The More Things Change…

Black Monday 2

“I’ll always remember where I was when…” That’s the beginning to a sentence that is generally reserved for some pretty important occurrences. I don’t remember, I’m not old enough, but I think the first time I ever heard that sentence was people discussing President Kennedy getting shot. Man lands on the moon. Challenger space shuttle blows up. And this week? We’re all discussing (I don’t think reminiscing is quite the right word) where we were, what we were doing when the stock market crashed on “Black Monday.” We’re not just remembering where we were for an event, we’ve coined a name for an entire day around this one.

And it really is a pretty deserving day. The Dow was down 22.61%. That’s almost a quarter of its value! Today, October 19, 2017, the Dow Jones Industrial Average closed at 23,164 and change. To match Black Monday, the Dow would need to lose almost 5,100 points tomorrow. It wouldn’t be a Monday, but that’s not really the point. Imagine how lousy your weekend would be if it started Saturday with the Dow Jones Industrial Average at a little over 18,000. And when it happened on a Monday, people had to go back to work the next day!

I was not yet a full time trader, but I was close. It was just over a month later that I began trading futures in the Gold pit on the Commodity Exchange (COMEX). I sold all my stocks shortly before the crash in order to have liquid assets to begin my trading career. Many a trader has uttered the phrase, “Better lucky than smart.” I’m one of them. And so as a bit of a shock to my young, enthusiastic, and of course optimistic self, I watched the major index that people at the time used as a large measure of their worth, erase almost a quarter of its value. Yes, I remember where I was when…

But what does that have to do with today? Can’t happen again. After all, in percentage terms, that day was a 76% larger loser than the beginning of the even more famous Crash of 1929. It is easy to argue that one was actually worse, because though the Dow “only” lost 12.82% in a day back in 1929, it lost another 11.73% the next day. If it had happened in just one day? It would have been just over 23%. And this actually brings me to the point.

I watched and listened today as the anniversary was discussed. The overwhelming sentiment seemed to be it’s an “outlier,” a statical anomaly. After all, the next worst day wasn’t even close. Remember? Over 22% vs. under 12%. This is one of those occurrences that you just happened to be alive for…statistically speaking. Chances are actually that multiple generations in your family won’t see such a day. At least that’s what statistics tell us. Even Introduction to Statistics covers this much. In an earlier blog I brought up the supposed unlikelihood of a 6 sigma move, or 6 standard deviations from the mean. And I’ve brought up Black Swans. But Black Monday was a move of more than 20 Standard Deviations! I can’t even imagine how many decimal places that is.

On top of that enormity of the event, we’ve got all sorts of circuit breakers. What could happen? We’ve made it so much harder to melt down than melt up (Yes, “melt-ups” happen…do we need to go into bitcoin and ethereum again?). But we had mechanisms in place back then to insure that you wouldn’t lose 25% of your money in one day. In fact, that’s what it was called at the time, “Portfolio Insurance.” It was the idea of buying options as ‘insurance’ against a big move against you in the overall market. Didn’t help most people.

And it wasn’t all that long ago we had the “flash crash.” Also previously covered. And now we’ve put in place systems to, hopefully, stop that from happening again. Unfortunately to me, this sounds much like crime or computer viruses. We always play catch-up. Not intentionally. We’re naturally a step behind. Successful criminals exploit flaws in the legal system, or some other system, to act in ways that were never anticipated. That’s why they’re successful. They think in ways we previously hadn’t. Unfortunately, we’ve found this to be the playbook of terrorists as well.

And so it is in the markets. We react. Something happens and we plug the “hole.” Like the proverbial finger trying to stop a leak in the dike. Another one opens. Think back to the recent “Great Recession.” Those evil bankers invented products that were destined to fail and they did. However!…and this is important…it’s difficult to contend that what they did was illegal, outside of fiduciary duty anyway. What they did was their job, or at least as they perceived it. We can discuss the problem with that on a moral basis, but in the end, their job was to make money without breaking the law. And after they did, we made some new laws. Same thing a couple of years later. Flash crash. High frequency trading. Etcetera. A group exploits the system as it’s built, and then we change the system.

I don’t know what we’re going to blame the next time. Maybe it’s ETF’s. There’s a nice false sense of security. Or cryptocurrencies, once we’re all “lucky” enough to have easy access. Maybe a cryptocurrency ETF and then we can make 2 new sets of rules. But something will happen.

While I don’t mean to be repetitive, I do realize that the theme of this blog in ways is very similar some previous ones. But that is kind of the point. Certain things in markets need to be reinforced. Over and over and over again. Mistakes that you promise to only make once, until you make the same one again. If you’re lucky, the second time will be the last. More often, we do it at least once or twice more than that.

When I teach, the most important thing I ever ask anyone to learn is the importance of discipline. In my 10 rules of trading, Discipline ranks #1; and Remember Rule # 1 rounds out the list. And the discipline we need in trading and investing is to never get too comfortable. Because it’s not just those who forget history that are doomed to repeat it. In markets, there’s always another shock of some sort coming. And then we get to make new rules again. And so on…

I’ve Seen This Movie Before

Déjà vu: the strange feeling that in some way you have already experienced what is happening now [Cambridge Dictionary]. It’s the feeling I had when I read that London’s transport authority would not renew Uber’s license to operate in the city. Transport for London (TfL) gave reasonable justification for the decision, but I couldn’t help thinking that there was more behind it than this. And that’s why I had the déjà vu feeling. Because when situations like this arise, when a new business is stopped from changing an industry, there are always reasonable explanations…and then there are the conspiracy theories. Personally, I love a good conspiracy theory, so let’s explore this one…in the name of business and finance, of course.

When the decision was handed down, it was after Uber’s request for discussions with TfL had been turned down. It was in spite of the hundreds of thousands of signatures on petitions. It was in spite of the many cities that had not crumbled under the weight of irresponsible drivers once the firm settled in. So it would “appear” (here’s that conspiracy stuff starting…) that the TfL was not necessarily concerned with solving the problems, for in the eyes of the city government, Uber itself is the problem, not the specifics pointed to publicly.

There is of course reason for concern. The traditional taxi business will suffer with the addition of Uber to any city. And when we say ‘traditional’ we mean decades of relationships between owners, drivers, and government. And then the new kid comes to town, supposedly acting as a bully until there’s nothing left of the old guard. A bit dramatic? Probably. Entirely off base? I’m not so sure.

I’m from New York. We have a lot of taxis. And those taxis have always had to have a ‘medallion’ to operate within the city limits. The medallion is something like a liquor license. You need a liquor license to serve alcohol at a restaurant. Otherwise, it’s BYO – Bring Your Own. And the liquor license value is determined by demand. Demand that is fueled by people that enjoy being served a drink in a restaurant from the bar, not their own brown bag. So when times are good, liquor licenses go up in value.

A taxi medallion was similar in many ways. There is a limited amount. You had to have one to transport the general public. And New York city kept getting more crowded, and except for an occasional set back, has been doing steadily better financially since Jimmy Carter’s tour of the burned out South Bronx 4 decades ago. And the medallion prices went up, and up.

medallion prices 2004 to 2014

Over a million dollars in 2014. Currently, a New York City Taxi Medallion trades around $250,000. 75% discount; like a going out of business sale…hmmmmm. And with the price cratering, there is as always a reverberation. Like other businesses or investments in hard assets, an entire segment of the loan industry in New York centers around medallion loans. And as with the mortgage banks when real estate values tanked, the banks in the business of making loans for medallion purchases are feeling the pain too.

medallion defaults

When Uber hit New York, there were cries about the safety of riders and the safety of pedestrians. These cries were mostly from the taxi industry, for as any New Yorker will tell you, there wasn’t a great deal of confidence in passenger and pedestrian safety the way yellow taxis are driven in New York. And as for killing an industry, the newest incarnation has its own competition, Lyft. Lyft is growing, partially due to Uber’s own missteps, but also because that is capitalism. New ways are found to do things, an industry changes, and competition helps these changes create the newest mature version of that industry. Few politicians in New York are currently arguing that Uber and Lyft have ruined our quality of life and endangered our safety. But they’re saying things like this in London…

I do understand this fight. I have definitely seen this movie before. I was a commodity futures trader screaming and yelling in trading pits in what we believed to be the most efficient path to true price discovery. And then the machines came in to take over. Many claimed that there was no way a market could effectively trade only on computer. The computer didn’t ‘understand’ the markets the way a broker did. And there would be lots of technological problems that would doom investor confidence. But the only ones truly yelling that the future was bleak if trading was computer based were the people whose livelihood was in jeopardy. I took the opportunity to learn to develop trading systems. Pro-active is I’ve found, much more effective…or in more common terms, “the best defense is a good offense.”

Exchange members looked for ways to fight it. But this was evolution. This was progress. And in the end, progress always wins. And those who fight it the hardest rather than accept it and find a way to work within the new order are the ones that will indeed suffer the most. And their backers are often called out for standing in the way of actually improving our daily lives. The little things. An easier way to get a ride when you need it. From where you want to where you want. Get in the way of those advances as a politician or exchange governor, and you may find yourself the one paying the price.

Uber will drive again in London. And Lyft is now looking at London as a future destination as the firm seeks expansion outside the United States. Technology has streamlined the way we hire a ride. It didn’t end up hurting more people in New York and I don’t anticipate it will in London. Or in the next city that gets a service like Uber. It’s a better mousetrap. Better mousetraps should be encouraged. It’s been said that every act of creation is at the same time an act of destruction on some level. But like trading, as long as that risk/reward balance is favorable, progress will win every time. That’s why it’s called Progress.