Mohamed El-Erian,CEO of Pimco explains Banking Crisis using McDonald’s take out window example

There are very few people who know how to explain complex things in very simple terms that any layman can understand. In my previous posts I have saluted people like Paul Krugman for explaining Sub Prime bust and Prof. Hans Rosling. Here in an excerpt from an interview Mohamed El-Erian, CEO of PIMCO gave to Fortune where he explains very well the 2008 banking crisis.

What really happened back then?

You go to a McDonald’s. You order, you go to one window, you pay; you go to the next window, you pick up your food, and you go. You normally can do it within 30 seconds.

Now imagine the following. There’s a payment window where you pay, and there’s a settlement window where you take the burgers. Now imagine that you go to the first window, and they tell you, $5. You say, “Where’s my food?”

And they say, “It’s at the next window.” You say, “I heard what happened at Lehman yesterday. At Lehman someone paid but didn’t collect. So I want my food now.” And they say, “I can’t give you your food now.”

The whole system is built on trust — that you’re going to trust for 10 yards. And you say, “Well, that’s what Lehman did. I’m not going to do that.”

Now what happened to that system? First, you go away hungry even though you had money. And the second window has the food but can’t sell it, so the food goes rotten. The system breaks down because no one trusts 10 yards between the first window and the second window.

That is what happened after Lehman. It was the most amazing thing, where nobody trusted what we all take absolutely for granted, and therefore you couldn’t match people up. That’s why we saw these amazing collapses around the world.

Sub Prime / Real Estate bust explained

Here is how Paul Krugman puts it.

You don’t know anything about the cows that contributed body parts to your package of ground beef, so you have to trust the supermarket when it assures you that the beef is USDA prime. You don’t know anything about the subprime mortgage loans that were sliced, diced and pureed to produce that mortgage-backed security, so you have to trust the seller — and the rating agency — when they assure you that it’s an AAA investment.

But nothing can explain the mess better than the funny video below.

Why I moved to Bay Area?

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Can I make 20% returns consistently in technology stocks?

I was posed with this very simple looking question, but more I thought about it the more I realized that the answer was not simple.

 The problem here is how do we define ‘consistently’? We know it is cannot  be ‘guaranteed’ because that will be ‘risk-free’. So it boils down to how much risk (read – portfolio fluctuation) you are willing to take before you bail out of your stocks. To answer this question I looked back last 10 years and collected 506 tech companies that satisfy the following criteria

  1. The company is in the ‘Technology Sector’
  2. The stock was trading from Jul 1997 till Jul 2007, That means no new IPO companies like Google were considered.
  3. The stock was traded in NASDAQ, NYSE or AMEX market (no OTC).

So I should point out that there is some ‘survivor bias’ in our collection logic, and we are also ignoring companies that merged or were bought out. The following chart shows the Risk vs Return Efficient Frontier for these 506  stocks.

Annual Returns of Tech Stocks

Average Annual Returns of Technology Stocks from Aug 97 to Jul 2007

Let me point out some interesting observations.

  1. If you held all these companies in your portfolio for all the 10 years (and invested equally in all of them in Jul 1997) your average annual return will be 24% (Yeah!) but you will see very large fluctuations in your fortune (ie will take a lot of risk). Your annual returns for the entire portfolio will fluctuate from 107% (in year 2000) to -25% (years 2001, 2002).
  2. In the same period the S&P500 companies returned only 10% but saw lesser fluctuations.
  3. The more interesting observation is made when you compare the individual stocks with S&P 500 risk/returns. Look at the stocks above the red dotted line passing S&P500 point. All the stocks above this line are those stocks which give better risk/return tradeoff compared to S&P500.
  4. The stocks closer to the top curved efficient frontier line are better performing stocks than those below them.

So to summarize, Yes you can make 20% in Technology stocks (looking at history) if you have a stomach to stay in the market. You also need to select a broad basket of stocks. I have not thought how you could have identified the winner stocks ahead of time, but for the curious here is the list of stocks that did better than S&P500 risk/return tradeoff. A lot of unknown names here for me, and more importantly most of the names I would have thought to be here are NOT! So there is a high chance that we may end up picking the wrong stocks.

 Winning Stocks
ANSYS INC
ELECTRONIC ARTS INC
APPLE INC
QUALITY SYSTEMS INC
SCANSOURCE INC
FACTSET RESEARCH SYSTEMS INC
DAKTRONICS INC
MESA LABORATORIES INC
COMTECH TELECOMMUN
INTUIT INC
ANIXTER INTL INC
PROGRESS SOFTWARE CORP
NAPCO SECURITY SYSTEMS INC
SYMANTEC CORP
DST SYSTEMS INC
AFFILIATED COMPUTER SERVICES
INNODATA ISOGEN INC
AEROFLEX INC
EPIQ SYSTEMS INC
MICROS SYSTEMS INC
RIMAGE CORP
AMPHENOL CORP
ANSOFT CORP
CAM COMM SOLUTIONS INC
THQ INC
O I CORP
CACI INTL INC  -CL A
POLYCOM INC
YAHOO INC
CASS INFORMATION SYSTEMS INC
NATIONAL INSTRUMENTS CORP
DIODES INC
ADOBE SYSTEMS INC
FISERV INC
CITRIX SYSTEMS INC
CDW CORP
MEASUREMENT SPECIALTIES INC
MANATRON INC
MICROSEMI CORP
SILICOM LTD
NCR CORP
ROFIN SINAR TECHNOLOGIES INC

Disclaimer:  All the views in this blog are strictly mine and does not represent my employers.

Creativity and Age

Mark Andreessen has an interesting blog today on Age and the entrepreneur, part 1: Some data.

In this he discusses if age is a factor on entrepreneurship. I am interested in its more general form of ‘Is creativity affected by Age’ and he refers good scholarly work by a professor of psychology at University of California Davis named Dean Simonton .

My key personal takeaway from this.

creativity is a function of two underlying factors, enthusiasm and experience. Enthusiasm provides the motivational force behind persistent effort, yet enthusiasm in the absence of the second factor yields just original work. Experience gives the achiever the ability to separate wheat from chaff and to express original ideas in a more intelligible and persistent fashion. Yet experience in the absence of enthusiasm produces merely routine contributions. Genuine creativity requires the balanced cooperation of both enthusiasm and experience.

This is exactly what I have seen in my 10+ years of managing innovative project teams. When forming project teams responsible for great innovative work, make sure you have

  1. Young blood that is very enthusiastic, creative and bold to stand against opposition.
  2. Experienced people who are open to new ideas and are not rigid about hierarchy.
  3. Make sure project teams are flat in structure, don’t make yound people report to old people.
  4. In meetings, always make sure everyone point is heard, and create an environment where you enforce the benefits of experience without of the box thinking and give both equal weightage.

Gapminder.org – Data Visualization Techniques

I have never seen a data visualization technique as impressive as this one. If you have not seen http://www.gapminder.org check it out. As a preview here is a presentation given by Prof. Hans Rosling at the TED conference in 2006.

I salute Prof. Hans for starting this initiative.

Google street view and its grand daddy

I have personal interest in LBS (Location Based Services), GPS etc. And recent release of Google Street View (copy of A9)  rekindled them.

This interest led me to this beautiful ‘Inexpensive Video Panaromic System’

Its amazing feet in just 6 weeks by Bill Meikle.

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