Chart Fun | Allegory Of The Cave

Is widespread ignorance a virtue? Is selective wisdom a vice?

The Greek philosopher introduced a gripping idea in The Republic — the Allegory of the Cave.

A group of prisoners have been confined to a cave since birth; chained, with their backs to the cave entrance. A fire casts shadows on the wall facing the prisoners. Through this rather dreary existence, the cave prisoners notice shadows of moving humans, animals, carts et al. The cavemen develop a learning model, ascribing names to the shadows that they perceive on the wall.

One of the prisoners is released from his chains one day and allowed to amble outside the cave. Plucked from the 2D world and cast into the 3D world, the prisoner is overwhelmed by first-time glimpses of life around him. Gradually, he begins to make sense of reality, and comes upon the realisation that he had been staring at shadows all his life.

The prisoner returns to the cave, eagerly sharing his discovery with the other prisoners. The latter — still chained inside the cave — infer that the released prisoner has gone insane, and ostracise him. They also stubbornly resist any attempts at their own release. The released prisoner, quite literally having seen the light, is unable to readjust to the cave dwelling. But having little experience of reality, he finds it equally difficult to adjust to the world outside the cave.

Plato used the allegory to explore the nature of reality, knowledge and ignorance (how do we know what we know to be real?).

Allegory time.

2018 gave investors what the earlier bull market years could not — a chance at self reflection.

Like Plato’s prisoner, more than a few investors found themselves unchained and released into the world; coming face to face with a reality that seemed to exist as shadows on the cave wall.

Time for intelligent sounding gobbledegook to make way for some Chart Fun with some open questions.

Equity in a sea of red

  1. If QE-On meant Equities-On, does QE-Off mean Equities-Off? For 2008 crisis prisoners who have been chained to QE, what are the implications of being unchained in a no-QE world?
  2. If Geopolitical Risk meant Equities-Off, why are Ukraine (skirmishes with Russia), Qatar (OPEC exit) and Saudi Arabia (sanctions) painted in Green?
  3. India has fared relatively well in a bad year. Can the oasis-of-calm line of thought be used to make a case for further gains?
  4. A handful of names held up Indian equity in 2018. Had India fared a deep red, what line of thought would be the most persuasive for further gains?

Long-term performance in an era of unprecedented easy money

US$ denominated

10-year world equity average return = 2%.

QE — commonly believed to have been the primary fuel for risky assets — On?

Many have aimed for debt-like risk for equity-like return, but have ended with equity-like risk for not-quite-debt-like return.

What’s your best guess for the next 10-year global equity return?

In the long-run we are all dead? A 20-year story

Time to put this quote — generally attributed to Keynes — to the test.

Entrepreneurs and investors in early-stage and small-cap companies often make the case for disruption as a potent force of capitalism. ‘Incumbents are ripe for disruption, small-caps are tomorrow’s large-caps.’ is heard often.

From a universe of listed Indian companies (ex-financials) that enjoyed 15% Return on Capital 20 years ago, over 50% continue to enjoy 15% Return on Capital today.

If high returns on capital attract competition and can be potentially arbitraged away, why is this list so sticky over decades?

In the long-run we seem to be (nearly) the same.

Elections matter?

Congress wins — markets rally (‘balance’).

Congress wins — farm loan waivers.

Had BJP won — markets would’ve rallied (‘continuity’).

Had BJP won — farm loan waivers, or proxy.

…yet an inordinate amount of opinion mongering is devoted to divining outcomes!

Time to sign off by invoking Plato.

How should markets, tasked with allocating capital, behave in a world at odds with learned realities?

Is widespread ignorance a virtue? If no one knows (or cares) about reality, an irrational line of thought can be monetised profitably for long periods.

Is selective wisdom a vice? The big money in investing is made when, a) there is variant perception, (b) when it turns out to be right. However, if the variant perception stays in the peripheries of market attention, one risks being ostracised like the returned caveman.

This caveman is eager to hear what you think.

Happy 2019!