Stock market is not the Economy : Unemployment numbers

Few things to note from the table

• During the 2008 financial crisis, unemployment rate went from 4.9% to 5.6% during Jan-June, 2008. S&P500 was at 1278 on June 27, 2009, down 14% from ~1500 peak
• Unemployment rate increased more rapidly during the later half of 2008 to end at 7.2% in December. H2, 2008 saw the fall of Lehman. S&P500 was at 887 on Dec 19, 2008 down 30% from June, 2008 and down 40% from ~1500 peak.
• Unemployment bottomed at 10% in October 2009
• Stock market bottomed at 683 in March, 2009 when the unemployment was at 8.7%

Stock market reflects the rate of change of bad news. 

• Rate of change of unemployment in H1, 2008 = -.15% per month
• Rate of change of unemployment in H2, 2008 = -.23% per month
• Rate of change of unemployment in H1, 2009 = -.28% per month
• Rate of change of unemployment in H2, 2009 = -.06% per month

The rate of change of unemployment numbers clearly show that the rate was highest in H1, 2009 which co-incides with the market bottom. The absolute unemployment percentage kept getting worst in H2, 2009, but the rate of change of bad news kept decreasing. So the market had already started increasing when the economy still kept shedding jobs. The economy hit bottom in terms of unemployment in October 2009 when the S&P500 was around ~1100 which was about 57% above the lows in March 2009 and still 33% below the ~1500 market top.

The stock market is a forward looking vehicle. During a recession, in order to look for the bottom, look for the point where the market starts ignoring the bad news.


Reference

• https://www.ncsl.org/research/labor-and-employment/national-employment-monthly-update.aspx

Attention Explained

Screenshot of Andrew Ng's explanation of attention model from the deeplearning.ai course

The problem with regular encoder decoder architectures arise when we have long sentences because RNNs dont do well in these scenarios. For eg : while translating a long sentence humans probably dont read the whole sentence and then translate it. The human mind probably reads parts of the sentence and then processes the translation for that part. This leads us to attention models. While translating a word, it weighs in the inputs to the word differently. 

References

1. Visualizing a NMT Model with attention
2. Attention is all you need
3. Deeplearning.ai - Andrew Ng's explanation to attention models

Encoder Decoder Explained

Neural Machine Translation

x1,x2,....,xTx - input sentence

y1,y2,....yTy - output sentence

Tx!=Ty, which means the length of the input sentence can be different from the output sentence

The problem with regular encoder decoder architectures arise when we have long sentences because RNNs dont do well in these scenarios. For eg : while translating a long sentence we probably dont read the whole sentence and then translate it. The human mind probably reads parts of the sentence and then processes the translation. This leads us to attention models. While translating a word, it weighs in the inputs to the word differently. We will cover attention models in a separate post. We will explore another encoder decoder architecture where the input is an image, hence the encoder produces an image encoding. 

Image Caption Generation

Encoder : Alexnet or any other Computer Vision model can generate the image encoding

Decoder : RNN like architecture can decode the encoding to create the image caption

y1, y2..., yT - image encoding

Transformers Explained

References

1. The annotated transformer
2. Attention is all you need

BERT Explained

NLP Primer

Attention

• Visualizing a neural machine translation model 

Transformers

• [June 2017] Paper : Attention is all you need
• [April 2018] Explainer blog post : The annotated transformer
• [June 2018] Explainer blog post : The illustrated transformer

Bert

• Bert explainer
• The illustrated Bert, elmo and co : How NLP cracked transfer learning
• Paper
• Multi-lingual BERT

XLNet 

• Paper : Generalized auto-regressive pretraining for language understanding
• Code : github link
• A fair comparison study of XLNet and Bert with large models

XLM - Enhancing BERT for cross lingual language model

• XLM explainer
• How is XLM different from multilingual bert
• Paper : Cross lingual language model pretraining
• Code : github link

XLM-R

• Paper : Unsupervised cross-lingual representation learning at scale
• Code : https://github.com/pytorch/fairseq/tree/master/examples/xlmr

XTREME

• Blog : A massively multilingual multi-task benchmark for evaluating cross-lingual generalization

Market, economy and the investors

1. Market in the short term is the rate of change of news - like a popularity contest
2. Market takes the elevators on the way down and takes the stairs on the way up
3. The economy may be doing bad, but the market may be doing well. 
4. Market is forward looking and the economy is current looking
5. Some job losses may be good for the economy and market, because that may clean up the old economy jobs and the antifragile
6. Economists may not be great investors
7. At the bottom of the crisis, any good economist should be able to say all the risks facing the markets and outline why the market may go down
8. Investing needs a healthy dose of optimism and faith during these tough times
9. Pessimists might sound smart, but optimists will make money
10. However, I don't want to imply that being a forever optimist and overlook your risks. Investing is personal and risk is always measured from a frame of reference which is life situation. The answer should be different for everyone. Here is an essay to analyze your mortgage and tail risks

Bulls vs Bears

Psychology of a bear

1. There is a chance that prices comes down and the bet is that prices will stay down for a long time
2. Higher probability of buying low because of lower price and larger time
3. Fear of not being a price taker in a bear market

Psychology of hold

1. Even if the price goes down, it wont stay down for a long enough duration. So not worth selling
2. There is a low probability of prices going up in the near term, but if I get out, it may be hard to get back in 

Psychology of a bull

1. Prices will go up in the short to medium term
2. The current prices are a bargain factoring in future earnings and revenue growth
3. Even if there is some short term variance, in the medium term the asset will be worth more and there is no reason in the horizon to liquidate this asset

Investing essays during crisis

Musings of an investor during a crisis

Insurance

1. Insurance is cheap before the crisis (Gold prices)
2. Once the crisis is clear, insurance becomes expensive (gold prices shot up)
3. Insurance is not free. Insurance can be a drag on portfolio performance during good times. Hence asset allocation and rebalancing is important.

Range of outcomes

During this covid crisis, the absolute range of outcomes still says vast

Negative outcome

1. The reopening of the economy can cause a huge second wave, leading us to close back again. That could be devastating for the economy. The Fed may have prevented a short term collapse, but the medium term uncertainty remains. Also that could lead to much more long lasting permanent damage in the economy. At this point, markets are probably pricing in a lost quarter. The crisis started in America in March when cities started to shut down. Hence, Q1 results were not really hampered. But the lockdown effect will be visible in Q2. Market is hoping that the economy opens up and by Q3, results start trending back to normal and we have a great Q4 like last year. I think that is what is baked into the prices and we have already seen a swift recovery from 35% lows. 
2. However, if the reopening is hampered by a huge second wave of the virus, the market would start pricing in more than a quarter and up to a year of lost revenue. Things would be interesting when the market starts to price between outcomes like
1. A quarter of lost revenue
2. Multiple quarters of lost revenue
3. Multiple years of continued revenue compression due to more permanent damage caused by a second wave 

Positive outcome

1. There is a possibility of a vaccine by the end of the year and several companies are already pre-scaling production in anticipating. This would definitely be the fastest vaccine ever
2. However, if it were to happen, it would be easy to say "long human ingenuity" or this is what you expect to happen if the whole world gets behind one common goal
3. Don't fight the FED. The Fed has done all that is their in its power to remove tail risks
4. American capitalism may have changed forever. With the Fed buying high yield bonds, we may be entering an era of Government Sponsored Enterprises. 

Both the positive and the negative outcomes are equally likely. At this point, it remains hard to say which one is more likely vs the other and in what timeline. The FED continues to mitigate tail risks in the short term. 

Sectors impacted 

1. Travel
2. Hospitality
3. Airlines
4. Cruises
5. Retail stores
6. Malls real estates
7. Oil

Sectors at the risk of contagion

1. Commercial real estates
2. Hospital industry
3. Mortgage banks
4. Junk Bonds

Commentary on Big Tech

1. The economy continues to migrate from atoms to bits
2. Big Tech stock prices indicate that
3. Silicon valley housing prices still correlated with big basket of tech stocks
4. User behaviors that would pan out in the next 5 years have been expedited within a span on 2 months
5. However, more short term revenue may be hit if the more companies get hit (ads could be more vulnerable than cloud revenue followed by retail)

Mortgage and tail risks

First let me start with what this post is not about. I dont plan to cover whether to pay off a mortgage early or to keep it. There are lot of articles in the internet covering that aspect. I plan to cover how to manage tail risks of owning a home, given real estate prices can be sky high in the coastal areas of the US. How to manage the mortgage dance with a balanced portfolio that can be resilient when tail events do occur.

This post outlines some of the tail risks pertaining to home ownership

1. Losing job and having too low emergency funds(~2 months) to cover cash
2. High debt equity ration of the assets (huge mortgage and equity prices crash leading to inability to service mortgage payments). This is more risky in case of multiple mortgages and rental businesses
3. Losing job and losing immigration status - a reasonable emergency fund(~6 months) may also fall short
4. Mortgage may go underwater (2008 recession)
5. Natural calamity (earthquake, cyclone, infectious disease affecting cities - 2020)
6. Having a huge mortgage towards the end of a short term or long term debt cycle

How can you structure your portfolio to account for such risks

1. Have significant emergency funds in short and long term treasuries
1. Account for 1-2 years of mortgage payments on primary residence
2. Account for 6 months - 1 year of rental payments per unit in case of moratorium on rents
3. Account for personal and family expenses in case you are out of job and rental income for a while
4. Account for medical emergencies in case of health insurance loss
5. This is what a healthy balance sheet looks like. Google had 120bn in cash, Microsoft had 130 billion in cash, Facebook had 60 billion in cash going into the covid crisis. For all these companies it stands for ~10% of their market cap. 
2. Diversify your equity holdings 
1. Dont have stock concentration risk in the similar companies. For eg : google and facebook both make money from ads
2. Dont have concentration risk through index funds and individual stocks overlapping. For eg : Google Facebook Amazon Microsoft make up ~50% of QQQ and 20% of S&P500
3. Dont have correlation between index fund and home price. For eg : QQQ and bay area home prices are correlated
3. Buy insurance when it is cheap and VIX is low
1. Hold some alternate asset classes like Gold, bitcoin
4. All weather portfolios. If you had one at the beginning of the crisis, then your portfolio hopefully rose during the crisis. Also you are probably deriving healthy income from your portfolio. 
1. 40% Long term treasuries
2. 15% Intermediate term treasuries
3. 7.5% Gold
4. 7.5% Commodities
5. 30% Large Cap Equities
5. Diversify when it is cheap to build your portfolio for the future. Some areas to look into
1. Commercial real estate
2. Emerging markets
3. Oil
6. End of short term and long term debt cycles lead to deleveraging across the economy. If you have made money during the current credit cycle expansion, it may make sense to take some chips off the table

PS : the pessimist sounds smart, the optimist makes money