakens. Watch for him to wake up soon...
  • Are we nervous now? No.
  • Get bullish folks. Want to play? Buy FANG (Facebook, Apple/Amazon, Netflix, Google)
  • The set it and forget it trade? Buy Alibaba and sell any bank leveraged to the teeth

…Back to my Nyquil. Nite!


Frank Troise is one of South East Asia's leading voices on FinTech. He is an active advisor to many of Asia’s leading financial firms, start-ups and technology firms. 

Mr. Troise has over twenty years of experience managing multi-billion dollar portfolios for corporations, endowments, foundations, and high net worth individuals.

Mr. Troise’s research, work op-eds, and career have been published in The Economist, Institutional Investor, The Wall Street Journal, Barrons, The Sacramento Bee, The Pacific Coast Business Times, Noozhawk, Derivatives Weekly, Pension & Investments, and Investment News. His investment letter has over 12,000 accredited readers and he is a frequent commentator on CNBC in the USA and Asia regarding market strategy for Squawk on the Street, The New Retirement Series, Power Lunch, Capital Connection, and Street Signs.

He is married, has two young children and relocated with his family to Singapore. He is extending his family office experience to South East Asian families. He is originally from New York and remains a devoted (frustrated) Yankees fan. He has an MBA in Finance from New York University and a B.S. in Managerial Economics from Carnegie Mellon University.