Two Roads to Contrarian Practice

The old proverb The road to hell is paved with good intentions has roots in human psychology, in perfectionism (Powers 2005) [1] and ethical intent valuation (Kruger 2004) [2]. The Powers study indicates that perfectionism backfires:

The results of both studies revealed a significant backfire effect of the implementation intentions on goal progress for participants high on a particular dimension of perfectionism (socially prescribed perfectionism). These perfectionists reported doing significantly worse at reaching their personal goals when they were asked to formulate implementation intentions than when they completed a control exercise. There also was evidence that implementation planning aroused negative affect for socially prescribed perfectionists. These results are the first to suggest that implementation planning may be contra-indicated for individuals with self-critical tendencies.

Kruger and Gilovich have argued that

Actions and intentions do not always align. Individuals often have good intentions that they fail to fulfill. The studies presented here suggest that actors and observers differ in the weight they assign to intentions when deciding whether an individual possesses a desirable trait. Participants were more likely to give themselves credit for their intentions than they were to give others credit for theirs...

But these studies, which cover only part of the phenomenon, may fall short in other ways, as pointed out by (Gioia 2021)[3]:

The assumptions we have typically used to formulate our theories and conduct our research have led us to be seen as irrelevant by an audience we should want to engage. Consequently, our approach to research and writing has put us on a road to hell. 

In other words, the intentions of researchers may be good, but their results, well...

So let's step away from academics for a moment. After all, you and I could probably come up with better stories about why this is true: People plan to be better than they actually are, and they fail to make sure that what they are doing is actually a good thing in its outcome. That happens because generating the intended result is hard. Having an intention is 100 times easier than following through in full, measuring the result, checking, and having the outcome audited by a third party. If you are measured by your words rather than outcomes, which is usually the case for most elite public intellectuals, then outcomes don't matter much to your reputation, salary increase, or Twitter follower count.

The Road to Heaven

One can take Nietzsche's aphorism from Twilight of the Idols

Out of life's school of war: What does not destroy me makes me stronger.*

and use it to flip the traditional proverb on its head to get

The road to heaven is paved with the bad intentions of others.

This a near-perfect copy of one of my first tweets on Twitter, and remains pinned today because I still feel it is subtle and profound. What this says is

When circumstances, the universe, or other people put obstacles in your path, your ethical and thoughtful response to them not only sets you up for success, but gives you moral authority and superior character.

This seems to be easily misinterpreted. Typically, someone will come with a Nazi-based example or a health problem to disprove it. But notice that by contradicting the saying or attempting to thwart it with rhetoric, they are fulfilling the implied prophecy of success through prolonged conflict!

The point is simply one should expect obstacles in any project, and by overcoming them you build character and succeed. If you are declaring a scientific hypothesis, the worst thing that could happen is that no one challenges it, until you have to go public. Instead, you need as many challenges of the hypothesis as soon as possible. If the challenges succeed then you have the raw data you need to revise the hypothesis. Your hypothesis gets better by being challenged, not by being accepted.

Contrarianism of the Road

The power of such proverbs is that they contradict naive common sense with a much more nuanced and useful understanding. When a politician says that their policy will help you ("road to hell"), you should be highly suspicious and check for the unintended consequences that they almost certainly are overlooking, probably on purpose. Conversely, when you encounter lemons ("road to heaven"), look for ways to not only make lemonade, but also to grow lemon trees, found a beverage company, cure scurvy, and create a line of skin care products using lemon oil.

[This is the first article in a series on contrarianism.]

* There is a useful answer to a StackExchange question that is worth reading about this aphorism. Some contend that the aphorism is widely misunderstood. It may be the case that Nietzsche's purpose is not fulfilled by the popular understanding, but that doesn't mean that the popular understanding, in its more nuanced form, is not useful as well.

References

1.   Powers, T. A., Koestner, R., & Topciu, R. A. (2005). Implementation Intentions, Perfectionism, and Goal Progress: Perhaps the Road to Hell Is Paved With Good Intentions. Personality and Social Psychology Bulletin, 31(7), 902–912. https://doi.org/10.1177/0146167204272311

2. Kruger, J., & Gilovich, T. (2004). Actions, intentions, and self-assessment: the road to self-enhancement is paved with good intentions. Personality & social psychology bulletin, 30(3), 328–339. https://doi.org/10.1177/0146167203259932

3. Gioia, D. (2021). On the road to hell: Why academia is viewed as irrelevant to practicing managers. Academy of Management Discoveries, (ja). Published Online:19 Oct 2021. https://doi.org/10.5465/amd.2021.0200

P.S.: If you search online for "road to heaven" most of the hits will be more recent than October 2020. But there is one question that was asked on Quora in 2014 that uses this phrasing. If you look at the log of that question, it looks like no one answers the question about heaven, preferring to focus on the traditional "road to hell" proverb and its meaning.

Chevron Corp (CVX) Valuation

The big bounce on Tuesday might have led you to believe that the downdraft in June was perhaps over, and that recession probabilities had eased. Actions of integrated oil company shares are contradicting that scenario, and may be indicating a recession. Chevron Corp (CVX) was as high as $182.40 on June 8, but is trading at b/a of 141.41/141.44 as I write this. What is it worth?

A Value Line report for CVX is available for free at the Value Line Dow 30 page. Using data from Value Line and a CFRA CVX report, it's evident that CVX, and likely the other oil majors, have had a rough time generating consistent revenue or profits in the last six or seven years. That leads to complications in estimating its earning potential. Future earnings are likely to be highly variable, not to mention political, so, instead of focusing on a single scenario, we look at several:

The first line assumes that oil prices stay at their current war-influenced prices for at least the next 10 years. The second line assumes that the war and its after effects end in 2022 or 2023, and that things are mostly back to "normal" by 2024. The third line uses the estimates published by CFRA for the current and next several years. The fourth line does the same but using Value Line actuals and estimates. The fifth line assumes that management has set the current dividend rate to 70% of their best estimate of long term average annual net income.

The duration (of earnings) reflect the volatile nature of oil company earnings, the already extant gradual decrease in average oil consumption, and the politics of climate change and electric vehicles. Discount rate is set at 5%. We could argue about the length of the decay portion of future cash flow and its rate of decline, but when you go out 15 to 20 years at a 5% discount rate, such changes won't be large.

The problem is that CVX was already selling well above full value in early June, and is still selling above its full value even now after a sharp decline.

If I had to guess, I would say that lines 2 and 5 are the right ones to use for a snap valuation of CVX. I would avoid buying CVX now, and sell it if I had it.

MMT Storm Warning

Central banks control interest rates and money supply, but they are not God and are still subject to market forces. Governments want low interest rates, providing temptation for the central bank to defy reality for too long. What happens if they fly too close to the sun? It depends upon whether you believe traditional monetary theory or Modern Monetary Theory (MMT). My June 16 posting alluded to some potential problems with the type of deficit spending that MMT adherents believe to be OK. Now there are signs coming from Japan that it is important to understand MMT in a hurry. 

First, some background. This Investopedia article on MMT covers some of the basics. The central idea of MMT is that

governments with a fiat currency system under their control can and should print as much money as they need to spend because they cannot go broke or be insolvent unless a political decision to do so is taken.

MMT proponents are optimistic about the side effects of government spending, typically saying that increased government spending has benefits with no side effects, and that traditional ideas of "crowding out" of debt investors will not cause interest rates to rise. Often they support expansive spending policies and use MMT to justify larger deficit spending.

Japan may be a current test of this idea, in that Japan has been holding interest rates at 0.25% and expanding its money supply in order to intervene in debt markets. A series of Zero Hedge recent articles have been sounding the alarm, warning that Japan's monetary policy has potential for an explosive collapse:

June 20: Bank of Japan Spends A Record $81 Billion To Avert Collapse, But $10 Trillion JGB Market Is Now Completely Broken

June 14: Japan On Verge Of Systemic Collapse With "Dramatic, Unpredictable Non-Linearities" In Financial Markets, DB Warns

June 14: Giant Hedge Fund Goes "Soros" On Bank Of Japan: Bets Billions That Japan, And MMT, Will Break

June 8: As Yen Crash Accelerates, It Puts Catastrophic End Of MMT Experiment In The Spotlight

March 30: Yen At Risk Of "Explosive" Downward Spiral With Kuroda Trapped... And Why China May Soon Devalue

The signal of interest is the value of the yen against other currencies. Over the past year it has moved lower, stair-stepping from 110 to the dollar, to 115, then ramping to 135 with much recent turbulence. 

Tug of War for Real Resources

According to the Investopedia article MMT says that

the only limit that the government has when it comes to spending is the availability of real resources, like workers, construction supplies, etc. When government spending is too great with respect to the resources available, inflation can surge if decision-makers are not careful.

We get inflation when too many dollars chase too few goods. Under MMT, how does government remedy that?

Taxes create an ongoing demand for currency and are a tool to take money out of an economy that is getting overheated, says MMT. This goes against the conventional idea that taxes are primarily meant to provide the government with money to spend to build infrastructure, fund social welfare programs, etc.

In other words, under MMT government must raise taxes to quell inflation. By removing money from the marketplace, there are fewer dollars chasing goods.

Inflation, however, leads to an ongoing confrontation with government if it is prevented from raising taxes. If raising taxes is too unpopular, then inflation continues and government cannot use this purported MMT mechanism for cutting inflation. Instead, it may roll out price controls, as has been discussed in recent op-eds in the mainstream media. 

Price controls or higher taxes in turn, however, lead to other side effects. Let's use potato chip manufacture as an example. With high taxes, wages paid to potato chip workers are worth less. The company has an incentive to pay workers in potato chips rather than dollars. With price controls, the dollar value of the chips is constrained, so even if the government forces a barter tax to be paid in dollars, the tax has less effect. If the workers then barter their potato chip wages for other goods, either government will receive less tax from unreported transactions, or reduced taxes (on fixed goods prices) even if they succeed at taxing the barter. In short, MMT leads to pressure to use something other than the sovereign's currency as a medium of exchange.

Another way of seeing this is to note that MMT depends on government having a monopoly on a medium of exchange. If it is in competition with other currencies, then market participants may be able to escape from any coercion that is implied by MMT money expansion. Then MMT succeeds only if government is an honest and trustworthy market participant, and refrains from policies that are coercive. In the case of a medium of exchange, "coercive" means not engaging in behavior that would cause a devaluation of the medium of exchange. Inflation causes devaluation, so in order to show good behavior, government then has to refrain from policies that cause it.

If higher taxes were truly an option for government, then it might get away with using MMT-like policies. But so far all real-world reactions to taxes appear to be significant, in that higher taxes significantly impact output. In practice, setting tax policy is constrained.

The Politics of MMT

Supporters of MMT are generally progressive, believing in Keynesianism, higher government spending, more involvement of government in the economy, and higher taxes. Perhaps this is not surprising in that proponents of traditional monetary theory are generally classically liberal believers in the free market, which go with lower taxes, smaller governments, and less involvement of government in the economy.

Nevertheless, some prominent left-leaning economists are not on board with MMT. The Investopedia article cites Paul Krugman's criticism of MMT:

Nobel Prize-winning economist Paul Krugman’s views on U.S. debt are similar to many MMT ideologues, but Krugman has been strongly opposed to the theory. In an op-ed in The New York Times in 2011, he warned the U.S. would see hyperinflation if it was put into practice and investors refused to buy U.S. bonds.

“Do the math, and it becomes clear that any attempt to extract too much from seigniorage—more than a few percent of GDP, probably—leads to an infinite upward spiral in inflation,” he wrote, “In effect, the currency is destroyed. This would not happen, even with the same deficit, if the government can still sell bonds.”

The question to ask is when would investors refuse to buy U.S. bonds? There are several scenarios:

• When they can move their money into real assets (real estate, commodities) with higher rates of return.
• When they can move money into other currencies offering higher rates of return.
• When the interest rates on government debt are significantly lower than inflation, and trading in real goods as a medium of exchange is possible. (Think in terms of buying the next five year's goods in advance, since the value of the goods would advance in parallel with inflation.)
• When they run out of money.

The first three strategies are also worthwhile defenses against hyperinflation.

Japan is especially vulnerable right now to the second problem, which is that Japanese investors can do better by buying dollars and investing in U.S. debt. As the yen declines in value they benefit. This leads to the situation covered in the Zero Hedge articles.

We have already seen the first scenario happen, starting in 2020. People bought toilet paper or houses. 

Ultimate Recourse

Behavior at the margins illustrates the consequences of deficit spending and use of MMT beliefs. When taxes are high, labor force participation declines due to early retirements and consumption of government transfer payments. Clipping a few percentage points off production then drags on economic output, lowering tax receipts and depressing production and general economic activity. This causes inflation. MMT then responds with higher taxes, causing further marginal declines in production, and more inflation. MMT makes no provision for the consumer's "ultimate recourse", which is to do nothing and vote for politicians willing to pay them to do nothing. 

Producers, on the other hand, have the ultimate recourse of producing only for their own account. A farmer who eats what he produces, barters for what others make, and does not sell into the market will escape MMT's effects. 

In effect, the government must make a market for its own currency, and ignoring the interests of the customers of the medium of exchange will result in diminishing the customer base and the robustness of the marketplace for that currency. 

Coming Soon: Making More Mistakes, Faster

Now that the market has corrected enough that there may be some well-priced stocks to be bought, you may see more articles from me in the next few weeks or months. I never announced it, and it may not be completely related, but when most stocks are full-priced, it takes a greater effort to put together a valuation and background story, so I am less likely to publish when the market is overpriced. I did come to view the market as overpriced for parts of 2021. The rally of 2020 was a surprise. That of 2021 even more so.

This is almost certainly ego-driven: I'd much rather publish an article which eventually is shown to be correct, than to publish something that is unfortunate and mistaken. This is a continual hazard when commenting on markets. The usual antidote among newsletter writers is a combination of equivocation and obscurity, so that while you are being dazzled or entertained, whatever happens later can somehow be likened to what was written before.

I think I have a partial solution to this problem: I can write articles in which I actually attempt to make mistakes. This won't be hard [sic]. The motivation is that rather than hoping you will think I am right, that I help you better by printing (virtually) more ideas, faster, with less filtering, and that you can, from your own perspective, correct for my mistakes and see what really needs to be done. I can't vouch for my ability to be wrong [sic]. In my own experience, attempting to reverse yourself in placing trades does not work. That is, you cannot be your own contrarian. It is far easier and more successful to be a contrarian to something one reads somewhere else. And it's not just a matter of not-invented-here. Somehow the brain just works better when it is presented with information that is from somewhere else. So my goal is simple: just continue to write and comment on the markets as I see them. Any mistakes will be easy and free, and you can benefit from them even if I can't.

Actually, that's not true. An article I wrote yesterday was written by a different person. I'm a different person today. So long as I am sufficiently good at changing from day to day and don't drag my ego along with me, I too can benefit from my being wrong in print.

I have been working on article on contrarianism that is getting close to being ready for publication. If all goes well, you will see it here in the next day or two. It should go very well with this article, which in reality is about contrarianism too.

Target vs. Amazon

As a kind of warm-up exercise, we can see that in the last few days Amazon said that it's Amazon's Prime Day will be on July 12 and 13 this year. Within a day or so, Target announced that it was scheduling its own Deal Days event for July 11 through 13. 

Perhaps Target is thinking:

• they get free publicity for their own sale, since people will conflate the Amazon and Target events
• people will spend all their money on the 11th, nothing left for Amazon!
• Target's sale will be seen as better since it is for three days, not two
• people will mentally equate Target's product selection with Amazon's

Contrary take: People will compare Target and Amazon service and fulfillment, as well as prices. Frankly, Target could lose frequently in this comparison. Also, this kind of alignment clearly marks Target as a follower behind Amazon.

Marketwatch reports that "Target said during its most recent earnings [discussion] that it had a glut of inventory to sell." Will retail competition slay inflation? Unfortunately, neither event includes discounts on gasoline, housing, higher education, or medical care. Both sales may accidentally feature lots of products made in China. But most Americans have too much stuff already, and right now they want to spend time outside and spend money on experiences, not buy things for inside the house.

Gasoline is Gold

Mini-theory: gasoline is expensive because people are doing all the outdoor things they were blocked from doing in the two-year pandemic lockdown. In which case we have yet another unintended consequence of aggressive social control public health policy. Demand won't let up until everyone has slaked their thirst for living rather than waiting inside, masked, watching Netflix and eating microwave popcorn.

Current Thoughts

Federal Reserve raised its benchmark interest rate 0.75% to a range of 1.5%-1.75%. These rates are still too low, and will be followed rapidly with more hikes. The Fed is behind the curve. Worse, "amateur pundits" were ahead of the Fed in calling for this move and the Fed has lost some credibility. Does it understand the markets?

Thoughts: The initial surge of post-COVID, stimulus-caused inflation was highly predictable. The additional surge of "return to normal" from pent-up activity was also predictable. When the country went into lockdown, the economy at that time was already hot and in need of higher rates; there may have been some residual of that still in late 2021 and early 2022, but that would not have been easy to call. What the Fed and many misunderstood was the secondary effects of the combination of return-to-work and stimulus money sloshing through the system. These will be transitory yet leave long-lasting marks on the economy. Gas prices at $5 (actually, diesel prices at $6) will do damage that could last past 2024. The sharp tightening of the housing market will leave many without good options and paying rent, both in the colloquial sense and economic sense, far beyond when they should have. The sharp rise in the housing market should have been a signal to the Fed to hike rates much earlier. Why didn't they? Excess concern with politics and appearances, and a sharp impact on Government borrowing costs.

What are the odds that interest rates will go structurally higher, causing a large step up in Government financing costs? Before COVID U.S. debt was too high at $24 to $26 trillion, but at least interest rates were low. Post COVID, if 10 year and 30 year rates have a secular rise to 5% or higher, the U.S. Government will be significantly hampered in its ability to service its debt. $30T at 5% is $1.5T in interest payments a year, vs. $24T at 2% and payments of $0.48T. In other words, the penalty for the bouts of COVID stimulus may be an extra $1T of interest payments annually, indefinitely.

Put options assigned early, traders may be thinking the market will be lower today and Friday, and higher next week. Certainly the emotions from the sharp losses last week and this week could dissipate over the weekend.

Though short term interest rates are sharply higher, not all banks are responding with higher savings rates. Capital One's online savings rate is still 0.3%, while Ally has raised its savings account rates at least three times, from 0.5% to 0.6%, then to 0.75%, and recently to 0.9%.

Marketwatch: Eleanor Laise and Katie Marriner report that housing prices in small towns have exploded. There is no inventory left, and the homes are often smaller, in need of work, and outdated. "Many baby boomers have sought out retirement properties far from the bigger cities" is part of the problem. To check, I recently looked at homes for sale near Lynchburg, TN, and found many $400k+ properties. The bonus: a number of these "over-priced" houses come with property, from 20 to 90 acres. Another aspect of the problem: areas near high density cities are most affected. Property in the Shenandoah Valley in Virginia was in short supply more than 10 years ago. The article also cites tight supply in New England, where proximity to Boston and NYC means that there is an oversupply of people fleeing urban areas.

(10:00 a.m. update)

Barrons reports 6/15/22 that Facebook ad rates have declined in each of the last 6 months. This includes declines of declines of 15% in March, 19% in April, and 19% in May. Instagram ad rates were up 15% in May, however. FB sells for a little over 12x TTM EPS of $13.21.

In a 6/1/22 WSJ article Karen Langley reported that some investors were seeing bargains in small caps. The decline in small caps has outpaced the market YTD. However, it was too soon then to turn bullish. As of today, the four stocks mentioned in the article have fallen significantly further. Using prices as of about 9:30 a.m. today, SHAK is down another 18.5% since the 6/1 article. ANF is down 9.4%, BCRX down 6.1%, and CUBI down 17.7%.

Purpose of Vorpal Trade: A Route to Independence

Although it has always strongly implied in the articles and topics covered in Vorpal Trade, an underlying motive for writing this blog is to share with others some of the knowledge and tricks that are useful for obtaining financial independence. Of course, it's hoped that it's useful for anyone with an interest in investment, psychology, or philosophy, but the theme that is in my head is that I want readers to get rich and be independent of the financial influence of others. 

There are several ideas that follow. First, I'm interested in giving you tools to become wealthy enough that work is optional. At the very least, this means helping you to retire comfortably. It could mean supplementing your income in later decades or retiring very early, or becoming independently wealthy. But even if none of these are immediately possible, I'd hope that some of this material allows you to attain enough saved capital that you have a sense of independence from your employer. Capitalism belongs to everyone, not just those who fit the stereotype.

Second, it is implied that these strategies are primarily for the benefit of independent investors. Meaning,  sometimes I will write about investment strategies that institutional investors can't use, are prohibited from, are disinclined to use, or are offended by. A classic example is index investing. I once wrote and delivered a presentation on how to beat professional investors at investing. It is quite possible to do it through indexing, and part of the mission of VT is to allow you to beat the average professional. This is not to say that some won't benefit from financial planning advice, which encompasses many more financial areas than I have covered or intend to cover here. If you have a need for advice on estate planning, insurance, inheritance, retirement cash flow, Social Security timing, or taxes, by all means please secure an expert. It may be a long time before any related wisdom might appear here.

Third is finding and warning about hazards in investment. Aside from the traditional scams, which I assume that most of us are aware of, there are internal psychological hazards to be avoided. These include problems of focus, awareness, distraction, emotional attachment, non-objectivity, and habit. The behavioral economists have figured out only some of these. Others are common sense, but since we are human, we may not be using all of the common sense we have, so reminders and exercises are useful from time to time.

Fourth, economics is fascinating and sneaky, and it intrudes on political affairs, so I'm interested in political economy because it affects the long term investing landscape. To be successful, we have to get out of our investments more than we put in, and society can put obstacles in the path of business that strongly affect whether it's worthwhile to make an investment in the first place. This is often where I'll wind up using the words "normative" and "objective", because what is a wonderful normative thought for someone else may make an investment objectively a bad idea.  

Finally, this blog is about the richness of the possibilities of investment and life in general. My bias is towards optimism, finding solutions, increasing wealth and living standards, and exponential growth. And perhaps not just in dollar terms, but in fulfillment, happiness, exploration of the world. We don't keep score with dollars because the score that matters; it doesn't. We measure dollars because that measurements objectively shows what works and what doesn't, and we delight in experimenting and learning about things that work. 10,000 years ago people lived day to day finding sources of food. We are doing the same, just with different tools.

These themes mean I rarely will write negative stories, philosophy for the sake of philosophy, or opinion pieces designed to forward an agenda. I may write against an agenda that is counterproductive for society, but usually even these will contain objective, neutral data or observations about the problems of the agenda being proposed. 

I may sometimes write articles or book reviews that seem somewhat removed. These will be several layers below the surface of investing, serving as foundations on which other ideas and mechanisms lie. Why? Exactly. Because I am still always asking "why?", and the asking often does not stop until I get to the deep layers. Once we have traveled through all the layers, though, we will have a profound sense of understanding and confidence that cannot be bought any other way.

Did Clans Cause the Kink in the Human Value Function?

Why should an investor investigate human studies fields like moral psychology, philosophy, and behavioral economics? Because people make investing decisions, people make consumption decisions, and the marketplace is not just influenced by but composed of decisions that people make. The nature of people is what drives the course of the market, profits, and long term prosperity. Then to be a good investor means being a good student of human nature and everything about human nature.

Of course, this absolves no one of the need to understand double entry accounting, charts of accounts, balance sheets, income statements, and the mathematics of compounding interest and finite series. You still make major mistakes if you get the human part right but fumble the numbers. The human mind is not very good at maintaining objective tallies over long periods of time or memorization of precise facts. Accounting math is still critical for obtaining and maintaining objective measurements of businesses and their results.

One meta-problem before us is how to weight our efforts in numeric evaluation against gains of human-centered knowledge. An implied assumption behind the number valuations of companies I've published since February is that the factual (objective, predicted long-term) value of a company may be different than how the market values it. We got the objective measurements from estimates of future earnings and the stability of the company's future revenues and growth. This is very numeric, but the basis for the numbers is often quite soft. To obtain such numbers, in 2021 we have to estimate how many widgets will be sold in 2031, and even in 2041. The accuracy of those numbers is highly questionable. The correct way to proceed is to refine your estimates of those numbers, and my proposal is that the best way to do that is to understand people. That leaves us with a potential division of labor something like 10% math, 90% psychology for our investment analysis efforts.

Prospect Theory: Interactions Between Loss Aversion and Clan Values

One way to check one the value of an investment theory approach that is heavily based in psychology is to look at the field of behavioral economics. In chapter 4 of Richard Thaler's book Misbehaving, on page 31 of the paperback version of the book, is a graph (figure 3) showing the utility of different amounts of gains and losses. It looks like this:

The curve is nonlinear for positive gains, with additional gains returning less amounts of utility. One hamburger right now is good and two is better, but at a certain point you are full and you don't want any more. 

Likewise, the curve shows diminishing negative utility for increasing losses. If I lose $1 at a poker game, I'm slightly poorer and my ego is bruised. If I lose $2 at poker, I'm even poorer, but my ego hasn't been bruised much more than it was before. 

The part that bothered Thaler and other behavioral economists is that this utility curve is not symmetrical. There is a kink in the curve at zero, with steeper losses of utility for small losses than there are for small gains. A loss of $1 hurts worse than a gain of $1 benefits. (Notice that the asymmetry of utility gains and losses is reflected in the availability of words in English. We have a word for small losses ("hurt") but there is no corresponding word for a small gain.) This phenomenon has been well-established through repeated experiments and reported in the economics literature. You can find many examples demonstrating it Thaler's book. It's not intuitive: Thaler himself says in Misbehaving:

Examine the value function in this figure at the origin, where both curves begin. Notice that the loss function is steeper than the gain function.: it decreases more quickly than the gain function goes up. Roughly speaking, losses hurt about twice as much as gains make you feel good. This feature of the value function left me flabbergasted.

What does this mean, and why does it exist? It's probably worth several articles or papers in themselves, but for now, I will say that it means that the human mind is trying to "ratchet up" its state in the world. Tentative gains are okay, but do not lose what you have. Perhaps this reflects a policy that is optimal for survival in a physical body. Loss of a limb or bodily functions that are permanent are very severe handicaps. It's not worth gaining a bunch of hamburgers if you suffer a deep wound.

There is a possible social explanation as well. In clan-based cultures, those in which scarce goods are often held in common by the community, gains are shared, but personal losses (cuts, bruises, exhaustion) cannot be. Hence, any losses are not shared, but gains are, and this internalization of the asymmetry of economic results experienced when living in a community are built into human psychology. When a hunter returns to the village, he alone bears all of the scars and injuries, but the meat is shared evenly with all. Some of us may no longer live in clan-based cultures, but most of the world still does, and nearly all humans did for at least the last 70,000 to 100,000 years, so those lessons are built into our genes. 

Anti-Normative Ramifications

That graph is important, and I suspect that it derivable from first principles for humans and most or all animals, and has ramifications for political economy, macroeconomics, and philosophy. Thaler says

That is a lot of wisdom in one image. Little did I know that I would be playing around with that graph for the rest of my career.

The graph may be even more important than that. Earlier in chapter 4 of Misbehaving Thaler says

Prospect theory sought to break from the traditional idea that a single theory of human behavior can be both normative and descriptive.

This little sentence is tucked away in a lengthier passage, but it shouts loudly, if you are looking for the message. Let's unpack it.

The phrase "traditional idea" indicates a common assumed idea, among academics. He is saying that it is a postulate of the business of studying human behavior; that few would question it. Hence, the sentence says that most academics are seeking theories that impose standards of human behavior based on scientific results. 

I'm not surprised, though such propositions are rarely stated explicitly. It could be that a lot of the motivation academics in human studies have is the desire to impose normative standards on others. People want to not only be correct for themselves in their own lives, they seek either to validate those ideas by affecting others, to gain by controlling others, or simply to control others for the pleasure of it. Academics have these same impulses, except that they seek moral superiority through knowledge and specialized analysis. 

But wait, does Thaler really mean to use the word normative in that sense? Earlier, he says 

By "right" I do not mean right in some moral sense; instead I mean logically consistent, as prescribed by the optimizing model at the heart of economic reasoning, sometimes called rational choice theory.

In case I was confused about the possible uses of the word normative, I looked it up. From a  DuckDuckGo search I got 

normative
adj. Of, relating to, or prescribing a norm or standard.
Establishing or setting up a norm, or standard which ought to be conformed to.

That seems pretty clear: it is the traditional use of the word, it is the way it is used in philosophy, and there are no additional nuanced meanings. The Merriam-Webster definition also does not admit for a meaning of "normative" as being "logically consistent." So, although Thaler is trying to use the word in one particular sense, I am suspicious that the proffered definition is a covering of tracks. After all, why re-define a word on the first page of a chapter to make it mean something else? Perhaps an editor flagged it, and Thaler expanded on his first draft, and in so doing attempted to sweep a distraction aside. 

Perhaps more likely is the idea that certain economists, such as behavioral economists, collectively misuse the word "normative" in a way that has come to mean something slightly different than the way the rest of us use it, but which still retains some of its original meaning, even if the community itself is unconscious of this retained meaning.

It seems likely that a community of behavioral economists would encounter this problem. Consider their task: They are seeking to understand how people make decisions in reality, which may not match what rational thinking says that they should do. Right away, we have a baseline problem: Is the rational thought process the baseline, or human behavior itself? What word do we apply? The word "normative" means "ought" normally, and so if people "ought" to be rational, then can we use the more academic word "normative" in its place?

The Verdict on Normative Human Studies

To return to the idea that inspired the previous section, it seems likely that most human studies academics are indeed seeking to construct a single theory of human behavior that is both normative and descriptive. Thaler calls this a "traditional idea", because academics assume that they have a license to pursue such a thing. Evidence: Several existing Nobel prize winning economists use their fame to push normative judgments through the mass media, judging and proclaiming standards for society. They are often even objectively wrong, but since newspaper articles are not peer-reviewed before publication, and opinion pieces are not intended to be fact-checked extensively, they continue.

Thaler's point was that behavioral economics succeeded in part because it breaks with this tradition, by seeking results that showed that humans behave in ways that are non-normative, in all senses of the word! Whether we use the normative definition of "normative", or Thaler's, we get to the result that people do not behave according to the rules of rationality. 

Which is something that any 14 year old teenager could have told you.

Apple Inc. (AAPL) Valuation

Apple needs no introduction. AAPL is widely owned by both go-go tech momentum investors and Berkshire Hathaway. What is it worth? Data is from Value Line, including growth rates. I've put together six scenarios:

scenario	base EPS	grow rate	grow dura.	growth rate from peak	dura. of post peak	disc rate	share value
2020 basis	$3.28	14.5%	12	-10%	8	5%	$111
2021e basis	$4.50	14.5%	12	-10%	8	5%	$152
market price	$4.50	14.5%	10	-7%	8	5%	$126
sharp obsol	$4.50	14.5%	8	-12%	8	5%	$89
nominal	$3.89	14.5%	8	5%	7	5%	$101
nomin, opt	$4.50	13.0%	14	-8%	8	5%	$171

Earnings are expected to rise sharply in '21 relative to '20, so I've included valuations from both bases for comparison. Since it is already May 2021, the nominal case blends the two. 

The challenge with valuing high tech is that trends do not last. When the nature of your business is disruption, you are subject to being disrupted by technology from other companies. That's why the sharp obsolescence case and nominal case use a growth trend of only eight years. I can hear people arguing about why the short durations are wrong. May I point out that 14 years is the same number of years since the introduction of the iPhone? If the argument is that the product is compelling to all of the people who already own it, that argues for stability, rather than growth. 

You can make other arguments that the iPhone user interface is an unusual sweet spot that will lead to loyal and extended adoption of Apple products for a long time. I've tried to reflect that in the numbers. In fact, the nominal case assumes that the post-peak period is a growth period, rather than the usual shrinkage. 

The story here is that AAPL's market price reflects a widespread understanding of its potential future discounted cash flow. There is no mismatch. Of course, it's so widely followed, why would there be a mismatch?

Coca Cola Consolidated Inc. (COKE) Valuation

Last time I promised to complete the beverage company survey, but once again the details proved to be significant enough to warrant a standalone article. Data is from company 2020 10K reports, Macrotrends, and company web sites.

Synopsis of Coca Cola Consolidated Inc. 

Largest Coca-Cola bottler in the United States, and bottles other brands as well. Distributes Monster, Fairlife milk, Dunkin' Donuts coffee. Has exclusive distribution rights for KO products in specific regions. Based in the Southeast, Midwest, and Mid-Atlantic portion of the United States. 13 manufacturing facilities, 14,000 FT and 1,800 PT employees. HQ in Charlotte, North Carolina. Has some religious elements in its Purpose; has a corporate chaplaincy program. Wal-Mart (19%) and Kroger (13%) together move about 32% of the COKE's sales volume. Shares some of the Coca-Cola legacy with KO. Capital-intensive, with substantial machinery and distribution investments. Has had average 1.7% net margin in the past. 

Main company web site. Investor Relations site has annual reports back to 2000.

COKE Valuation

Revenue and earnings data is from Macrotrends. Note that the EPS figure for 2020 matches that for fully diluted shares of 12M (Macrotrend) versus the current outstanding count of 9.373M (COKE 2020 10K). Dilution matters in valuing COKE, and recent gains likely means that all promised incentive shares will be issued. Amounts in the table are in millions.

	revenue	oper income	net income	oper margin	net margin	shrs	EPS
2020	$5,007	$313	$172	6.3%	3.4%	12	$14.73
2019	$4,827	$181	$11	3.7%	0.2%	12	$0.97
2018	$4,625	$58	-$20	1.3%	-0.4%	12	-$1.72
2017	$4,288	$102	$97	2.4%	2.3%	12	$10.30
2016	$3,130	$131	$50	4.2%	1.6%	12	$4.34
2015	$2,306	$98	$59	4.2%	2.6%	12	$5.12
2014	$1,746	$86	$31	4.9%	1.8%	11	$2.73
2013	$1,641	$74	$28	4.5%	1.7%	11	$2.42
2012	$1,614	$89	$27	5.5%	1.7%	11	$2.39
2011	$1,561	$88	$29	5.6%	1.9%	11	$2.52
2010	$1,515	$96	$36	6.3%	2.4%	11	$3.19
2009	$1,443	$95	$38	6.6%	2.6%	11	$3.37
2008	$1,464	$59	$9	4.0%	0.6%	12	$0.78
2007	$1,436	$82	$20	5.7%	1.4%	12	$1.71
2006	$1,431	$85	$23	5.9%	1.6%	12	$2.00
2005	$1,380	$92	$23	6.7%	1.7%	12	$1.99

Past revenue growth is not entirely organic, and has been supported by acquisitions. Valuation assumes a 2% net margin for base year EPS, which is above COKE average. COKE uses raw materials that are subject to inflationary pressures, and faces a monopoly supplier in its license agreements with KO.

scenario	base EPS	growth rate	grow dura.	growth rate from peak	dura. of post peak	disc rate	share value
pessimistic	$8.35	3%	14	-5%	12	5%	$144
optimistic	$8.35	12%	16	-3%	20	5%	$467
nominal	$8.35	6%	15	-4%	16	5%	$213
curr price	$21.53	3%	10	-5%	10	5%	$300
curr pr (dilu)	$14.73	5%	14	-5%	12	5%	$304
marg expan	$12.00	15%	7	-5%	16	5%	$295

The inclusion of "curr price" scenarios is an attempt to reconstruct what the market currently believes, using EPS estimates and manipulating the growth rates and duration to get the current market price as a result. '21 and '22 EPS analyst consensus estimates are $21.53 and $23.02. This seems optimistic, indicating that the market believes that recent elevated earnings are sustainable. Most of the other scenarios assume 2% net margins, which is closer to but above the historical average. 

Investment Discussion

COKE has already moved up from $150 to nearly $300 since 2019 on strong gross margins and earnings. It was as low as $75 in 2014, so COKE has already doubled in price twice in the past seven years. Nevertheless, historically COKE has had lower margins and it operates in a commodity business with thin margins that make earnings much more random than the beverage companies with greater proprietary elements, such as KO, PEP, and KDP. 

As so often happens when the market price and intrinsic value are close, and the valuation has a wide range, it's difficult to make a recommendation without deeper knowledge of product trends. For example, perhaps COKE is making most of its margins on specialty products like Monster and coffee. Even if carbonated Coco-Cola products continue to sell poorly, COKE's fortunes may be more determined by their non-KO brands.