Sunday, April 13, 2014

Meeting Minutes



We had a wonderful meeting of minds at La Madeleine’s.  We had 4 attendees: (from left Jeff Harrington, VJ Arjan, Tommy Schultz, and Ry Zamora who also joined us later on.


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A quick note about the hiatus: For 3 months in a row, Mother Nature decided not to be kind to our Scarlet Kings meetings.  It seemed that every time we had scheduled our meeting there was either ice, or snow, or hail, or all three.  For whatever reason, the Weather Gods had decided to punish us, but thankfully after numerous lucky Rain Dances to appease the Weather Gods, we were able to regain their favor and the weather was back to normal on this past Sunday the 6th.  : )


Oculus Rift and the Next Wave of Virtual Reality


Facebook made headlines recently by buying Oculus Rift for $2 billion.  (It also bought Whats-App for $19 billion, which Jeff mentioned it probably did for its subscriber base as opposed to the actual instant messaging platform.) 

Followers of our blog would know that the Scarlet Kings have been discussing the Oculus Rift for several months now as a potential industry game-changer (no pun intended).  We all discussed how Facebook could potentially utilize Oculus Rift and also the virtual reality wave to come.

For those who have not been adequately introduced to the Oculus Rift, it may be a good idea to see some videos on YouTube.  To call the virtual world, virtual, would actually be a misnomer. The world within the Oculus Rift is so real that those who stay in the virtual world long enough not only grow accustomed to it but also have some trouble distinguishing between that world and the real world.

Although we had some trouble coming up with exactly how Facebook would intend to use this technology, we figured that the worse-case scenario would be that it would lease this technology for royalty income.

Tommy mentioned some of the uses of virtual reality and why it is going to be so huge.  For one, it allows people to experience a setting anonymously.  A particularly specific instance would be, for instance, a college student who is writing a paper on the Middle East and wants to experience virtually a Hajj (holy pilgrimage) in Mecca, Saudi Arabia while not assuming the cost or the safety risks of going to Saudi Arabia itself. 

Jeff mentioned that one of the drawbacks of virtual reality is that it only satisfies one of our senses, sight.  It leaves something from the user to be wanted if it cannot touch or smell. 

However, even this may not be long in coming.  Recently, life scientists at the University of Louisville have been able to help paralyzed patients walk again through spinal shock treatment.  The stimulation from the electric shock allows the person to reconnect nerves that allow for movement.  The question then arises, it is possible to use electric shocks to simulate sensory perceptions as well?  Could an electric shock to a certain part of the brain simulate the sensation of touching or smelling in a virtual world? Well that seems to be the implication these scientists may have come to.  A video is attached below so you can see this miracle for yourself:



Also, with the development of artificial intelligence, it is entirely possible to deal with objects in a virtual reality as if they were humans.  This can be seen today in the use of AI characters in video games.  In these games, the characters are using artificial intelligence software to interact with the gamer.  Tommy mentioned that several of these have passed the Turing test, which is a measure of a machine’s ability to exhibit intelligent equivalent to that of a human. One such example would be the HK-47 droid in the game Star Wars: Knight of the Old Republic (video of the HK-47 droid is attached below). 



http://www.youtube.com/watch?v=ooak56OSUWM

Incredibly, continued Tommy, this is just the tip of the iceberg.  Soon there could be virtual classes on how to shoot a bow and arrow, or virtual classrooms, or even virtual workplaces.  The ramifications and scope that this technology could extend to are almost limitless.  It could very well be reminiscent of the virtual world portrayed in the movie The Matrix.

Tommy went on that over the next few years there would emerge 2 types of people.  One type would buy into this virtual world wholeheartedly and would decide to function in this world and another type that doesn’t and chooses to remain in the real world.

Eventually there could be machines that would be intelligent enough to deal with every single aspect of our lives.  Recently Amazon’s CEO, Jeffrey Bezos, stated in his earnings call last week that Amazon is developing technology for drones that would deliver its packages to its clients in 30 minutes or less.  These drones are in the final stages of testing and should be able to deliver packages very soon (assuming that the legal hurdles have been overcome).

This poses the potential question, years and perhaps decades from now – Do people, therefore, become obsolete?


Russia and the Ukraine


Putin with Ukrainian counterpart Yanukovich

Of course, we had to discuss the topic of what is currently happening in the Baltic region.

In short, here is what is happening: The Russian army is moving into the Crimean part of the Ukraine; the international community has responded by denouncing the Russian government’s actions and also by imparting economic sanctions.



There are a few points that we discussed:

-       80% if the Russian federal budget comes from oil and gas exports to Europe.  A long-term European sanction on Russian oil and gas would cripple the Russian economy.

-       One of the great interests Russia has especially in Crimea is a naval base, Sevastopol, which is protected by a treaty and also happens to be the only Russian navy base that is liquid all year round and doesn’t freeze over.

-       The Crimean region of Ukraine is composed of mostly ethnic Russians, hence the over 90% approval to annex itself to Russia.

-       Russia, which has been anti-NATO for decades, will do anything in its power without inciting too much animosity to prevent Ukraine from joining NATO as it serves as a geopolitical buffer between the NATO-states and Russia.

-       Russia is playing a weak hand.  Due to the incredible inefficiencies that still exist in the Russian economy, the cost of oil production in Russia is around $100 a barrel.  The potential to inject huge financial resources to back their political ambitions are lacking thereof.

Here is what may happen.  Jeff mentioned that the country of Ukraine, outside of Crimea, is hotly divided as well.  The eastern part of Ukraine is pro-Russia and the western part is pro-Europe.  Ukraine may, therefore, be permanently divided.  This would particularly be the case should there be a decision made to join NATO.  Certainly that would antagonize Russia even more and would lead to further military embarkations.


Who is Tony the Tiger looking at?



It is certainly fascinating observing the psychological ploys of marketers.  Jeff mentioned the amazing Cornell study in which researchers found that of the 57 boxes of cereals in the cereal aisles, 51 of them had their cereal mascots looking downward, aimed squarely in the light of sight of children 48” and under.

These researchers found that “trust level goes up about 18% if you make eye contact with anything.  This is even simply a picture on a box, but also increases your likelihood to want to purchase the cereal.”

Here is a link to a video describing this study in more detail:



Mt. Hoax


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In February, Mt. Gox, one of the largest exchanges for Bitcoin was shutdown by federal authorities and had to declare bankruptcy.  It is estimated that nearly $500 million worth of bitcoins was wiped out.

Jeff mentioned that although Bitcoin allows its owner to circumvent the banking system and is a way for its owners to remain anonymous, Bitcoin is still a very flawed form of currency.  He mentioned that large drug emporiums and cartels, like the Silk Road marketplace, have used Bitcoins to cover their tracks and conduct business without the oversight of the law.

Mt. Gox was initially founded in Japan as a card trading exchange – “Gox” literally standing for "Magic The Gathering Online Exchange". 

Jeff believes, however, that should financial corporations ever begin to create derivative contracts for Bitcoin, it could become a legitimate currency.  Governments would do everything they can to prevent Bitcoin from succeeding though, as the ability to print money is one of the most profitable things a government can do.


Monkey Economics, Freud and the Animal Subconscious



“Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.” – Albert Einstein
“We are the middle children of history, with no purpose or place. We have no great war, or great depression.  The great war is a spiritual war.  The great depression is our lives.  We were raised by television to believe that we'd be millionaires and movie gods and rock stars -- but we won't.  And we're learning that fact.  And we're very, very pissed-off.” – Tyler Dearden in Fight Club

We entered into a philosophical discussion regarding essentially why people behave the way they do, particularly why do human beings as intelligent as they are, repeat their mistakes over and over again?

Human stupidity is so fascinating for some that there are even organizations, like the Darwin Awards (www.darwinawards.com), that collect tales of such instances and keep records them on the internet.

Tommy brought up a TED talk on monkey economics.  It is an absolutely fascinating video, and it is reproduced here for your viewing:



The gist of the talk is this.  Researchers at Yale University designed a simple financial market for monkeys to see whether monkeys would behave similarly to humans in certain circumstances.  One of the circumstances tested was the monkey’s behavior involving loss aversion.  For instance, let’s take 2 scenarios:

-       Scenario 1: You have $2000, and have a 50% chance of losing $1000
-       Scenario 2: You have $2000, and have a 100% chance of losing $500

Most people would pick option 1 because even though the probabilities are exactly 50% for each scenario, people would rather risk losing $1000 to have a chance of losing nothing at all.

Long story short, it turns out that monkeys, like humans, also suffered from loss aversion just like humans do.  It may be, therefore, that the reason behind humans repeating financial mistakes over and over again may have something to do with our biology and an ingraining of our predication for having a certain behavioral bias over several, several millennia.

VJ mentioned that Freud was a huge proponent of the subconscious mind and that deep within every “refined” human being is still the potential to behave like a pure animal.  He mentioned that this is especially the case when a person’s survival is at risk – if there is a risk of losing food, shelter, etc., then so-called “intelligent” humans can become instinctively compelled to do very unintelligent things.  It also happens to turn out that when having too much of a survival commodity can end up making us do unintelligent things as well. For instance, when we have too much money, there is an instinctive desire to have more, also known as greed.

Some of the most human irrational behavior can be found in a crowd.  In a crowd or due to social pressures, people can do the most incredible things.  There is a common saying among investors regarding “following the herd” or “following the public”.  It is certainly interesting to note that the public has been usually on the wrong side of the market, time after time throughout history.


Which way from hither Mr. Dow Jones?

“Numbers don’t lie, people lie about numbers.” – Kevin Day

No meeting of the Scarlet Kings would be complete without asking where the market may be headed from here. 

Although some economic reports like producers index and consumer sentiment seem to be improving, the market seems unable to break into new highs – this is especially the case for several large cap staple companies like Apple, Coca-Cola, Wal-Mart, McDonalds, etc.  Ry mentioned, however, that the economic data is only going to be as good as how truthfully it has been disclosed. 

Going back to the previous topic about “following the herd”, we may even start seeing the beginning of analysts looking at reports with rose-tinted glasses.  Untruths or exaggerations of the truth have the habit or tendency of popping up towards the end of bull markets – so we will have to see whether people will start lying about the numbers or not.



On the heels of the meeting, the latest payroll report was also less than flattering.  It seems that there may be some stalling regarding corporate hiring due to the cost cutting and restructuring measures that several corporations have been engaging in to deliver higher profitability.  Revenues, however, are not growing and are being revised downwards over the next year or so.

The consensus was that even though on the surface the market looks okay today, there are reasons to be concerned and cautious.  The current bull market is the 3rd longest bull market in U.S. history.  

That being said, there are indications that housing could lead to another leg of the continued recovery before this run ends.  Jeff explained his case for a shallow correction in the midst of a rotation out of momentum stocks. He went on that the momentum crowd includes tech, which is a mild bubble across the sector while some if the concentrated momentum stocks are out in fantasy land. Every correction so far has been a launching pass for future runs. His attention has been on the P/E ratios, which indicate the overall market is about fairly priced (not cheap, not overpriced). 

Earnings are important because they make up the 'E' in 'P/E' and the bar for this quarter has been set too low, in his opinion. Many leading economic indicators are also moderate to strong. Also, last month's employment retort saw the economy return to its employment peak set before the crash of approximately 116.3. In other words, we have recovered all of the jobs lost during the recession. He does not see the economy stalling, so any correction, to him, will be shallow.

Still, anything can go wrong.  Oftentimes, it is not just the overvaluation of equities but an external event that can serve as a catalyst or excuse for a selloff in the market.  At the moment, it seems that investors are in the market as there is no other safer place to put their money.

Although we do not know when the correction could take place, we foresee anywhere between on the low-end,10%, to high-end, 40% correction to take place when it comes.  The key for all of us is to avoid the “Deer-in-the-headlights” syndrome and to proactively prepare should that time come, so we can adequately protect our assets.


From Omaha, Nebraska…



“From the CenturyLink Center in Omaha, Nebraska, USA - Ladies and Gentlemen…..Leeeeeeeeet’s get ready to rumble!!!” – Ring announcer Michael Buffer (if he ever attended a Berkshire Hathaway meeting)

Ry and VJ will be attending the Berkshire Hathaway Annual Shareholder’s Meeting in Omaha, Nebraska so, unfortunately, there will be no meeting next month.  On the bright side however, there should be lots of pictures, videos, and notes that will be uploaded for you all so you can experience the “Buffett Shrines” for yourself : ).



The next meeting, therefore, will be on Sunday, June 1st, 2014. 

For those who have not attended a meeting, but would like to attend, please email your wish to VJ Arjan at scarletkings@gmail.com


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