Jesse Livermore: The Search for the Truth with the Anonymous Master – Invest Like the Best

Check out the Invest Like the Best Episode Page & Show Notes

Key Takeaways

  • The 3 main forecasting tools – intuition, analysis, statistical inference
  • Jesse believes the cyclical nature of the market will slow down, which is good because it will reduce the boom-bust cycle and thus reduce market panic
    • “I think inflation will be low forever. I think interest rates will be low forever.”
  • The problem with depreciation is that it’s calculated against the historical cost of assets and not the replacement cost
    • A historical cost calculates the cost that was paid for the asset
    • A replacement cost (market value) calculates the cost it would take to replace the asset
  • Praise in public, criticize in private
  • Fulfillment = progress + meaningful work 
  • Markets should be more expensive than they were in the past
    • People should expect lower future returns and valuations to stay high 

Intro

  • Jesse Livermore (@Jesse_Livermore) is one of the stars of the financial twitter universe who writes anonymously and goes by a pseudonym

Who Is Jesse Livermore?

  •  Jesse Livermore is an alias for an anonymous Twitter account that shares financial research and thoughts about the markets
  • Jesse began to dabble in investing while attending college
    • After college, Jesse joined the military and then went to grad school – while there, Jesse’s fascination with investing skyrocketed
      • After graduating, he took a STEM job just to make more money so he could do more market trading
  • Jesse uses Twitter to share his thoughts on the market and discuss investing with other people
    • He also has his own blog

The 3 Main Forecasting Tools

  • Investing is about making good inferences and forecasting – there are 3 main tools people use:
    • Intuition
      • Pros: Low-cost tool that gives you an answer based on past experiences and pattern recognition
      • Cons: Non-transparent, somewhat of a black box.
        • Works best when you have a lot of experience and are in noncomplex environments
    • Analysis
      • Pros: Don’t need a lot of data and can be applied to regime changes to draw a conclusion, can deal with unique cases and changing variables, is transparent
      • Cons: Easy to be wrong if you just miss a single variable
        • It’s also easy to use a story to convey a theory that may be incorrect – make sure to test your analysis and add a margin of error
    • Statistical inference:
      • Pros: Able to test things in a reliable way at low-cost, closer to reality than other tools
      • Cons: You need to have the correct sample size or trial size – if you get heads 10 times in a row, it doesn’t mean it’s a weighted coin, but if you get heads 1,000 times in a row – it certainly is.
        • You have to be careful of random variables that are actually independent and don’t matter – the color shirt you wear won’t affect how many times you get heads on a coin flip

Thoughts On The Market

  • Jesse views asset markets as banks:
    • Valuation is a function of the returns you demand, liquidity, and structures of confidence (where everyone believes they can take out their positions when they want to sell)
      • As an economy evolves, these structures will grow to become more effective and people’s confidence in them will rise as well
  • Jesse believes the cyclical nature of the market will slow down, which is good because it will reduce the boom-bust cycle and thus reduce market panic
    • “I think inflation will be low forever. I think interest rates will be low forever.”
      • There is enough data to suggest that inflation will be back anytime soon in the U.S.

Calculating Depreciation

  • Depreciation is the cost of maintaining current assets from wear/ tear and obsolescence
  • The problem with depreciation is that it’s calculated against the historical cost of assets and not the replacement cost
    • A historical cost calculates the cost that was paid for the asset
    • A replacement cost (market value) calculates the cost it would take to replace the asset
      • For example, if you bought a piece of land for $10,000 over 30 years ago, it’s likely that today the land is worth several times more (replacement cost) and not just $10k (historical cost)
    • This is a problem in U.S. accounting because companies calculate the initial payment for the asset (historical cost) and not the replacement cost (current market value)
      • During periods of high inflation, the price of asset depreciation becomes very understated and thus earning becomes overstated
        • Because past earnings may have been overstated due to inflation, it’s a mistake to apply historical data and average it out to calculate the current market value 

Jesse’s Research Takeaways

  • There’s no empirical way to measure depreciation – you have to use accounting models 
    • Depreciation needs to account for the physical decay of assets and also the competitive decay of assets
      • Ex. – If you buy a Kodak camera if can last for 10 or more years but since technology is constantly improving, the camera will likely be outdated in 3-5 years 
  • Whether you are a discretionary investor or quant investor, you need to use free-cash-flows in your models – it’s one of the only ways to calculating misstated earnings  
  • Markets should be more expensive than they were in the past
    • People should expect lower future returns and valuations to stay high 
      • Expect opportunities to buy cheap to stay restricted going forward

Lessons From The Military

  • One big lesson from the military – praise in public, criticize in private
    • Everyone’s status matters to them, be careful not to challenge rank or cross lines in public
  • Build incentives that reward different opinions and ideas without criticizing coworkers in public
    • You don’t want to make your peers into enemies by criticizing their work in front of others, but you do want to be able to challenge ideas because it’s possible the person is wrong
      • The ideal scenario: Whenever someone gives a presentation, have all of the employees jot down the biggest weaknesses in the proposal and privately send the notes to the boss
        • This preserves everyone’s ego, allows peers to earn points with the boss, and provides feedback to the presenter to allow them to improve their idea

Additional Notes

  • It’s usually better to have a simple model instead of a complex one because there are fewer things that can go wrong
  • If earnings are overstated during inflation, and if there is always inflation, that means earnings are constantly being overstated
  • The trend in the unemployment rate is a good indicator of when recessions start and end
  • Jesse’s most viewed blog post of all time: The Single Greatest Predictor of Future Stock Market Returns
  • Fulfillment = progress + meaningful work 
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