Subtle part of the Kelly Criterion:

Sharpe goes up as fraction of Kelly goes down, especially from .5 -> 1 Kelly.

You should want a margin of safety on never going above .5. Which is an argument to aim for most like .25 Kelly. It's impossible to put a hard number on what the true Kelly size is. Edges on bets are not fully known. So is downside risk. Correlations between bets isn't even that clear. And all of this constantly changes.

In the outcome that $NVDA:

A: Stays dominant in AI hardware, it's going to beat $TSM a fair bit.

B: Stops being dominant in AI hardware, it's going to drop a lot. Plus, $TSM will benefit from even larger volumes of hardware spend.

$TSM seems the much better risk:reward. The tail risk with $TSM is China invades Taiwan. But after studying modern submarine tech, I'm convinced that's very unlikely. And over time, $TSM is going to bring more of its capacity to the USA reducing that risk.

I'm seeing many posts calling an ai peak, or pointing out near record high positioning in semiconductor stocks.

I'm in the camp that this is more like 1995. The ai show hasn't even gotten started. AI is not a fad, and the great white-collar displacement hasn't even really begun yet. And that is going to happen.

I think it cannot come soon enough. We can once again make real progress in the physical world.

A few guys I know already do pretty well beating the market.

If they'd just take on a fair bit of leverage, they'd be absolutely killing the market instead.

https://twitter.com/walt373/status/1941969351822717421

This is the key way to use leverage well. If you're only 40% gross long - both in terms of beta adjusted and the raw gross - then you're so unlikely to drawdown even as much as the market generally during a meltdown. Never mind having a crazy blowup. The only way that's really even possible is concentration, which also does not mix with leverage.

"Stress-test at 100 % correlation: Size gross leverage so the portfolio survives if every sleeve gaps down together. (I aim for <–30 % projected drawdown at 100% correlation).

Eight people asked me for my thoughts on the market setup in the last couple of days, and normally that's rare/intermittent.

I'm not sure what that's a tell of by itself. I'm a short seller first and foremost, so I guess people are finding it hard to be bullish the market? Which seems like a bullish signal at least short term.

My thoughts on the market: Maybe we get a recession maybe not, hard to say, nobody knows. And this trade war stuff essentially worked out well in the end, which people still seem in denial about. But far more important than either of those is AI. Focus on AI. I think this is 1997. The main thing I can be sure of: AI is going to kill most knowledge jobs - lawyers, programmers, doctors, etc. It's going to kill drivers. It might even kill plumbers and electricians - at least the simpler jobs - as people can use the AI to easily do their own work? I used AI for interior design and that seemed to work great - I bet it refined my setup more than all but the high-end interior designers.

AI will be way cheaper and way better than humans.

People still seem in denial about AI or at least are underappreciating it. I still read comments once in a while that AI isn't really AI at all, that it's just a glorified search engine, etc. Which means AI has a long way to go up.

AI is going to lower everyone's costs/barriers to starting a business. But it's also going to put lots of people out of work. It should be very deflationary. But that's tricky too given the world's fiscal situation.

First chart are start dates of speculative rallies. These have always been tough periods for me.

Second chart are the results of my hedge fund partition. Around -3.5 Sharpe including the .7% I lost today.
From my Q3 2023 hedge fund letter,

Autocorrelation

Militia runs with two key factor mismatches. We’re long low to medium volatile companies, and short very volatile ones. We’re long profitable businesses and short cash incinerators. This causes the autocorrelation.

There are stretches where volatile, cash burning companies trade up far more than the market as a basket. Sometimes these moves are explosive which isn’t worrying. If anything, I might get more bearish after a rapid blow off top in junky stocks. That’s often the point of peak madness, a fine time to try pressing short bets. The problem is when bad companies are persistently strong, like from May through July 2023.

There are many possible causes of sustained flows into junky stocks. A couple examples,

* A new, big technology is coming out. Charlatan management of the worst companies will reliably lean into the hype. Like AI this year.

* Too much government stimulus, causing easy money to flow into speculative investments. Like during Covid.

* Junky stocks sold too hard, too fast and are more likely to rebound for a while

Should have less focus on the dollar and more focus on winners and losers relative to the dollar.

Stronger MXN seems obvious
Weaker EUR seems quite likely
Stronger JPN less clear than before, but probably yes
No clue on INR, will avoid since I can't play their stocks anyway. US stocks are screaming that bears are wrong. Flat since the tariff shock and major world reorientation began.

US stocks got a boost from the weak dollar, adjusting for that it's still basically down 5-10%, but still that's no crisis.

What happens if/when countries agree to reorient against China? Zooming out, most would say that is good news for stocks long term. And like I pointed out in a post yesterday, a 1-2 year pain period that the market knows is temporary doesn't really matter at all. Once other countries agree, there's less uncertainty than covid even.

Stop lying to yourself about investment time horizons.

If your basket of 7 stocks (factors) underperforms over 3 years, it almost certainly means you need to change.

After 3 years of underperformance your edge is thin at best, but most likely negative. Instead of using time horizons as an excuse - a dark, ego protecting road - spend time tearing down every individual stock you own. One by one. There are problems in at least some of them.

Most sellers have to accept credit cards to keep their business competitive and they increase prices slightly as a result.

People who don't buy using credit cards with a kick back lose.

The well to do with fancy cards benefit.

The key cause of this is forcing sellers to state/display that people paying cash or debit get a discount. Instead, sellers should be allowed to quietly do this. Sellers should be allowed to do what they want. Credit card buyers for sure change their behavior based on being charged more for using a credit card, even if the difference is slight. That's just human psychology.

Serious questions to think through:

Why does this insane speculative market environment ever have to end? The one where narrow stock bubbles rapidly expand to historic extremes. A electric helicopter concept company being valued at $10 billion, Fart Coin being worth billions, or a joke internet token of a joke internet token trades for $30 billion. Or where today a company trades for $200 billion at 100 times revenue and isn't even growing that fast. Or where a company's entire business is owning an asset and trades for 2.5x the value of that asset - for $80 billion.

I started investing in 2018 and this crazy environment is the only one I've invested in. To me it just seems normal. I realized very fast that the shorts telling me things like, "It cannot do X" were wrong when $NIO did what it did.

Like other short sellers, I sure hope it would go back to the good old days. That would sure be nice! But I really don't see why it will. My base case is that this continues indefinitely.

One thing that would end this market environment is a real recession, which we haven't had in 16 years. Before that, we had one in 2000, in 1990 and in 1980. Before that, we used to have recessions often. What's that trend suggest? To me, that's a long enough trend that I'd be stupid to ignore it.

Perhaps the USA has entered such an extreme golden age, with mind boggling economic prosperity, that recessions don't have to happen anymore. It has clearly been trending that way in the numbers, right? That's one case for assuming this is the new normal.

Or, counterpoint, maybe fewer recessions are due to unsustainable fiscal policy that started under Raegan and we're going to have an extreme meltdown when this all ends? Which brings me to my next point:

Another thing that would end this crazy market environment is persistent inflation. For my whole life guys said how inflation was right around the corner due to the USA's reckless fiscal policy, and yet that inflation didn't come. Only after a truly insane policy of wiring people wild amounts of money during covid did we get a brief wave of inflation. But that just isn't strong of evidence that inflation is coming. That was an outlier event. And now with AI soon cutting down the cost of office-oriented work to nil, betting on deflation seems maybe smart. I'm even thinking to get long the damn $TLT lately on that thesis, it's only the large US deficit that makes the bet too hard.

I'll conclude with this thought experiment:

Pretend we are rapidly going to enter a post scarcity world from here. Something like Star Trek's version of the future. So that Joe idiot constantly has tons of credits automatically deposited into his account every month, we never get inflation or a recession again. Just take that as a given.

Do markets ever have to act rationally in that world?

Are markets likely to crazier or less than they are today? I think it's good to think about this in terms of "What is the absolute worst-case scenario for shorts?" And as long as the evidence points towards us heading that direction, just pretend it's true. You can always change your mind fast when core CPI hits 5%+ on seemingly no news or when unemployment actually goes up significantly again. Change your mind AFTER the data gives you a reason to.

(Watanabe)The 25 years you managed the fund coincided with Japan's "lost 30 years." How did you view the Japanese economy during that time?

(Kiyohara)I don’t think it was a "lost 30 years," and I don't understand what was supposedly lost.

If anything was lost, it might have been Japan's semiconductor industry. Beyond that, I don't think there were any sectors that were lost and caused a national loss.

In my opinion, Japan has spent time becoming more reasonable since the major mistakes of the 1980s.

The 1980s were an era with zero governance in listed companies. The interests of minority shareholders were ignored, and each corporate conglomerate engaged in wasteful capital investment battles to save face.

As a result, to repair their damaged balance sheets from deteriorating performance, companies repeatedly issued new shares, continuously eroding the value per share.

In 1990, when the bubble burst, Japan began to walk the right path. (Watanabe)How do you evaluate the changes in corporate governance of Japanese companies?

(Kiyohara)I hold them in high regard. Governance has changed 180 degrees. This is the primary reason I am positive about the Japanese stock market.

Corporate mergers have progressed, wasteful capital investments have been eliminated, and now dividend increases and share buybacks have become the norm.

The Japanese companies and stock market have taken time, but I believe they have become quite impressive compared to the 1980s.

If I were to be even more ambitious and expect something more from Japanese companies, it would be "further corporate integration."

To address the two issues of "declining domestic demand" and "expanding into overseas markets," scale is necessary.

I still think there are too many listed companies. If they want to grow, they need to look abroad, but they can't do that effectively while remaining small.

They need to grow and build a solid framework.

I get the allure of starting an airline. I just came up with one that would use a single shared G550 that flies back and forth daily between NYC and London. These are rough numbers - if anyone knows something here is way off, please correct it:

Nearly 1,000 people fly first or business class from NYC to London daily, and the same number fly the other way. A G550 airplane seats 16 people. Does it pass your smell test that 1.5% of that daily traffic could be interested in sharing a private jet at a good enough price?

A used G550 airplane sells for $10 million. With $2 million down you'd take on a loan for $8 million. Yearly interest would cost $800k.

It costs $40k to make that trip, inclusive of pilots, maintenance, fuel, airport fees, etc. If the plane flew back and forth every day the yearly cost is $30 million.

Could you charge $6.5k/seat? Business class on commercial costs $2.5k for a comparison. At that price, it seems that if people were aware of the option (a tricky point), the plane could largely full most of the time. If on average you filled 12 of the 16 seats, the business would do $156k/day in revenue round trip, which is $57 million of revenue.

Now I'm surely missing quite a few expenses in this analysis. But that gap sure seems big enough to investigate - that'd be a hell of a gamble given you'd only even be putting a few million dollars into an LLC. Also worth mentioning that this specific business idea does not work on most routes - the daily traffic is just too low. And trying to run the strategy on many routes doesn't work because it would be too hard to market many routes at the same time, on the same one airplane.

This seems like a real competitive advantage. $GOOG

Operating income:

$MSFT - $110 billion
$META - $60 billion
$AAPL - $120 billion
$GOOG - $100 billion
$AMZN - $50 billion

= $440 billion and growing

$NVDA revenue - $100 billion annualized. I could easily see those companies investing a third of their operating income into AI hardware, where NVDA capture's the lion's share of the profits. And the tech giant's operating income will probably keep growing from here.

The giants must realize (correctly) that they could be in an existential arms race. If they're wrong, what's really the cost in the grand scheme of things? 18 months of operating income over 5 years? Who cares. Extreme spending here is a complete no brainer. For contrast, Microsoft bought Activision Blizzard for $70 billion. They're going to spend way more than that on AI.

There are other customers, too. And we haven't even seen a wave of large AI IPOs yet - which are coming... right? It's weird they haven't come yet. Remember how big the EV bubble got? Rivian peaked at $150 billion company and Nio $100 billion. Why shouldn't new AI companies be even bigger? Surely people are putting these together - but I guess a company that big takes longer to put the deal together?

$NVDA is 50x earnings today and growing for the foreseeable future. The fact that we're doing valuation in terms of pure earnings, and it's not even at some insane multiple... well I just can't help but think there is more upside.

The super bull case depends on governments / militaries quietly being by far the biggest customer. They could easily spend more than all of the tech giants combined. And this seems more likely than not.

One bear case is that electricity is the bottleneck which slows AI capex. I don't really buy it, though. I expect plants to get built aggressively with endless lobbying and again probably the military pressuring the government, too.

The best bear case that I can come up with is that someone comes up with a competitive product to $NVDA. Which maybe. If anyone has seen a better guess please share:

This thread has a bunch of random points about Japan that I've been stewing on.

Corporate taxes are higher in Japan and Japanese corporations must pay on their global income while US ones do not. Point being, if profits are earned in stronger foreign currencies the yen tax revenue go way up, helping Japan's dire fiscal situation. This gives the government a clear incentive to keep the yen weak.

Japan's fiscal situation is far more dire than the USA's. Their debt:GDP is way higher and unlike the USA, their population is projected to decrease so there will be fewer people to pay it off. This gives another incentive for Japan to have a weaker yen, so that corporate income tax can carry more weight.

The Nikkei is down 14% in 20 days. Another day like this and it's right on the line of being a bear market. Shocking fact: If the Nikkei enters a bear market, it's still up YTD.

There's too much pessimism on multi-family, and $ABR is probably fine a lot of the time. Apartments really didn't overbuild that badly. While some equity is in trouble, and most lost money that bought from 2021, I just don't see a big wave of insolvencies - and that's what $ABR needs to be seriously troubled.

If I could collect the short borrow fee, I'd probably be long. Especially because this one is likely to go up a fair bit during a bad market wide short squeeze. Also, if I had to short, I'd just buy these. And if I were long, I'd buy these, too. This is way too cheap for a binary outcome $ABR:

I had someone translate the first three chapters. What a strong opener:

https://twitter.com/TeddyOkuyama/status/1767120541637632301

Princeton Newport Partners was Ed Thorpe's hedge fund. That's a cool connection:

(1/3) The books that helped me most as an investor:

1. The Righteous Mind - People draw conclusions instantly and justify post hoc.

2. The Scout Mindset - Only the rare person has an open mind, most just join tribal thinking. Be that rare person and identify others like that. (2/3)

3. Boom and Bust - Market bubbles are predictable and most often technology driven. Do not short these growing bubbles until after they're deflating.

4. Dead Companies Walking - Find and short companies that have a $0 price target. Hold to zero, especially for taxes.

Often as I review my Japanese longs, I get real squinty eyed. It's not just one company. It's like all of them.

Why does this trade for 5x earnings? $3288 Better earnings growth than $GOOG or $AAPL for 5x earnings.