George Soros - Reflexivity Explained
Вставка
- Опубліковано 28 гру 2020
- George Soros is the most famous Macro Hedge Fund Investor. His Theory of General Reflexivity in economics is the theory that a feedback loop exists in which investors' perceptions affect economic fundamentals, which in turn changes investor perception. The theory of reflexivity has its roots in sociology. Soros believes that reflexivity disproves much of mainstream economic theory and should become a major focus of economic research.
New Paradigm for Financial Markets by George Soros: amzn.to/37UCMFH
Radical Uncertainty By John Kay & Mervyn King: amzn.to/3mZm0cE
Plain Bagel on Tesla: • Investor Beware - The ...
Patrick's Books:
Statistics for Traders: amzn.to/3eerLA0
Financial Derivatives For Traders: amzn.to/3cjsyPF
Corporate Finance: amzn.to/3fn3rvC
Patreon Page: / patrickboyleonfinance
Visit our website: www.onfinance.org
Follow Patrick on Twitter Here: / patrickeboyle
Most underrated financial channel
Definitely
Boo!!; Richard Wolff is the financial genius!! Soreass is a 1%prick!
Not everyone can be as popular as TikTok stars who claim you can be a millionaire at 18 through crypto and NFTs.
Actually, Patrik is quite surface level. He knows a lot of separate facts and theories, but often doesn't understand the bigger picture. The ability to remember and regurgitate complex information doesn't correlate to intelligence unfortunately (coincidentally it is the reason why higher education is overrated)
The best thing about Patrick is he is from the hedge fund industry and has some serious practical knowledge of how things work.
I like the blend of quality information and dry humor. Thanks for sharing
Patrick is such a good youtuber. He posts exactly the right videos.
An example of reflexivity is when Google maps shows you two roads one if them has traffic and the other doesn't have it, so you go with the less trafficked road but then everyone else whould assume the same thing and because of that the first one would lose the traffic and the second one will gain it.
I think the simplest example of reflexivity comes from an example you gave on your applied portfolio management classes.
If everyone starts investing in indexes rather than actual stocks, there'd be fewer people investing in the actual companies. That would directly changes the underlying (the stocks that make up the index) and their fundamentals (less capital, more imprecise pricing, etc.) which would, in turn, be reflected on the index. As this repeats indefinetely over time, you have a feedback loop in which, eventually, the index and stock prices are largely disconnected from actual value, thus rendering the index useless as an index (i.e. Goodhart's Law).
If the index, which is supposed to reflect the overall state of the market, becomes a product (in which we invest), than it goes through a fundamental shift. It now reflects investor's convictions and beliefs about the future returns (or lack thereof) offerted by that index.
@@amsalmeron Also the property market example which is in The Alchemy of Finance in the first chapter. As real estate prices begin to get higher (for whatever reason), more people develop real estate. As real estate loans take into account the value of the real estate the increase in prices leads to more money being able to be obtained in a loan. So the prices get bidded up each time the properties are sold.
Maybe your example is actually better explains the feedback. There's just a lot in the theory really. Soros explains in the documentary Soros that he actually traded based on understanding connections in the economy. Later in his career he moved to macroeconomic considerations and in that area he used reflexivity. He had quite a few failures early in his career. And like with Warren Buffett and Peter Lynch value investing and the chart trading of 1910-1990 and price ladder day trading and correlation trading once people start using the technique it becomes less effective.
You know that individual stocks now actually move in sync with the index. It's really irritating.
Index ETFs hold the stocks that comprise the indices. That's how price formation for index ETFs works. So if you invest in an index ETF, you invest into the index companies stocks.
Index futures are a different matter, but nobody invests in futures.
That's a poor example because when you invest in the index, your investing in the underlying stocks, and if the index grows, it must buy more stocks......which is the same as people investing directly into the stocks.
Thanks to our growing list of Patreon Sponsors and Channel Members for supporting the channel. www.patreon.com/PatrickBoyleOnFinance: WIlam, Robertas, Hernan Merino, Random Encounter, Nieuwsbrief Ikwil, Bee Positive Consulting, hyunjung Kim, John Cadena, Ian Tracey, A Smith, Callum McLean, Oscar, Simon Pena, Alexander E F, Cyrus Yari, Ed, Pavle Obradovic, Erik Van Ekelenburg, David O'Connor, Zak Patterson, Ki Ryu Chan, Pjotr Bekkering, Drew, Ivaylo Kunev, Alex, Robert W Proudfoot, EatEmAll, Michael Boensel, pooh shmoo, Robert Muller, Andre Michel, Ivan Iliev, Gopaljee Atulya, Milan Tomic, Mark Hooker, Artem Vasenin, P H, Mathews Sebonego, Sebastian, Michal Lacko, Shamikh Rana, Friday Guy, Marc De Mesel, Augusto Ramos, Soy Boomer Doomer, Bob Slartabartfast, Robert Feiler, Camil Dbouk, Erik Montesinos, Matthew Loos, Az Indragiri, Aman Bali, Lautaro Parada, Pratap, Deborah Joseph, Robin Sung, cab1260, Timothy Baird, Bruce Roberts and Kurt Johnston
Kurt Johnston approves of this message.
Wow, what a valuable concept. Thanks for posting!
Years ago I participated in making a rating system for a video game that expressed "skill" as a single number. We had many difficulties as each iteration of our system performed well when looking back but diverged over time. It turned out those being rated were concurrently adapting to our rating system. Or in other words reflexivity.
By iteration 9 of our system, we discovered that purposefully having a system that was fuzzy and imprecise in some ways gave the most accurate system after factoring in the player's predicted adjustments to our system.
I wonder how many systems in our world use a similar mechanism? I am going to post to our old forums about reflexivity. It seems there is a good chance that was what we were fighting back then.
Teach me
Would you mind expanding upon this? I’m assuming by “skill” you are referring to “how good you are at the game” vs an mmr rating. Am I wrong here?
Was the game you worked on Battlefield?
Tesla. At one point, they were almost bankrupt. Now bankruptcy is no longer an option because they can sell as many new shares or convertible bonds as they need. Also, they can underpay their employees but offer stock options. If they want to make any MAs, then Musk can just start a new hype train and the MAs can be paid in stock and stock options, which will probably inflate the stock price even more. Tesla's equity with its inflated stock price can basically be used as free cash by the company at any time and this process itself can inflate the stock price even more. It's a pretty self-reinforcing process in my opinion.
Tesla is so high because it was shorted so much that its like a completely deflated short bubble. Now nobody wants to short Tesla because it's too risky. It helps that the CEO is a genius, the existing product is excellent, and no one knows when they are going to blow the top of some new market that nobody knew existed yet.
You saying bankruptcy is no longer possible makes me wonder if Elon can snatch defeat from the jaws of victory regarding Tesla
nadamasdisponible Micheal Burry dares to short Tesla
@@djeieakekseki2058now that it's down 30% to 600 he should cover. Probably already has.
nadamasdisponible I think he is waiting even more, but maybe yes.
Brilliantly explained! I’ve never understood Reflexivity until now.
The information you provide in your videos and the topics you cover are outstanding. Thank you so much for making these, and Happy New Years!
Patrick has got an element of class
Totally
Just an element?
He was a fucken hedgies bro, how the fuck you think he got there by being a bun
Why? Because he has a British accent?
thats not a British accent bro@@maddenker
Before offering my own example of reflexivity, let me say that I really like the answer about Volatility Markets by Johnathon.
My example would be ESG-Funds. These are often sold by showing their superior performance over the last years. But this superior performance could be due to increased interest by investors, which drives up stock prices, making this a self-fulfilling prophecy.
Fundamentals are also affected, also only partly by the price impact itself. Mostly the change is a consequence of societal shifts, which is not strictly reflexivity. The increased interest in ESG actually increases demand for their products, banks are under pressure to favor ESG-friendly companies when providing credit, governments are under pressure to subsidize ESG-industries.
ESB is just a number that is tacked on to placate a small group. It actually punishes Tesla and rewards Shell. This type of fad played out before.
@@xrunner55 well I think this is directly in line with it becoming a bubble, albeit a small one. This would be the misconception that goes along with the other positive feedback loop, and once people realize that misconception, or it becomes exposed, then the bubble pops
Good Example of Reflexivity
The Iranian currency, the Rial, has traditionally traded relatively stable against the US Dollar and other major world currencies. Like many currencies in economically developing nations, the Rial (known locally as the Toman, 10 Rial equals 1 Toman), was subject to a relatively high annual inflation rate. Nonetheless there was some form of stability with regards to the exchange rate between the domestic Toman and foreign world currencies. This changed when Trump came to power in the US and left the Nuclear deal (that the Obama administration entered into) and consequently imposed the heaviest economic sanctions ever imposed upon a nation, against the Islamic Republic. This in line with the so called ''maximum pressure'' policy aimed at disrupting and containing Iran. These sanctions made the exchange rate quadruple in less than a 6 month period (first half of 2018). In short: the local currency devalued heavily and we could even say that it was in free-fall for a while, and this lead to all imported goods (if they could be imported at all due to sanctions) to quadruple in price.
The currency devaluation prompted the Iranian public, businesses and government related entities alike (basically the whole market), to buy foreign currency as a hedge against the excessive degree of devaluation, which itself was not precipitated by the printing of money (the general conception of what inflation is) but by economic circumstance. This buying of foreign currency aggravated the devaluation of the Toman which lost even more value. Here we can see one factor precipitating the next and by doing so aggravating the situation. All this amounted to a type of domino effect, where each reaction adds weight to the downward motion in the currency exchange rates, which were well under way by now. All this lead the Toman to collapse further and further to almost a 7th of the original ''stable'' exchange rate over the course of the following years.
In addition to buying foreign currencies and precious metals Iranian market participants also began buying the local stock market frantically. In essence the market was fleeing having ownership of value dominated in Toman. Since Iranian citizens and business entities are prohibited from buying foreign assets due to those very same sanctions, they were left with the sole opportunity of buying Iranian assets. Meanwhile the Iranian economy slowed down tremendously and locally listed companies performed poorly. However due to the devaluating Toman, prices for Iranian shares went hyperbolic. This in part because as the Toman lost value, listed companies and their holdings did not lose value (at least not if they weren't holding local currency) and these shares rose in price as their value is denominated in Toman (the Toman declines in value, and consequently shares increase in price as their value remains relatively unchanged in relation to the declining value of the Toman). Due to the massive influx of capital into the stock market share prices went hyperbolic. As rising prices drew in more buying, this led to the stock market effectively crashing up (this indeed is the only example I know of where the market literally crashed up instead of down), and all this, mind you, whilst the Iranian economy increasingly found itself in a state of decline. More Iranian shares were traded during and after the collapse of the Toman than ever before. As the government was strapped for cash in this economic environment, and share prices were rising government entities sold part of the large holdings of shares they owned, this as these entities were, and probably still are, major shareholders in virtually every Iranian listed company. This provided the market with much needed liquidity as it was crashing up, here again we see the fire being fueled my the conditions the fire itself precipitated.
All in all we can see that during an economic and financial crisis, a stock market valuation bubble emerged, accompanied by increased trading volume (substantiating its validity), all the while whilst the actual fundamentals of the companies listed were deteriorating due to the underlying economic conditions and political outlook. Exactly because of the economic and financial woes (and the specific conditions in which Iran found itself) a thriving stock market was created, culminating in a stock market bubble.
In my example, the collapse of the Toman is a downward self-feeding feedback loop, which in turn created an opposite ''reflex'' upon the stock market which, driving shares prices up hyperbolically and inducing a consequent upward self-feeding feedback loop, or in other words; as the currency became underbought and undervalued, the stock market, as a consequence, became overbought and overvalued. Here the stock market bubble emerged from the currency crisis. Both feedback loops are ''positive'' feedback loops and exacerbate one-another's intensity, even though it is obviously the currency crisis which fueled the stock market bubble, the currency crisis itself being precipitated by economic sanctions.
This situation is currently on-going, and though still volatile, crashing behavior seems to have abated for now. However, valuations of the currency and share prices currently exist in a state of severe disequilibrium. With the corona crisis not contained in Iran, yet Trump (presumably, at the time of writing) leaving office soon, we will see what the future holds for the Islamic Republic. Though for now there does not seem to be light at the end of the tunnel for Iran yet. It could well be that the present situation persists and continues to evolve for years to come. A possibility is of course that the Toman will stabilize and eventually will gain relative ground against other world currencies, if this were to happen we could perhaps see a ''negative'' feedback loop where the valuation of the Toman and the stock market return to a new mean, which will then be established. However as the stock market is currently overvalued, it is not unimaginable that it will crash, this again ''reflexing'' through the financial market and in turn affecting the valuation of the Toman. If the Toman, however, continues to devalue a stock market crash is initially less likely, yet anything is possible in the long run of course, and that which goes hyperbolic, should come down. Everything depends on how well the Iranian economy is going to be doing. As economies go Iran's economy is actually quite stable, especially compared to other economically developing nations, however the current conditions (here we also have to think of the current health crisis) are certainly testing its inherent strength. All in all Iran finds itself in uncharted financial territory.
In the end the valuation of FIAT currencies depends on perception and amount in circulation (these themselves of course are rooted in economic reality and overall market consensus/zeitgeist). To keep a currency from experiencing large amounts of inflation it is of course possible to revert back to a value-backed system of currency (such as the gold standard). Any asset can be used to back a currency; the lands, holdings, and natural resource deposits of a country, for instance. These assets could all be bundled into some type of financial vehicle which upholds the value of the currency, the proportion or amount of which could even be adapted as to influence the exchange rate when needed. Of course such a solution comes with problems of its own, yet it would put an end to a nation having to compete in ''the great the financial currency manipulation bubble competition'' in which all nations which use actual free floating currencies currently find themselves. Iran is certainly the most severe victim of the inherent flaws and abuse of this free floating currency system, as it is actively used to wage financial war on Iran, here we can see that a free-market does not always work to be benefit of all participants, nor does it necessarily guarantee economic or public ''freedom'' for anyone involved. A departure from FIAT currencies could create some sort of equability, both internally and with the world market, and with actual commodities/physical possessions in stead of pure perception (which in the financial sense always implies speculation). This would effectively make any market inherently stable and less prone to volatility of any sort (including ''good'' vol.), as such, such a system could potentially function as a forced self-inducing ''negative'' feedback loop mechanism. Such an approach however does not seem to be in the interests of politicians and their peers, and as such has, to my knowledge, never been attempted in the modern day.
I would like to take this opportunity to remind everyone that an entire civilization of 90 million people (more than 1% of the world's population) find themselves under the heaviest sanctions ever imposed on a nation. On top of all of that came an unrelenting Corona epidemic whilst Iran has severely reduced access to medicine and foreign supplies due to the sanctions. Not even to speak of how people manage to feed themselves, let alone pay for possible medical expenses (such as the upcoming vaccinations) during all of this, when their currency has, and is, experiencing massive devaluation, the economy is essentially broken, work is scarce, importation of many goods is externally prohibited, and a lockdown is in place.
My heart goes out to the kindhearted and generous people of Iran
Thank you, I truly appreciate your channel.
Thank you very much for sharing!
Fiat currencies are backed by the entirety of a nation's economy. It's asinine to tie monetary policy and the strength of a currency to the ability to dig shiny rocks out of the ground.
Tuisto, thanks for taking the time to post this as it was very informative. On the flip side and not to sound rude and ignorant, shouldn't these sanctions and the consequence that come with it induce the people of Iran to seek a regime change? I like to think outside of economics that placing these sanctions would eventually incentivize the population to remove a brutal and reprehensible dictatorship.
Baller brother . Thanks so much for sharing
@@jamesbldwn1 No it would induced bombs in cities of the US because kids are dead as a results of America sanctions on medical supplies.
Reflexivity is an extension of a fractal function. A fractal function is a function where the output of one iteration is used as the input for the next iteration. Reflexivity is multiple functions being piped into each other. This leads to a mathematical explanation behind many of the most confounding elements of markets. Their seeming randomness, our inability to predict their behavior, and their random propensity to just completely collapse on themselves.
Price being the ultimate example. Market participants use price together with outside information to make decisions on what orders to send to the exchange. The orders are matched resulting in a new price which is then used as the input for the next set of market participant decisions. This leads to an incredibly complicated ecosystem with multiple feedback loops and connections. It creates a complicated system that is inherently difficult to predict let alone model. There is no known shortcut calculating a fractal function's value x iterations in advance. All we can do is run the system and see what it outputs one iteration at a time.
In plain English terms, I'll tell you Im a scumbag without telling you Im a scumbag . "Reflexivity " George Soros.
Love this channel. I bought all three of your books. This is what UA-cam needs. Actually inside baseball material on how markets work with respect to the internals and the dynamics between market makers and institutional money. Maybe you can do a video on how the SPX weekly expected move applies to market makers and hedging risk.
So good to see your channel is growing so fast had been following you when you had few thousand subscribers. Great job Patrick keep it up 🙂
Hi Patrick,
Loving your content. As an Electronics Engineer what you are describing is Amplifier theory 101, i.e. if you have negative feedback of an amplifier you create stability and if you have positive feedback you create oscillations.
Great video I remember reading this book years ago I’m not quite understanding it. Thank you for Your concise explanation of the subject
Glad you mentioned the Plain Bagel channel. I liked his analysis of Tesla.
Good video. Glad I found your channel this year. Here's to more great videos next year.
Patrick can you make a video about the biggest SPAC this year, Pershing Square Tontine Holdings
I left a ton on the bone with Alchemy of Finance. It took many re-reads and I’m still not sure I’ve grasped a substantial amount of the book. Thanks for filling in some holes!
Ah Patrick, always appreciative of your sartorial splendour (and delivery.)
Happy new year! I was wondering if the debt cycle could be explained by reflexivity. Sure it’s the Basis of the most common monetary systems and it might not even be comparable. However, the more I think about it on a global scale I really think that we could see a mean reversion in the upcoming decades😅🤔
I really enjoy your channel! The video you made with coffeezilla really helped me to find you!
Thank you Patrick, I love what you are doing here, please keep it up.
The amount of information and unprecedented ease of access created a new field of misinformation and it’s even easier to access.
Making decisions is an art not a skill.
Great video Patrick, enjoy this type of content covering broader theories.
Thank you for summarizing this interesting concept. Happy new year!
The Volatility Markets are a great example of reflexivity. The more premium that is sold, the cheaper VIX becomes. In turn, market participants view the markets as safer and buy less insurance. This creates a feedback loop that continues to drive volatility lower until an external event violently inverses the loop. Volmageddon happened because the short VIX trade became too crowded, but no one really learned their lesson. It has recently become popular in some pensions to sell puts to generate yield.
Bonus round: While not a Volmageddon event, Niederhoffer’s ‘97 bet against S&P 830P shows how fast “safe” bets like selling vol can quickly break down and blow up. I’m hoping since I managed to rope your old boss into this, it will somehow raise my chance of winning your book.
I think the electronic vihcle or enviromental boom right now might turn out to be useful in the future. Tons of companies that do things now. That nuro company in silicon valley managed to make a self-driving delivery car after all. Of course many companies are just shit in this bubble but some will thrive like amazon and the rest who survive the IT bubble
@Jeff Jeff yeah I regret this comment a bit now. It was clearly just part of the november-feb boom
This video is so calming and peaceful. Was really nice listening to it! Thanks for the detailed explanation, it was especially insightful, such as George's point on why academia hasn't adapted it and what that they are discussing it more these days.
They are not traders/investors so it`s impossible for them to understand that their modells are always wrong. And the prices in the market is always " the price at hand". They are always stuck in trying to find out " value", but reality is that it is impossible to find a objectiv 100% sure method for finding that out. Investing and trading is part science and part " art", and the both are important!. But the last is the most important.
you are such a great source for book recommendations.
I read When genious fails and two market wizzards books because of you, Sorros Credit Crisis Book and radical uncertainty are next.
Very interesting, amazing how Soros' quotes from years back are still so relevant today. When you were talking about Amazon being able to raise cheap capital I immediately thought of Tesla raising 5 billion at this record high valuation and the stock price even rising after the announcement despite expected dilution. Maybe the current crypto/bitcoin market is also an example of a positive feedback loop? Because the price rises so much it gets the attention from multinationals, institutional investors, regulators etc thereby adding legitimacy. In turn, this pulls over wary investors fueling the loop. Maybe also the defi market specifically with all the billions being staked and borrowed against within days of new 'defi' initiatives launching (between brackets because 99% of defi projects aren't even truly decentralized...). Either way, as a genetics student I would never have learned of theories such as this one without this channel, so I am very grateful for the high-quality content that you make!
Hi Patric, found your channel from a video on #Coffeezilla
. Very good content, please carry on. If I may suggest in a video like this if you put some slides, makes just more sense and the broader audience will get the point more quickly. never the less content of the channel are brilliant, thanks.
The ev market is a perfect example. Thank you for your video
Short squeeze phenomenon is a good illustration of reflexivity. The shorts covering their positions drive the price up, which urges more short sellers to cover. In addition rising price attracts new buyers and that fuels the situation even more. The prime example of this is October 2008 when VW shares skyrocketed 5 times, making the German cars group very temporarily the world's most valuable company.
Thanks for the great content Patrick!
Happening as we speak ;)
Let's see if we set a new record this time 😉
lol
I think the most obvious example of this is the EV market, and specifically TSLA. We see capital injected into the company which is fueling their aggressive growth strategy across the globe. The trouble is trying to value this company as a tech stock vs. an automotive stock, and investors are viewing as both. While the stock may one day go down, I believe everyone keeps “adding fuel to the fire” as you mentioned to keep inflated the value of the security.
Hello Patrick, Bitcoin is a good example of Reflexivity. While I agree with much of your video I have reservations in regard to regulations. As with anything, regulatory measures fall into the "Goldilocks" problem. Too much regulation and the economy slows (deadweight loss), too little and another housing bust. The number of people who lost their homes would argue for a bit more regulation. Happy Holidays to you and yours.
these are informative and strangely enough, kind of relaxing.. thanks .. keep going brother!
Example of Reflexivity - Tulip mania was a period during the Dutch Golden Age when contract prices for some bulbs of the recently introduced and fashionable tulip reached extraordinarily high levels, and then dramatically collapsed in February 1637. It is generally considered the first recorded speculative bubble (or asset bubble) in history. In many ways, the tulip mania was more of a hitherto unknown socio-economic phenomenon than a significant economic crisis. It had no critical influence on the prosperity of the Dutch Republic, which was the world's leading economic and financial power in the 17th century, with the highest per capita income in the world from about 1600 to 1720. The term "tulip mania" is now often used metaphorically to refer to any large economic bubble when asset prices deviate from intrinsic values. Text Ref. Wikipedia.
Nope.
@ Open, Peon, Nope
@@zenglider2145 The tulip bulbs in question did have an intrinsic scarcity. It was only when the tulip breeders cracked the technique that the arse fell out of the market.
@ So you're asserting that without the crack in technique by breeders the stable going price of a tulip bulb would have continued to be valued at more than 10 times the annual income of a skilled artisan?
@@zenglider2145 Have you heard of Apple?
Another insightful video by Patrick , love your videos , man.
You know, the comment about how reflexivity might not be a bad thing is very thought provoking
A good reflexitivity example in the market is the relation between the spread (aum - assets value ) of grayscale Bitcoin trust (GBTC) and Bitcoin price itself. As GBTC is the only traded vehicle to have direct exposure tu Bitcoin, and as prices of Bitcoin increases, so does the spread between aum and assets value
Hmm, I don't think I understand it. Do you mind to break it down? Thanks.
Hi Patrick..! I enjoy watching your videos. As a courtesy, I always play advertisements without skipping. Because I want to contribute some for your effort to educate us. Today also played 10 advertisements ( Including 1 hour long). I am watching from Malaysia.
Wish you a happy new year..!
He owns a hedge fund Jeffery he does not need the money. I’m sure he would rather you spend an hour of your time doing something more productive than watching an advert that will earn him a fraction of a penny
thanks Patrick. so well articulated!
Not a specific example...But, the mechanics of market reflexivity (positive / negative feedback loops) are very similar to gamma exposure on open interest.
From my perspective, value at risk is one of the most important manifestations of goodhart's law in which participants have a certain inbuilt tendency to reduce positions at almost the same price. In a way positive feedback can be understood as micro sense and macro nonsense. Based on certain commonly accepted indicators like VaR or stop losses or moving averages etc, there will be a set of rational responses. Rational responses to commonly accepted indicators are not an issue if they are not commonly adopted(note the paradox in the statement). However by definition such a state of affairs cannot be realistic. Hence the tendency for selloffs to exacerbate into crashes when positions are too crowded.
Great video sir. Just found the channel through the coffezilla interview.
Hi Mr. Boyle,
Great video. You gave some fantastic examples of reflexivity that helped me conceptualize George Soro's whitepaper on the subject which he has posted on his open societies website.
I believe passive index funds are a good current example of reflexivity, but hear me out before you call me Chicken Little. I don't necessarily believe the sky is falling, yet.
John Bogle created an amazing product with his passive index funds, and it is true that they outperformed active money managers after subtracting their exorbitant fees. This outperformance is an example of a positive feedback loop.
Then Warren Buffett pounded the table that they are the best option for the average investor, and I still believe he is right, but as the saying goes, "what the wise do in the beginning the fool does at the end." Another positive feedback loop.
Now the pandemic has warranted massive money printing by the feds, who have flooded the market with cash by buying bonds. This has pushed the bonds into negative yield territory and investors chasing a decent return have turned to the stock market because bonds are unsatisfactory. Another positive feedback loop.
So, like the recent Wall Street Journal article asked, "Has the Fed Rewritten the Laws of Investing?" Perhaps no one knows. But the stock market is certainly high compared to historical norms and a regression to the mean should not be unexpected.
I believe the defensive investor can keep their money in a passive index fund currently. But a few lessons from the last financial crisis should be heeded to avoid tragedy-
1) Do not borrow excessive amounts of debt and plow it into the S & P 500 with the expectations that it will only go up
2) Manage expectations and please do not put money into the market that you need next year for a down payment on a house, etc. Invested money should have a long time horizon (10 years or more).
Thanks for reading and your consideration of sending me a free copy of your book on derivatives. I look forward to any constructive criticism!
another great video, keep up the good work. love your content.
Thank you for all of your videos. Any possibility you would also share your audio in podcast format? Would you love to listen to your content on my smartphone.
Great video, keep up the good work.
And on reflexivity XRP and Ripple could be a case for that. Just we don't have the full picture yet but the price had gone down 60%.
I need to go back and listen to this a couple more times.
would love to hear you overlay the theory of reflexivity on btc! your channel is among the best on the internet. awesome content mate, keep em coming!
The "price trend" is itself a positive loop. This is applicable on both uptrend as well as downtrend.
Now do the same on General Theory of YOLO (GTY)
That's called the Walpole School of Economics.
Soro's Reflexivity theory always reminded me of Heisenberg's Uncertainty Principle...you cannot know the position of an electron because beaming photons of light on the electron changes the path of the electron, much like market participants interacting in price discovery changes the price itself. Combine that with the Butterfly Chaos theory and you can imagine how market's can react unpredictably.
interesting comment!
The fiat currency is the source of all our current bubbles and troubles. They make credit so cheap because governments can just print money. They weren't able to do this during the era of the gold standard.
@@plainguy3567 I still find it in disbelief that there are those who think they can go back to gold. I felt uncomfortable with FIAT but going from an experiment that provide successes and failures to a known cause of instability and unmanagable crisises, is simply backward looking and nostalgia-induced amnesia.
Fantastic video, subbbed!
It's 11 months later and I think this is the best video in the past year.
I think the Ripple situation that's going on right now would be a good example of negative reflexivity. Ripple crashed about 66% right after the SEC sued them for being a security after growing to be one of the biggest crypto currencies. (SEC claims they're a security, Ripple claims they are a currency) It will be interesting to see how that whole situation turns out, definitely some lessons to be learned there very soon.
I love the dry humor, more of it, please. I find your presentations remarkably understandable for a someone not well- versed in the lore.
An example of refexivity - call cards
In the 1990s, the Irish telecoms monopoly sold prepaid tokens allowing the customer to make phonecalls from public phones. The tokens came in the form of a plastic card with a chip in it. The plastic cards themselves were decorated with attractive images or artwork and there was great variety of images available.
Over time, people began to collect the cards for the artwork itself. As more and more different images were used, people began to trade and value these cards. Soon, people were buying the cards for the collector value alone, without intending to use them to make phonecalls. They thought their value would increase over time as they got older. And of course, the cards themselves were plastic and durable which gave confidence in their longevity. People paid more than the face value of the cards, especially for rarer ones. Sometimes multiples of the face value.
However, the system of buying prepaid credit for public phones was eventually challenged by the rise of the mobile phone. People no longer needed public phones or callcards and the excess supply of hoarded cards meant their value as collectors items was eroded. Within a few years, they were valueless - not even used for phonecalls
Hi Patrick, I have a couple examples of reflexivity that are occurring at this time. Canadian real estate, particularly Vancouver & Toronto driven but historic low interest rates and the belief that foreign buyers will push prices to the moon and 20 years of recency bias. Second, any WSB meme stock :)
There's no way the bubble is going to last long - me in 2015.
At this point a 50% market crash would still keep prices higher than when the idea of a real estate bubble first became popular.
None better than housing prices in certain areas of the UK - take the housing prices of Aberdeen which, are entirely reflective of its local economic driver (oil and gas) in terms of employment numbers, company investment, buyer sentiment etc.
When there was 2008 national downturn, this area was so far in its own economic bubble that it hardly seen anything. Now with house prices going up, it's stuck in the cement of the same sector which is barely moving. It's almost inverse in correlation to consumer and retail price indices nationally in UK at the moment.
If you take a look at somewhere like Leeds then compare property price growth, it's quite something.
A little gem hidden in the list of videos
I think the best example of reflexivity is the simple trend following swing trading programs (e.g. using things like macd cross). More or less by definition, these are positive feedback. I'm not sure how much of high frequency trading is done this way, but suspect that a very high percent is.
No, HFT doesn't involve using some sort of MACD implementation.
Dr Gabe Maté on addiction and treating drug addicts as criminals creates criminal behaviour and other forms of social ills. Criminalising drug users also impedes the methods of treatment. Is this a form of reflexivity?
Having treated 2500-3000 addicts and alcoholics I can say whether they are “treated” as criminals or not, they have almost all engaged in criminal behaviors prior to receipt of the treatment provided to them. I would also maintain that the lions share of those behaviors were “disease induced.” Of course that raises the questions about culpability which cannot be solved herein.
5000 like, lol you were optimistic. You'll get there, your contnt is amazing
Bitcoin is a rather interesting example of reflexivity. When news points to bullish events for BTC (USD inflation/increased acceptance among institutional players), this generates immediate positive fundamentals since the simple perception that BTC is a valuable currency increases its value. BTC follows Metcalfe's law (widely used to value telephone companies) where as more people use and believe in it, the value of the network grows by n^2. This means that any news about BTC is basically good news. Amazingly, BTC is a system that experiences an increase in value based on adoption since adoption increases scarcity (which as it is basically a commodity, means that its value goes up as more players enter the space). Thus, we see positive reflexivity since positive perceptions generates positive changes to the very fundamentals of BTC, but should there be a sudden surplus of BTC on the market, we'd see positive reflexivity to the downside. One can easily see this with how the news media overreacts to BTC gains/losses, using rather biased wording such as rocketing or plummeting on the day. While this has always been present for any asset class, it seems almost excessive for BTC, indicating that several untimely pieces of bad news could quickly reverse BTC's fortunes. Nevertheless, BTC also appears to present some cases of negative reflexivity on the short term scale as demonstrated by the news's predictions quickly turning false almost as soon as they're published. Mean Reversion strategies are especially effective in BTC since like any currency, its value is based on the individual's trust in the system. This means that when people frequently panic-sell/FOMO buy, "smart" buyers/sellers wait for these moments and push BTC back toward the trend. An interesting aspect is that BTC has rather tightly hugged a logarithmically-linear growth curve since its inception, suggesting that negative feedback plays a role in keeping it within this trend despite the massive pumps/dumps investors experience.
Sidenote: An interesting aspect about BTC is that it is very hard to come up with a reason for BTC to have any intrinsic value, unlike Eth. The two answers most commonly cited are adoption and the actual resources required to add to the blockchain. The first appears to be the most accurate because it effectively claims BTC is too big to fail. However, there are better currencies that require less resources to mine and have more use cases. If the first reason is what the market truly values, BTC's value would be highly based on positive reflexivity where more participants will lead to a snowball effect. However, over the long term, it seems silly to value something that has no intrinsic value (then again, we valued gold for a really long time, and it just looks pretty) when there are more efficient, less resource-intensive cases. In that case, I could see BTC adoption slowly falling off (since as it currently stands, there's no chance for BTC to be used for everyday transactions). All it would take would be a collective consensus doubting BTC's value as a storage of value for such an event to occur. After all, should we truly value the work people put into adding into the blockchain? From a supply-demand standpoint, BTC's minimum value is pegged to the resource costs to mine the blockchain, which are still rather extensive, since if there were no economic incentives BTC would simply have no more validators. Nevertheless, if BTC's value were to dramatically fall, I could see little in terms of "natural" negative feedback, since the supply would remain the same. (The difficulty in mining blocks would be altered to match the lessened computing nodes to keep the rate at a block every ten minutes) To be fair, there are new use cases for blockchain technology being built on BTC, so we don't know what the future holds.
@Joshua Tsai I agree with you on most except the following . Higher Bitcoin price doesn't warrant more participants or more adoption , it is quite the opposite, higher prices mean less adoption and more hording of the Bitcoin ....
>>> ... here are new use cases for blockchain technology being built on BTC ...
@@poohshmoo9892 I think higher prices cause FOMO and since BTC is divisible, people will still buy pieces of BTC (just think of it in terms of Satoshi's). I do agree that institutions/miners might start hoarding BTC instead of trading it. In this case, yes, adoption would go down, but scarcity would go up and maintain the price. (If price fell down from this hypothetical super-high price, it would likely be bought back up by the masses who wanted to "get-in" on it). It is questionable? whether the number of addresses is important for BTC anymore. I think number of miners (for proof of work) matters more for BTC price. If BTC price went up, there would probably be an increase in miners. Then again, I could be wrong on this; however, it does match the current rhetoric I hear in the community about BTC being digital gold that is not meant for trading, so number of addresses using it for daily transactions shouldn't be super important.
I do agree that as a currency/blockchain BTC has a lot of flaws. However, due to its wide adoption, I hope that eventually layer 2 solutions will be able to make BTC have some of Eth's use cases for example by increasing TPS enough for smart contract capability to be possible. Once again, it is also arguable that BTC was never meant to have any use-cases, so it's unnecessary, but it would give BTC a "real-world" peg. I've heard of a few groups attempting to make smart contracts with BTC, not sure how successful they've been.
The best and the most underrated finance channel.
Hi Patrick. I saw a talk by Slavoy Zizek where he talked about the Freudian concept of the " fetishist split " wherein a person or perhaps group ... know, yet do not know .. holding both reality and denial at the same time.
I see this in the markets as a positive reflexcivity in a general sense when in a bubble phase... It's interesting that Soros says this is where he charges in and invests heavily with a mind to correct when necessary...... just an observation...
I know the absolute best example of reflexivity but I saw the video is only at 2.6K likes so I just went and shoplifted Patrick's book from a used book store. Best book ever. My copy has handwriting on the inside cover. It says " Merry X-mas Mum! Luv P.B.
First of all, love your channel and so thankful UA-cam randomly recommended a video with you and Coffeezilla (Despite me never watching his videos..)
My pick is unfolding before our very eyes: Bitcoin.
The reflexivity mechanism? GBTC buying up the stable float of availiable bitcoin. As retail, pensions, instititutions and casuals pile into GBTC for its ease of gaining exposure, it must buy up more BTC to keep up with demand of its own shares. BTC has finite supply and the float keeps getting squeezed higher and higher with no real instrinsic change that matches the level of its price rise.
Conclusion: Either BTC and crypto become a fully fledged new asset class, or regulation brings its price back to earch, then it may be like the railroad example, central banks around the world will now have more knowledge and infastructure to create their own blockchain.
Ah you mentioned Tesla, but if you recall your early trading days, in the late 1890s, remember the great bicycle bubble? Sure the new design (like electric cars) was transformative, we still ride this core design today, but the positive loop blinded investors to the market cap and potential of cheap imports, so new bicycle companies and bicycle stocks crashed. Happy NY :)
In understanding the concept of efficient market hypothesis (EMH) I prefer the premise offered by Gene Fama, one of the originators of the concept. Fama didn't claim that EMH accurately reflected the reality of security prices. He only introduced EMH as a means to measure the performance of various investing strategies against comparable unmanaged benchmarks. Fama had initially been agnostic about whether the EMH is a fundamental principal of asset pricing. He applied the EMH as a useful yardstick for the sake of comparison. Interestingly, Fama didn't consider EMH to be a particularly earth shattering concept. EMH certainly wasn't the main focus of his early research. He was probably as surprised as anyone when others found the yardstick of EMH to be an especially noteworthy idea. Thanks for the video Patrick!
Happy new year man! Wish you money for the next one
Same to you!
Thanks Patrick, talking of investing classics, I have your Statistics book on order, any plans for publication on Kindle?
The example on asset bubble fitting into Reflexivity theory is Bitcoin itself. The market has distorted the price (value is different topic) of Bitcoing by making it easy to move between wallets, also buy and sell on exchanges with a click of a button. A potential positive feedback loop with Bitcoin is IF people can start using it in any meaningful way like buying goods with it ( but no) and that will bring more growth and confidence /reinforcement in the asset ( I refuse to call Bitcoin currency ). However such positive feedback loop hasn't happened yet due to fundamental flaws with Bitcoin structure ( high transaction fees, long transaction verification times, lack of dispute/chargeback process to battle fraud ) . Negative feedback loop with Bitcoin is if say 51% of the hash power falls into the hands of one miner which will go against the idea of decentralization, and also create conditions for "corruption" of the ledger , and/or double spending. In fact 75% of total hash power of Bitcoin miners are concentrated in China already. ( that 75% of the total hash power are distributed among couple of miners not one )
A result from the negative feedback loop will be to balance miners distribution or even enforce it somehow. The limited nature of Bitcoin ( limited to only 21Mil in total ) seems to play only into inflating the bubble, the higher the price , the more the hording of Bitcoin, and the less the hope for meaningful usage of it , which eventually will cause buyers to dry out and price to fall but still doesnt solve the problem with positive feedback of any sort. Growth of Bitcoin price has been exactly as you explained in the video. I see plato of it when derivatives on Bitcoin are introduced next year ( Chicago Board Option Exchange said will offer options on crypto in 2021 and I assume Bitcoin too ... CME Group to Launch Ether Futures on February 8, 2021 ... ) I'm in no way close to good in explaining my ideas but I hope readers will get my point.
To add on the topic , the blockchain tech on which Bitcoin is based is also part of the example with negative feedback loop. ( some of the cons baked into the Bitcoin are fixed in different type of implementations .. for example instead of using consecutive blocks, a cryto ledgers can use tangled blocks which is direct result of negative feedback loop ( fixing high verification times ) ) ... and what is the sureway to burst the Bitcoin bubble .. .ban exchanges (ban buy or sell Bitcoin for dollars , euroes.. erc) ... without exchanges Bitcoin price will be 0 .. but value still exist ( due to the usefulness of the blockchain tech )
Best example of reflexivity is the like button on this video. It reached 5000 as required for the free book then stagnated. It seems that because people are unable to short the likes on youtube videos we are not getting a bust that was promised.
The best example of reflexivity is Wallstreet UBS default on Puertorican Municipal Bonds from 2007-2013.
Definitely taking notes
Great video. Happy new year
Same to you!
Index funds have been growing due to the low returns of active funds.ETFs on junk bonds will have a negative feedback loop especially in covid times and the the lack of support on non-investment grade assets by the central bank.
Auto loans will also crash due to the transition to electric cars.
Please keep making videos!
Patrick, this is a great idea. Interestingly, I wonder if the reflexivity can be cast in the light of the standard financial literature as the principle of more risk = more reward. Using the dividend discount model, the dividend growth rate is convex with respect to stock price. Under Jensen's inequality, higher uncertainty about dividend growth rates would lead to higher stock prices. So, for the NASDAQ in early 2000, the higher uncertainty about future dividend growth rates of the new technological revolution offered by companies like pets.com lead to higher growth in the index hence positive reflexivity. Once there was more experience about the potential dividend growth of these companies, the prices fell due to the lower risk associated with more certainty in the dividend growth rate (again applying Jensen's inequality here).
In that sense, the reflexivity story of the early 2000s is just a story about risk.
The advice Soros gives that you should not short stocks in a bubble state is also a standard example thought in economics under the name of rational bubbles. As long as the expected value of a stock is positive, bubbles can persist for a long time. Nothing quite irrational about that. So cast in the standard finance literature, Soros's advice is quite mainstream; it is the age-old saying more risk = more reward. When the risk dries down, Soros moves on.
"higher uncertainty about dividend growth rates would lead to higher stock prices". I don't follow your reasoning. As an investor, I would expect to be compensated more for the increased risk. The only way that can happen is if the price falls (increasing my expected return).
Great video. many thanks.
Thanks for making
Excellent stuff as always
I love how you put it at the end - despite the bubble popping, a very important infrastructure was laid out, so overall it's a good thing. Kinda hard to believe such wise thinker also almost broke UK...
Man, I love your suits in every videos!
"Well a measure becomes a target, it ceases to become a good measure". Well said. You can see this reflected in the entertainment industry today. Critics, game journalist, "good rating", etc loses their meaning recently.
Is the fastest runner the person who runs the fastest 100m? Maybe not but it is a good start.
@@davieb8216 I don't get it, plz elaborate more.
Using the reflexivity template you described I am looking at it in way of a series unsustainable negative feedbacks loops which started and are being driven by the overarching positive feedback loop of Amazon
One of them which caught my attention was Party City(PRTY) which I have been following for the last 1 year.
The negative feedback loop which started for party city due to Amazons positive feedback loop.
- PRTY is a predominantly brick and mortar store setup, Amazon is known for killing.
- PRTY sells commodity items such as costumes, party gifts, etc, most of which can and are being sold on Amazon.
The flaws I saw in this were that
- To curate any kids party I will buy balloons which can be reliably bought from party city.
- For kids party and other parties most likely there is always a theme in mind which needs to be executed. Each element of this theme needs to be carefully selected. Amazon selections are based off pictures.
The most important question i asked myself.
Do I want to save costs on a celebration by purchasing almost every decorative item or costume I need for it from Amazon ?
A: No.
Good argument, but It did not age well... Thanks, for making such a precise example, however!
I love the logical structure and the example. How do reflexive pressures allow for efficient markets?
As a student of behavioral economics in my undergrad, now getting my masters in finance, I am amazed how many people immediately discredit the idea of reflexivity. While it certainly questions much of the simple-math-model-modified-until-it-reflects-reflects-reality approach of economics and econometrics, I think it is quite evidently true in experimental and anecdotal evidence that prices are both somewhat disconnected from fundamentals and inherently influence later fundamentals. The sad truth, as a lover of economics and finance, is that the fields suffer a near-fatal degree of physics-envy. While math is important, it should be used to build models from experimental research and not arbitrarily assumed axioms, no matter how logical or optimizing.
Natural sciences get to play this game because it is simply more realistic to build good axioms there. In its inherently probabilistic and multi variable nature the social sciences lack this luxury. As I always say "The only vacuums in the social sciences are in our minds". You can't make simple mathematical models of behavior and expect any level of predictive quality when they hold things like unlimited information and rational optimization as axioms. We should be proud as social sciences that we have come so far despite the added difficulties of our field, and instead of mimicking the natural sciences methodology, should instead mimic its predictive power.
Math is great and necessary in econ and finance, but it is being misused. This allegiance to physics-like math models prevents us from fully accounting for psychology, reflexivity, irrationality, animal spirits, and whatever other term you have for fundamentally human variables influencing decision making of agents in an economy.
Do experimental research. A lot of it, with varying methodology. Then build mathematical models describing this behavior. Then modify those. I think you'll find they are more descriptive of reality. Don't make absurd assumptions and pin it on "simple human behavior in a vacuum" as no such thing exists.
Doubt this comment will get me the book, but I just had to get it off my chest. I see a bright future for econ, finance, and the social sciences as this is becoming more accepted and considered by academia. However, we do still need to fix p-hacking, significance bias, and post-hoc hypotheses if we want our experimental research to be worth anything.
Also, regarding the idea of "if investors can't see the bubble coming how could regulators?", I think Soros would argue that some investors do see a bubble coming, but have an incentive to invest, then prepare to divest as soon as the pop approaches. If this is the case, then sharp regulators would also be able to see the bubble, though perhaps not the pop itself, coming.
Nice comment
Well said
Great analysis of Reflexivity. Regards.
One instance of Reflexivity can be when Analysts give Stock/Trading Calls on TV/Reports. The Market participants (mostly Retail Investors) would rush in to Buy/Sell in that direction. Thus becoming a self fulfilling prophecy as the Stock price would move in that direction, with more and more Traders taking the same Trade.
So Airbnb have a negative cash conversion cycle leading to high levels of cash on hand when they’re growing and when their growth slows or stops they may end up w/ negative revenues (refunds) - Based on your explanation this could be considered a form of positive reflexivity. Reminds me of the risks present in carry trades in the book “rise of carry”.
In that sense, if prices of the assets are a direct prolongation of the reflectivity effect, what is the value of finding alpha? And Besides that, do you think volatility is affected as well? As always, great content patrick!
Making a bet in on the idea realizing it’s objective value while subjective takes support the thesis before it’s fully realized.
I read the book mentioned twice, and my mind kept wanting to skip the whole reflexivity idea as if he was just labeling something I already knew.
Yeah I've read it as well. Seemed like a very long-winded explanation of boom and bust cycles. Basically just its just overbought and oversold markets though. I didn't even agree on his explanation of it completely. its too simplistic
Top stuff mate