The art of optimism
Photo by JOHN TOWNER on Unsplash
Pessimists don’t start businesses.
It’s fair to say that anyone with the temerity to start a company (let alone three of them) from scratch is more than likely to have a positive slant on the world. You need to believe in people, and you need to believe in ideas.
We know that Coronavirus is hugely challenging for governments, companies, individuals and families everywhere. This isn’t really simply a healthcare crisis – it’s several crises rolled into one. Healthcare, markets, even geopolitics are all reeling from the shock of “lockdown” and what it means for the global order.
We’re hugely aware of the anxiety and suffering this crisis is causing, but it’s in our nature to be optimistic. Maybe we’re predisposed, as investors and entrepreneurs, to believe in upside potential? Or perhaps, as founders of an agile startup with low fixed-costs, we simply have less to lose than more established players? We are forever mindful of the fact that entrepreneurs are not entitled to success, and often have less to lose than those who cannot afford to take the risk of starting a business in the first place.
This leaves us asking a fundamental question; are we being too optimistic? Should we be more anxious, more risk-averse, more scared of Coronavirus?
In seeking to answer that question, we have once again succumbed to the somewhat meandering style that you might have come to expect from us. Proceed if you like the sound of a thought piece that explores the self-delusion of great men, contemporary philosophy (and weight-lifting), old school behavioural finance, not-so-distant economic history and the savageries of war.
Enter the Reality Distortion Field.
We are a bullish bunch at Three Body Capital, but even we sometimes take it too far. When our better halves chastise us for betting the farm on risky new ventures, we take great pleasure in explaining the benefits of cultivating a healthy dose of self-delusion. Referring to Steve Jobs' ability to manipulate the truth in order to inspire people around him to do the impossible, Apple's VP technology Bud Tribble famously coined the term “Reality Distortion Field”. Indeed, this tendency was so instrumental in Apple’s success as a business that Walter Isaacson's official biography of Steve Jobs mentions it a full 34 times!
Like everyone else, we were left reeling by the onset of the Coronavirus pandemic. But as time has gone on and we have acclimatised to the early days of the “New Normal” (or however it is eventually branded by the media), we’ve become accustomed to the pervasive negativity out there. We’ve started to consider the myriad ways that we can emerge from this crisis stronger, wiser and better.
Certainly, we’ve learned some cool new skills. Cost reduction, improved communication, a renewed focus on physical and mental wellness, huge volumes of reading, reinvigorated parenting, even better sleep. All this is happening on an individual level. But the potential for large-scale improvements to the way that families, businesses, civil institutions, healthcare services, supply chains and other vital infrastructure operate is huge. And it gives us great nachas!
The antifragile business.
Nassim Nicholas Taleb is the kind of person you’re wary about quoting. He is just so brilliant – and so aggressive with that brilliance – that you worry about misinterpreting his thinking and ending up with a sharp slap on the wrist, administered via his highly entertaining Twitter account. But like us, he’s into weightlifting and wine, and hopefully he has the capacity to forgive the odd misappropriation. His concept of “antifragility” provides a helpful way to rationalise the impact of Coronavirus in the glass-half-full way that so appeals to us.
Taleb has pointed out that everything in the world has a relationship with volatility:
Fragile things suffer from volatility. Mugs are fragile. When you drop one, it shatters.
Robust things resist volatility. Earthquake-proof high-rises absorb seismic energy.
Antifragile things profit from volatility. Human bone gains in density and strength under episodic load and stress..
Despite antifragility being an important characteristic of our world, one that influences our biology, society, politics, economy and culture, we have failed to recognise its importance. So much so, we did not even have a name for it until the aforementioned options-trader turned weight-lifting philosopher came along. This has led to the common conception that fragility’s opposite is resilience. It’s not. The opposite of things that break when dropped isn’t things that don’t break. It’s things that get stronger.
Optimising for resilience, as the Coronavirus crisis shows, would have been a good start. But what actually was optimised for was efficiency, and that created a highly vulnerable state. If resilience is about surviving chaos, antifragility is about thriving. Ask any business founder which outcome they’d prefer, and the answer is obvious. By structuring our lives and companies around antifragility, we can succeed where others fail. Antifragile things profit from disorder, and since the world of business tends to be chaotic, it makes sense for us to build antifragile companies. This is exactly what we are seeking to do with Three Body Capital.
How to structure companies that adapt to changing market conditions, thriving when others fail?
It’s rare for airplanes to crash, but they do. People die. It’s terribly sad. But airlines do a pretty decent job of keeping us safe. They achieve this by building systems that compartmentalise errors. In Antifragile, Taleb points out that failures are positively correlated in many man-made systems, meaning that one failure increases the chances of another. That’s how you get contagion, bank runs, markets spiralling out of control. But in the aviation industry, mistakes are negatively correlated. Which is to say, a crash reduces the chances of future accidents.
Not only does negative correlation promote resilience by preventing errors from spreading through the system. It promotes antifragility by ensuring that errors actually reduce the chances of further problems occurring. How does this work in practice? When things go wrong, the aviation industry goes into error isolation mode. It conducts exhaustive inquiries into mistakes. These are hyperbolic, since one crash has little statistical impact on the aggregate safety of passengers globally. Once the error in the airplane has been isolated, action is taken to stop that same error from occurring in other aircraft. This might include pilot training, or mechanical replacements.
Founders (not to mention investors) can learn from this. We can build companies and portfolios that compartmentalise errors, absorbing failures without harming the broader business. We can learn from our mistakes and use them to our advantage.
Fear itself.
For this kind of adaptation to occur, we need to live and operate in hope. But that is not always a given.
In 1933, the atmosphere of the global economy was similarly fraught. After years of intense economic pain, people were talking about a different kind of peak: the peak of the Great Depression. In this context, President Franklin D. Roosevelt’s inauguration address was awaited with great anticipation by the American public and indeed, people the world over. The great man didn’t fail to deliver, rattling off a short 1,883-word speech (barely longer than this blog post), which has become famous for one sentence in particular:
“The only thing we have to fear is...fear itself.”
This immortal line (listen here) has been playing on a loop in our heads in recent weeks, capturing the pervasive behavioural element that is playing out in markets – and in homes – across the world. Roosevelt’s speech went on to describe this element as:
“ – nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.”
We’re not for a moment calling the trepidation and outright fear that surrounds Coronavirus unjustified – in many cases, it is – but there is now a very real risk that fear of the second and nth order effects relating to the pandemic distortions will paralyse national and global efforts to turn the tide and restore the “Old Normal” that afforded us such freedom and quality of life (if that is even possible). In other words, people are not just scared of COVID-19; they’re scared of other people’s fear.
This kind of sublimated fear is damaging in aggregate, and it’s damaging on an individual level too. It causes great anxiety and mental anguish. And it breeds inertia, as people decide that it is safer to do nothing than risk taking action. Human beings have a perverse gift for extrapolation – we tend to over-react to threats in order to preserve our survival and perpetuate our genetics. As we’ve explored in a previous blog post, the qualities that made us great at dominating the food chain at the dawn of our species are rendered flaws in an industrialised society. The instincts that make us good at surviving all too often make us bad at enjoying life.
The same is true of investing. The animalistic impulses and capacity for love that compel us to protect our families can cloud our judgement when it comes to managing risk and deploying capital.
The great beauty contest.
In conceptualising the ongoing impact of the pandemic on markets, we are yet again reminded of John Maynard Keynes’ famous Beauty Contest which teaches us that investors shouldn’t price shares based on what they think their fundamental value is, but rather on what they think everyone else thinks their value is. Or, more precisely, what everybody else would predict the average assessment of value to be. Keynes said:
“We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth, and higher degrees.”
Markets have always been modulated by fear and greed, and today is no different. Except that things are not playing out how most people expected. As our friend Chaitanya Kotadia recently pointed out in his excellent “Weekender” newsletter:
“I opened the first page of WSJ today, and it was so bleak! I opened the New York Times, and it was even bleaker! And then I opened my live financial markets page, and it was BRIGHT GREEN.”
And as we write this blog post on a wet and windy Thursday evening at the end of April, CNBC is reporting:
“Jobless claims have now topped 30 million over the last six weeks, and data showed a plunge in consumer spending and personal incomes in March. All the major averages are still up double digits for the month, and the Dow and S&P 500 are on track for their best month since the 1980s.”
In India, the US, the UK and indeed, the world over, markets are decoupling from newsflow. That is interesting, and encouraging. Could it be that the great beauty contest is a leading indicator for the global economy and the restoration of normal life? We’re not economists and we’re not clairvoyants – which is probably a good thing, as we don’t believe that either profession offers much help to investors right now.
The next crisis.
Right now, the prevailing narrative is Coronavirus. Before that, it was the Trade War, Brexit and a bunch of other massive themes that now seem laughable in their relative triviality. But are they?
The Trade War (or more accurately, the stark economic, political and cultural realities that underpin it) isn’t going anywhere. It’s just buried under a million news articles, tweets and Zoom calls about COVID-19. The next crisis will no doubt be something completely new that blindsides all of us and makes us feel utterly naïve and foolish for not seeing what was, in hindsight, so obvious. After all, the experience of crisis has come to define our species – we lurch from one breakdown to the next, partly because causing and surviving great strife makes us human, and partly because the media demands it.
History shows that it’s more possible to succeed in a crisis. From where we’re sitting, the key is not to react to markets, or seek to predict their movements with bold calls and ideological diatribes. It is to adapt to the new reality with which we are presented, developing new ways of seeing and hearing what is going on around us. By doing this, we can modify our behaviour and learn to thrive in new environments.
We’ll spare you the evolutionary analogies and instead pause to reflect on those who have actually done it. You might expect us to launch into an exploration of wildly successful companies founded during recessions (including GE, GM, IBM, Disney, HP, FedEx, Microsoft, Google and Facebook), but you’ve probably heard those stories. So instead, let’s focus on one very special person whose story can teach us much about how to flourish under adversity.
A very important lesson.
The late James Stockdale was a man who experienced true suffering during his lifetime – and achieved true greatness in the process. If you want a way to measure the size of a person’s contribution, then sure, he won the Medal Of Honour, America’s highest military accolade. But his achievement – in terms of what he did for himself, his friends, and his country – reaches beyond measurement.
While on a mission over North Vietnam in September 1965, he ejected from his Douglas A-4 Skyhawk, which had been struck by enemy fire, and parachuted into a small village. He was severely beaten and taken prisoner, before being held as a prisoner of war in the Hỏa Lò Prison (dubbed the “Hanoi Hilton”) for the next seven-and-a-half years.
As the senior Naval officer in the prison, he took it upon himself to organise the prisoners’ resistance, enforcing a code of conduct which governed torture, secret communications and behaviour. One story in particular captures the essence of his courage and creativity.
Informed by his captors that he was to be paraded in public, Stockdale slit his scalp with a razor to disfigure himself so that he could not be used him as propaganda. Then, when they covered his head with a hat, he beat himself with a stool until his face was swollen beyond recognition. Later, when Stockdale was discovered with compromising information that could implicate his friends and threaten their safety, he slit his wrists so that his captors could not torture him into confession.
After seven and half years of incarceration and tortue, he was reunited with his family on US soil. Stockdale later said:
“I never lost faith in the end of the story, I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade.”
When asked who didn't make it out of Vietnam, he responded:
“Oh, that's easy, the optimists. Oh, they were the ones who said, 'We're going to be out by Christmas.' And Christmas would come, and Christmas would go. Then they'd say, 'We're going to be out by Easter.' And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart.”
Stockdale’s learnings are instructive for all of us at this time, as we navigate the lesser tortues of lockdown and loss of freedom, struggling businesses, imperiled jobs and children with cabin fever! In order to survive, he mastered a kind of doublethink – an Orwellian ability to hold two apparently contradictory thoughts in his head at once:
“This is a very important lesson. You must never confuse faith that you will prevail in the end – which you can never afford to lose – with the discipline to confront the most brutal facts of your current reality, whatever they might be.”
Jim Collins went on to describe this duality as the “Stockdale Paradox”. It strikes us that Stockdale wasn’t really a master at managing mental and physical pain (which nonetheless he did exceptionally well) – really he was a master at managing uncertainty.
Embracing uncertainty.
Not knowing what is going to happen next defines life. So it follows that in order to enjoy life, we must embrace uncertainty. That is why we named our business after the Three Body Problem.
At the end of another tiring but extremely rewarding week at the coal face of a seemingly irrational stock market, the current landscape demands precisely this kind of approach. For us, the key to navigating these times professionally and personally lies neither in naïve optimism or wide-eyed pessimism; it resides in carefully managing both extremes and leveraging the beneficial elements of each. It means embracing uncertainty.
Such an endeavour cannot be achieved alone – it demands teamwork, honest feedback, and yes, the occasional heated exchange between friends. Then again, what else are friends for?!