A Beam Falls From The Sky: Seeking A Coherent Strategy

In The Face Of A Unique Event

seekingalpha.com/article/4342743-beam-falls-from-sky-seeking-coherent-strategy-in-face-of-unique-event

Jim Sloan May 4,

2020

Summary

In Hammett's "The Maltese Falcon" a beam falls driving a sidewalk chip into the
protagonist's cheek; he walks away from his life only to establish a similar life elsewhere.

My friend Meyer walked away from his life in 1938 Austria after reading a message on a
park bench telling him that the world had changed permanently.

The interplay of extreme events and pleasant normalcy presents the hardest problem in
the markets and our lives; the two seem opposites but are deeply connected.

To engage the rare event one approach is to begin with a tentative model and then
improve upon it using Bayesian principles as new information becomes available.

I describe how I used this approach first with the virus then with market actions as well
as some initial modeling of possible future economic paths.

"Cast a cold Eye/On Life, on Death/Horseman, pass by!" - W.B. Yeats, Under Ben
Bulben

In March of 2018, I wrote an article entitled "The Hardest Question" which discussed the
tug of war between normalcy and rare moments of crisis. The "Flitcraft Parable" - a brief
digression in Dashiell Hammett's The Maltese Falcon - is about a man who disappears one
day leaving behind a successful business, a wife he is on good terms with, two children,
and a house in the suburbs of Tacoma.

When the detective (Sam Spade) finally runs Flitcraft down the man, he lives in Spokane
with a wife similar to the one he left, a successful business, a baby, and a house in the
suburbs. He explains that a beam from a construction site had fallen 8 or 9 stories
narrowly missing him but driving a fragment of sidewalk into his cheek. The falling beam
shook up Flitcraft's view of the world as if "somebody had taken the lid off life and let
him look at the works."

Spade then sums up the story as he understands it:

He wasn't sorry for what he had done. It seemed reasonable enough to him. I don't think
he even knew he had settled back naturally in the same groove he had jumped out of in
Tacoma. But that's the part of it I always liked. He adjusted himself to beams falling, and
then no more of them fell, and he adjusted himself to them not falling."
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Flitcraft's experience resembles the psychological journey of many investors confronted
by a market crash. A good financial advisor might have helped if only by telling him to be
steady and don't overreact. Beams fall from the sky from time to time, but normal times
will return. The underlying principle of good financial advice, and good life advice, is that
sudden falling beams are exceptions while pleasant "normalcy" is the powerful
underlying trend.

There is, however, a more complicated view of the unique event. A friend who escaped
Europe under Hitler told me his story, truth not fable. He is now over 100 years old. Let's
call him Meyer.

Meyer grew up in Austria in the 1930s in a prominent and wealthy Jewish family and
watched the steady advance of Nazism through its annexation of his country. He started
giving serious thought to the situation and began to notice small things, such as a non-
Jewish uncle whose Nazi sympathies were manifested by the fact that he named his dogs
after the gods and heroes of Wagner operas. A few days after Kristallnacht, in November
1938, when pro-Nazi mobs broke the glass windows of Jewish shops, Meyer experienced
his own falling beam. Someone had stenciled on a park bench across the street from his
home: NO JEWS ON THIS BENCH.

That pulled it all together for Meyer. He made his preparations to leave and informed his
family. His family disagreed. Events like this come and go, they said. They were unwilling
to leave everything they had and everyone they knew - the pleasant everyday life they
were used to. They felt confident that their position in the world protected them. It
would blow over. They nevertheless accepted his right to make his own decision.

Meyer left by the eastern route through the USSR, made his way to the U.S., got a quick
wartime Harvard BA, and ended up working in American intelligence in postwar Europe.
There, he learned the fate of his family and friends, all of whom died in the camps.

The Opacity Of Unique Events

The falling beam is a metaphor rather than a true event, but it does encapsulate the
rarity and randomness which make the full implication of crises essentially unknowable.
Over a period of time, Meyer had recognized the implication of things that were
happening right in front of his eyes. He had assessed the risk to his own life. He had
assessed the likely duration of the event and the probabilities if he attempted to ride it
out in place. Above all, he had managed to overcome the point of view of his family and
friends who were determined to avoid seeing what was happening right in front of their
faces.

A beam falling from the sky is a perfectly normal event. It has happened a couple of
times in Chicago in my lifetime. This is also true of market crashes, wars, revolutions,
pogroms, and pandemics. They are all part of normalcy in its larger sense. They happen.
They just don't happen very often. They also have a randomness that makes their

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appearance impossible to predict. The next one could arrive tomorrow morning or in a
hundred years. They are not always immediately recognizable. Events that initially
resembled past disasters have often turned out to be false alarms.

Other events have been missed at first by those living at the time, although, with
hindsight, they appear obvious. People at the time didn't see them coming because they
had lived their daily lives by the assumptions, habits, and platitudes, which had
governed the past experiences which got them to where they were. Meyer saw that he
couldn't persuade his family and friends. That would require overturning a lifetime of
everyday experience. His relatives were confident that they understood the world and
knew the odds. Meyer simply left. He was 19.

I was the same age when I created my own falling beam. It was in the middle of my junior
year at Harvard, and I was well on track to the same life of comfortable secure normalcy
enjoyed by Meyer's parents. I took a leave of absence and volunteered for Vietnam.
Harvard had taught me all it had to teach about the path to a successful and comfortable
life, but it had taught me nothing at all about the true nature of the world. I was at
serious risk of never learning. What my life needed was a shaking up. I stepped across a
line, swore an oath, and had the great good luck of becoming a completely different
person.

The main thing I learned in Vietnam was that the definition of normal used by most
people is an illusion arrived at by shoving out of one's sight a lot of important things that
they preferred not to think of as "normal" - this despite the fact that these things happen
every day somewhere in the world. Harvard smoothed out the larger definition of
normal and taught that all you needed in life was to be smart, study a little, work a little,
be prudent, and be nice - plus maybe do a little giving back to the less fortunate. I
resolved never to succumb to the view that this was the whole picture. Over the years,
since that first decision, particularly after getting to know Meyer, I developed a sort of
protocol for responding to unique events:

1. Make an initial assessment of the risk and need for immediate action.
2. Acknowledge what you don't know.
3. Establish a preliminary model.
4. Modify and improve the model as more facts become available.
5. If necessary, take decisive action even with incomplete information.

The above principles include a model for approaching rare events which is based on
Bayes' theorem (you can google it), which involves starting with a premise that may be
somewhat shaky. Bayes statisticians call it your prior, and you continue to make
improvements on it. It works pretty well in the markets, in part because it gives you
permission to change your mind when new facts appear.

In many cases, Bayesian thinking involves the math of a simple equation with data
updated persistently. You will have noticed the use of this Bayesian process in the many
scientific analyses of the novel coronavirus. The math isn't always helpful because of
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barriers to good data, but the Bayes process, even without adequate data, can be helpful
when making judgments based on the facts you have. The following section is about the
way this simple system contributed to my understanding of the present crisis.

My Timeline In Reacting To The Coronavirus Crisis

The novel coronavirus first came to my attention in late January when I read accounts of
events in Wuhan and realized that there was a subtly different tone in these reports than
in accounts of annual seasonal flu. The media always made too much of the flu season in
order to get viewership, but I sense a difference this time. I get the flu shot every year
but otherwise ignore flu warnings. My tennis students have noticed that I never take a
sick day, and I share with my younger students confidentially that I am a visiting observer
from Alpha Centauri 3 and got the whole earth series.

The reality at my age is that I probably still have at least partial immunity for every major
flu starting during my childhood in the 1950s. I actually haven't had either flu or a cold in
25 years, but I suppose I'll learn more about my immune system shortly. At my age, I'm in
the cross-hairs for this one.

One of the first things I looked at included the 1918-19 Spanish flu which killed an
estimated 675,000 Americans in a population then at 103 million. That's about two thirds
of 1% - the equivalent of about 2 million deaths in the current U.S. population. My great
grandfather and two of his sons were among those who died of Spanish flu - a fact
worked out by family members with an interest in genealogy and some knowledge of
history.

The three family members who died were hardy South Carolina farmers, which fit with
research I had read somewhere years before. It explained that, while ordinary seasonal
flu kills a disproportionate number of older people, deaths from the Spanish flu fell most
heavily upon healthy young people. This puzzled the medical community for quite some
time until researchers were able to demonstrate that Spanish Flu deaths often seemed
not to result directly from the flu itself but from its triggering an extreme overreaction in
their immune systems.

I dug up a New Yorker story from 1997 which described an epidemiologist's determined
quest to dig up preserved corpses of Norwegian sailors who died of Spanish flu and were
buried on an island off Norway and above the Arctic Circle. The belated autopsies
confirmed the overactive immune system thesis. I hastened to get up to speed about
"cytokine storms," the deadly hyperactivity of our own defense system.

At this point, the Wuhan flu, as I called it then, had started to get my serious attention.
The question in the back of my mind was whether a pandemic would be worse or less
bad than 1918-19. There was much greater natural social distancing of the population in
those days (we were less urban), perhaps offset by the heightened risk of transmittal by

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millions of returning soldiers coming home from World War I. This abnormal amount of
travel appeared to be a major contributing factor in the much more deadly wave in the
fall of 1918.

In 2020, of course, the level of travel on an everyday basis is larger by orders of

magnitude than the homecoming of a couple of million soldiers spread out over several
months. Offsetting this is the superior knowledge and skill of modern medicine, superior
communication, and the probability of strong centralized government intervention as set
against the piecemeal response in 1918-19 which made cities like Philadelphia which was
slow to lock down have an outcome much worse than cities like St. Louis, which executed
a lock down instantly. Philadelphia actually had a homecoming parade with a crowd of
200,000 to welcome returning soldiers. Along with the advantage of contemporary
research and information is the key advantage of our having the experience of 1918-19
to look back on. We had a shot at avoiding their mistakes. I realize now that this
comparison was my first effort to model the virus event.

On February 11, a Harvard Gazette interview of Chan School epidemiologist Marc Lipsitch
argued that the virus was certain to overrun borders and multiply relentlessly into a
global pandemic. I became the first person at the tennis club where I work to start
wearing gloves to teach tennis and do workouts. I shared my view with colleagues. This
thing is going to run the table, I kept saying, and watched them try to control their
expressions. Had I become a bit of a nut?

Two days later, I sent an email to my wife's cousin, also an epidemiologist, who
confirmed that the thing was coming, was in fact already there in Tehran. The
government was lying about the numbers as the Chinese had done. She was worried sick
about her elderly mother.

So it was real.

The rest of the modeling has been in the news daily from a few days after that exchange
of emails. It's the basic equation of Bayesian statistics - a prior estimate that gets
updated and improved as further information is received. Its problem was and still is
lack of an adequate denominator of actual carriers, which was difficult to know because
hard numbers could involve only those tested or who presented themselves at hospitals.
Without that number, it was hard to calculate either the rate of spread from R-0 or the
percentage of deaths. This accounts for the widely differing range of estimates. Never
mind. By that time, I knew enough to act.

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1. I took the minimum precautions to protect my own health. I did weight workouts
only when nobody else was in the weight room. Understanding that a cart of 300
tennis balls along with several ball hoppers presented an ideal environment for the
transmission of a virus, I set aside my own identifiable hopper and used gloves and
sanitizers in tandem to avoid virus contact. I suggested tennis court distancing and
used drills that avoided close contact. I also became more careful about my diet
and getting plenty of sleep. I spoke to my daughter, a medical professional, about
Quercetin, a supplement I already took which was supposed to be an immune
booster. My daughter, who herself has an immune system disorder, said I should
absolutely keep taking it, though she had more worries about herself than me and
hoped I would look after her children if it came to that. But don't, whatever you do,
she said, suggest it to a lot of your friends because there's an acute scarcity, and
there will be people like me who will die if they can't get it. I offered to send her my
supply, but she personally had enough.
2. On February 19, the S&P 500 peaked. I watched for a few days as it began to slide.
That's the way most crashes start. I started thinking about going through my
portfolio and selling positions that were in the red. I ordinarily do this once a year
in November or December in order to build a tax loss bank. I did a lot of thinking.
On February 25, I sat down at my computer, took a deep breath, and blew out all
positions in my taxable accounts which were under water. It happened that these
were almost all emerging markets ETFs which I had bought over the past six
months or so. They had been up a fair bit at the top and now were down just
enough to be in the red. At that time, they were down about the same amount as
U.S. indexes, but it had occurred to me that they were likely to fall longer and
harder than U.S. stocks. Fine. Click, click, click. I wrote about it here.
3. I started looking at other things. It struck me that, under the worst case scenario,
my state university pension was imperiled. I live in Illinois. I had thought of my
pension as a phantom bond, maybe BBB rated and with a 3% annual inflation
kicker. Considering a lifetime of experience in inept and venal Illinois, I quickly
downgraded it to junk. It registered immediately that having to downgrade a
perfectly wonderful pension was a factor I needed to take into account when
considering my equity/fixed allocation.
4. For the next week, I talked daily with my daughter who told me that half of her
colleagues had children sick with the virus and there was a good chance that within
a couple of weeks there wouldn't be a doctor in western Massachusetts who wasn't
sick. It updated the Bayesian model in my head as to the seriousness of the thing.
By March 3, with the market decline getting steeper, my sense was that the market
was in the early stages of realizing things which I already knew. What would
happen when the market fully grasped the rest of it? With that upgraded
information, I realized that the unwinding of recent buys made sense for my Roth
and Rollover IRA accounts as well. I did another, smaller, round of selling.

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 5. A careful examination of all family accounts reassured me that the cash and near
cash positions were adequate with margin to spare even in a worst case scenario.
This phase of response to the market crisis was complete within a few days. I was
done selling.

Thinking of the pandemic was like thinking about a war. March 3 was probably close to
the end of the beginning. Ten days later, the club where I teach tennis was closed, and I
bought long-term healthy food supplies to wait the thing out with social distancing. My
wife immediately started nagging me about frozen blueberries and vegetables and fish
crowding our freezer. She was afraid they might go bad. She would do the future
shopping, she said.

I explained that they had a shelf life of at least 18 months, and I hoped that they would
go bad because they weren't there for our convenience or shopping safety but as a
precaution in case the supply chain for food temporarily broke down. I also bought
several gallons of rum and several large bottles of high-quality organic lemon juice, so
that I could have a stiff pre-dinner cocktail and tell myself that it was healthy.

Those were the immediate actions dealing with survival issues - first to engage the health
issues then to survive potential large risk in the markets. Here were the Bayesian
updates and extensions to secondary effects presented as a sort of protocol.

1. Study historical comparisons but also note areas in which important variables may
be different.
2. Consider how similar events in the past may generate misleading feedback loops
that change the outcome in the present instance. I remembered in the process
having learned from the historian E.H. Carr that the Bolsheviks, who were steeped
in revolutionary history, coalesced to destroy Trotsky and support Stalin because
Trotsky looked the most like their bete noire Napoleon. Stalin eventually had most
of them shot.
3. Notice details - my wife's cousin's concern for her mother in Tehran.
4. Think of other people who might need your help - my daughter.
5. Consider secondary effects and adjust: new risk to my pension.
6. Jump the gap to anticipate more distant second order events like a potential supply
chain breakdown.

Buying Despite Misgivings At A Short-Term Bottom

By March 23, I was feeling pretty comfortable with the selling I had done. It felt like I had
knocked down my portfolio risk by more or less the right amount. The right number for
me is no particular number but is best measured as the number at which I go to bed at
night indifferent to what may happen the following morning.

My point of indifference also factors in the things that may happen further out - next
month, next year, several years. Over the long term, I tend to be somewhat more positive
about risk assets, but I also reminded myself that a longer period also provides more
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time for unexpected events. At this point in my life (age 75), that future point may be too
distant to matter much. In practical terms, my default allocation tends to be around
50/50, stocks/cash equivalents. I tweak this one way or the other when something going
on in the world drops an extra weight of some kind on one side of the seesaw.
Happiness is going to bed at night feeling indifferent. By early March, I knew that I could
watch the market rise or fall with a shrug.

As the market fell, I made a list of 9 stocks that I would buy at the right price. I have a
personal rule that, when the market falls 30% or more, I will buy something on a modest
scale no matter what I think. During the climactic selloff on March 23, all 9 stocks hit their
buy points - points at which they would have been cheap in the Old Era just ended. I
threw in a little discount to reflect the unknowability of what might lie ahead. All nine
were quality stocks with good defensible niches, low debt, strong cash flow, and
excellent returns on capital. Those things defined the qualities that I think are most likely
to succeed in the New Era.

I slept on it and got up the next morning, sat down at my computer, and bought all 9 in
predetermined size within ten minutes: BANG, BANG, BANG. It wasn't the absolute low,
but close enough. I still put the odds at 60-40 in favor of lower lows, an opinion I
documented in an email to a friend. It was a matter of companies I liked at the right
price.

Two days later, I sold one of them - one of the two medical stocks - at a modest gain. I
had gone over my earlier research and noticed a couple of imperfections. I used the cash
to add proportionately to the others. I thought it possible that I might hold any or all of
them for a long time, but I might also sell. That night going to bed I still had the feeling of
indifference. Good. My portfolio allocation was correct.

Owning the remaining eight felt okay. I still had quite a bit more cash than I had on
February 25. I could go to bed every night with a feeling of indifference about my asset
allocation. (I'll give you a sample with three of the nine stocks I bought, very dissimilar in
market cap and from different market sectors: Alphabet (NASDAQ:GOOG)
(NASDAQ:GOOGL), Stryker (NYSE:SYK) and ABM (NYSE:ABM). Let me emphasize that this
is not a current buy recommendation. They are currently up more the 20%, 30%, and
70%, respectively, and I myself wouldn't buy them at this point even if confident about
the overall market.)

Was March 23 the market bottom? I don't know. Nobody else does either. I began with
the initial model that it was not, but this wasn't a deep conviction. It was rather an
opinion grounded in nothing much but comparison to past severe declines and my
opinion that the market was overpriced to begin with. To the extent that you believe in
technical thinking, it seemed like a bottom you could trade, but it didn't seem to have
either the panic level or the despair that usually comes with really important bottoms.

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The trouble is that the history of market crashes does not contain an event quite like this
one. The recovery was so sharp that, on intermediate term charts, it's hard to separate
the line of the rapid decline and the rapid ensuing rally back up. Unless you are wearing
glasses, it appears like a single line. That hasn't happened in the past except for
mechanically generated flash crashes like the one in 2010.

Alternative Histories And Sample Market Paths

A number of recent series available on Amazon Prime and other apps have involved
alternative histories. Sitting at home, I have watched several, including The Man in the
High Castle (in which Germany and Japan have won World War II) and Counterpart (in
which an accident in an East German lab has caused the world to divide into two, sharing
their history up to the fall of the Soviet Empire but diverging as one of the worlds is
afflicted by a pandemic). Both play to my fascination with potential alternative paths set
in motion by a singular event. Both have plots which might have been generated by a
Monte Carlo simulation.

Monte Carlo simulations are another tool for getting probabilities for future events. The
basic approach is to produce a Monte Carlo simulation in which you enter every piece of
data you have up to the present moment and instruct the computer to spit out randomly
as many alternative sample paths of the future as you want - thousands if you wish.
That's what economists call econometrics, although their focus is a single most probable
path which makes their public estimates seem to me overdetermined. Such forecasts
are useful mainly as a baseline against which you measure surprises - Bayes again.

A key point is that the many Monte Carlo paths are not equally likely. Many fairly similar
paths are bunched near the center of the Gaussian curve, and the extreme paths seem
to be so unlikely that you can eliminate them. It's similar to future paths of subatomic
particles. Photons (light) have probability amplitudes distributed in the same way so that
we tend to see only the amplitudes bunched in the middle, the underlying reason light
particles appear to "know" how to shift direction when moving from water to air.

The problem with purely quantitative Monte Carlo simulations is that there are too many
numbers and too many missing or dubious numbers. Instead, for things like the present
event, it's better to employ a lifetime of personal experience and knowledge, some of
which will be relevant, and some of which will not. What I'm going to do with this
problem is run a make believe Monte Carlo engine inside my own head and ask it to run
off 1000 alternative future histories. I'll give you the three basic outcomes. The most
probable future history has some grim elements, but an outcome with some redeeming
features.

Model Number One

The current rally will fail over a period of 8 or 9 months and the market will fall to
an ultimate low at which it is down more than 50%.

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 The next three months will resemble the worst three months of the 1930s
Depression. There may even be brief bank holidays as banks strain to the limit
keeping up with the things the Fed wants them to do. Most banks will survive and
eventually thrive as long as the Fed acts in good faith with them. I haven't sold my
JPMorgan (JPM), Bank of America (BAC), or U.S. Bancorp (USB).
The recovery will start slowly but begin to improve in many areas of the economy
by late summer, but it will begin to appear likely that a second wave of the virus is
coming. An overreaction by authorities and public panic will lead to a firm
shutdown. This will lead to a sharp but brief secondary bear market. It may
resemble 1938.
Market price earnings ratios will gradually decline for years despite having low
interest rates as the discounting factor for free cash flow. The low PE in 2026 will be
the buying opportunity of a lifetime.
A massive rebuilding of infrastructure along with a Green New Deal will combine
with a high tech military buildup to get people back to work. It will be the core of a
Congressional compromise on fiscal stimulus. This infrastructure spending will set
off a massive economic recovery and a return to modest inflation starting at 2%
and creeping slowly to 3% after a decade. Helped by the lock downs and the new
habits it created, we will have some success in slowing down climate change and be
happy to have spent money for it and created jobs at the same time.
International integration of business and supply chains will gradually resume but
at a much reduced level. Most Americans won't give a twopenny damn about
people in other countries, but some will lie about it. Many will attempt to care
more strongly about other Americans of all origins, beliefs, ethnicities and class.
Those who have survived to this point will be careful with money and focus on
basic things for decades. This is bad news for businesses dependent on aggressive
consumerism. Parents will pass their world view along to their children and
grandchildren. Many people will be surprised to learn that they are happier.

The closest historical analogue to this model is the 1929 Crash followed by the Great
Depression, World War II, and the brief inflation, then recession, which followed. These
events took place between 1929 and 1949. The difference in the current event is that
time will be compressed. What happened over twenty years will happen over six or
seven but with long after-effects.

Fairly close variations on Model Number One represent about 60% of simulated
outcomes with 400 of on the negative (left) side of the peak of the bell curve and 200 on
the positive (right) side.

Model Number Two

In this simulation, the U.S. will resemble Germany at the end of World War II. The
German version fits the long U bottom most feared.

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 In the beginning, every imaginable mistake is made, and the effort to get money to
ordinary citizens is too little and late. With no one able to buy, the corporations
that received money soon run out of it and a shocking number of businesses
collapse.
The first three years are an unmitigated disaster. Supply chains break down. Some
people live by barter, and many of those who had been solidly middle class drive
many drive miles into the countryside to exchange valuable belongings for food.
Farmers' markets crop up everywhere and there are long lines.
Instead of statistics, let me summarize a three page short story written by German
writer Wolfgang Borchert in 1946. The title is Das Brot (The Bread). A husband
sneaks down in the middle of the night and cuts himself a slice of bread from their
meager bread ration. His wife follows him to see what is the matter, he makes an
excuse, and they have a brief conversation which carefully and awkwardly avoids
the subject. Lying in bed his wife can hear him chewing. The next evening after
serving each plate the two allotted slices of bread, his wife gives him one of hers,
saying the bread just doesn't go down well for her in the evening.
In this version, we all learn things about one another we had hoped never to have
to learn. People sink into collective depression and wander around aimlessly like
zombies.
In the majority of versions that most resemble the actual outcome in post-war
Germany, economic leaders like Walter Eucken and Ludwig Erhard (later Chancellor
of West Germany), prevail in a power struggle, and reform the economy using a
split model of free market economics and a social welfare system as well as
banning cartels and monopolies. It comes too late for Wolfgang Borchert who died
in 1947 at the age of 26 and never knew that he would be recognized as one of the
era's greatest writers.
In this model, the U.S. is reestablished as the envy of the world, and seems to have
actually benefited from the difficult years. Some historians recall the fact that
twenty years after WWII many American competitors claimed that the Germans
and Japanese actually had an advantage in rebuilding their industries from scratch
with the newest technology. This time, it benefits the U.S.A.
In the most pessimistic version of Model Two, the brilliant and strong-willed
economic reformers do not prevail. This is the worst of all outcomes, but as I write
this, the probability of this Model appears to be diminishing, falling below 10% even
in its milder forms.
Hardly worth thinking about? Well, I am afraid that there are quite a few less
fortunate people who will live through a version of the Borchert short story in both
Model One and Model Two. Fortunately, the next Model is much more optimistic
and may occur as much as 30% of the time.

Model Number Three

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 The Fed improves its own model of what is happening, and the Executive branch
and Congress also improve their grasp of the situation. All act more quickly on
much larger scale, attach less importance to their ideological differences, and make
compromises. All look less to the next election and more to the place they will have
in history.
The first entity to see this on the way has been the financial markets. The rally that
began on March 23 is real and will continue. The yield curve remains positive and
actually steepens significantly. Absolute rates rise slowly but steadily. The stock
market never undercuts the recent lows. Incredibly, it rises to new highs despite
the drag of a number of companies which sink into various levels of reorganization.
Most survive but wipe out common shareholders.
On the face of it, the stock market approaching its all time high strikes many as a
reductio ad absurdum. How can that be reasonable? Then, a possible meaning
begins to occur to a few analysts. The Fed has exceeded $15 trillion in various
survival and stimulus programs with more on the way. Congress is well on the way
to a compromise to pass and implement massive infrastructure and Green New
Deal programs. The money in circulation is exploding.
Businesses like the explosion of money, and the market likes it even more.
Commodity prices are rising big time, and everything measured against money
begins to go up in value. Many people are already doing better than they were
before the crisis and the persistent threat of deflation is over.
Here, this model bifurcates sharply. In about a third of the scenarios serious
inflation arrives within the decade. For all other scenarios, inflation roughly offsets
the deflationary undertow present in the recent past and the two opposing forces
recede at more or less the same rate. Nobody cares. All you have to do in life is
survive and prosper one day at a time.

These three models are simply the ones which with variations seem most likely.
Variations of the three sit on a smooth curves which has the familiar bell shape. The
future will resemble the past in many ways, but a few things will have changed
enormously - including some social customs that bear upon the economy and others
that will bear upon our personal lives.

The thing to remember about models is the exchange between the military commander
and his weatherman. The weatherman told the general that the weather forecast was so
doubtful as to be worthless. The commander replied that it didn't matter, they still
needed the model for planning purposes. Thinking about it that way, a wildly inaccurate
forecast is nevertheless a very constructive first step.

For now, I'm sticking to Model Number One, as wildly inaccurate as it may be, as the
framework on which to operate going forward with Bayesian adjustments as new facts
appear. I'm also continuing to watch events involving the banks I own and the nine
stocks I bought on March 24. I'm keeping open the possibility of selling, but probably tilt
in most cases to holding even as/if the rally begins to fail. My odds for a lower low remain
about where they were on March 24: 60-40 in favor of an ultimate lower low.
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Cast A Cold Eye
Recent studies suggest that climatologists were slow noticing the early evidence of
climate change because they tossed out brief instances of exceptionally high
temperatures as "outliers." They reasoned that the outliers were so intense as to distort
the expected smooth curve and thus should be removed. Modern statisticians know
better. It is almost always a mistake to throw away outliers just to give a smoother shape
to the curve. Outliers are a very important part of the normal.

This very important principle applies equally to all abrupt life-changing events - beams
that fall from the sky. We leave them out of the model we shape for our lives because
they are so abrupt and inconvenient. A few people never really encounter one. We
therefore establish a false dichotomy between rare events and normalcy.

Over the periods of our lives that fit the narrow definition of normal - the smoothed
curve - we absorb thousands of observations and create thousands of habits and
patterns of thought that apply in similarly tranquil periods. We also come to feel that the
worst things that can happen are things like lost love, business setbacks, rejection by a
friend, a sports injury, an illness or condition with some lingering consequence, or the
death of a loved one. It's only natural to be absorbed by the small departures from the
everyday which, positively or negatively, fill our lives.

One of the effects of being immersed in everyday ups and downs is that there is a lead
time before we allow ourselves to believe that the world may have fundamentally
changed. We know that things change, but expect it to happen in a way that gives us
plenty of time to ruminate before we have to take action. How can a few facts over the
course of days, weeks, or months overturn everything we know from personal
experience?

The key takeaway here is that really large and important events which happen
infrequently are nevertheless part of normal human experience. The other truth is that it
is often important to engage such events immediately. The entire body of our past
experience resists both the recognition and the action. Is it possible to counter-program
that tendency?

The army thinks so. The British army and the U.S. Marines are both notable for intense
drill and repetitive training in firing a rifle accurately. In the case of the British, it grew
from the observation that firing a rifle at another human being stood so far outside the
range of ordinary experience that in wartime the majority of infantrymen never aimed or
fired their rifles at all. That's the primary purpose of regimentation and drill - getting you
to forget everything you have learned in your previous life and automatically do the right
thing in combat. The eminent military historian John Keegan wrote about this in several
of his books, including The Face Of Battle.

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Meyer and I were each presented with events which forced us to accept the new rules of
rare events at an early age, 19 in both cases. I continue to marvel at the fact that he put
together his own playbook while staring at a park bench. We both left lives which offered
"all the appurtenances of successful living," as the detective said of Flitcraft. Meyer left
everything. I volunteered for Vietnam. We both had good luck. What we both learned -
what Meyer may have known a good bit about to start with - was to look at the world
coldly and at a distance, identify the facts, and take decisive action.

I hope readers, most of whom will be younger than I am, will find some potential
guidelines here which will help them develop their own rules and playbooks for getting
through this event.

For younger people facing the first major out-of-scale crisis of their lives, my best advice
is to remember the most common soldier expression when bad stuff went down in my
war: It's a normal day. I have felt bad for my own children that they never had the
opportunity to experience such an event in their youth. You have that opportunity. Make
the most of it.

Disclosure: I am/we are long GOOG, ABM, SYK, JPM, BAC, USB. I wrote this article myself,
and it expresses my own opinions. I am not receiving compensation for it (other than
from Seeking Alpha). I have no business relationship with any company whose stock is
mentioned in this article.

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