Dao of Capital Summary & Notes

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I recently finished reading Mark Spitznagel’s (Universa Investments) Dao of Capital and for my own clarity and understanding I typed up notes and a summary. I have tried to keep the notes opinion free or indicated when I am expressing my own view or extending and or applying the conclusions reached in the book. Thank-you for reading and hope the below is informative!

Photo by Marita Kavelashvili on Unsplash
  • The core philosophy of Austrian Investing is positioning and taking a loss today for better positioning in the future, taking a ‘roundabout’ path. Using means for a particular end. E.g., Robinson Crusoe & Henry Ford.
  • Promotes deduction about the future, rather than explicit forecasting. Using a teleological approach, i.e. looking at the purpose a phenomena serves rather than the cause by which they arise.
    — I would extend this to the importance of looking at incentives within a system or framework, and additionally, look at the duration of the incentives, most often the duration is short therefore there is a trade-off for short gain and long-term pain.
  • The Austrian school broadly advocates deduction and praxeology (the study of human action and conduct) opposed to mathematical modelling and forecasting based on those models. The Austrian school advocates using the observations from praxeology to then deduce what occurs in the future.
  • Spitznagel draws from Lao Tzu and Von Clausewitz to setup his philosophy of the roundabout.

Lao Tzu:

Von Clausewitz:

  • Spitznagel advocates going backwards to go forwards / the short-term sacrifice for longer term gain — Zweck zeil, Wuwei, waiting, active patience. Looking for the unseen compounding and investment. Innovation is often ignored by capital until it is obvious.
    — Tom’s examples / thoughts:
    * TSLA — despite the huge operation investments, the business was ignored for an extended period of time until certain buckets of capital recognised it and allocated to it.
    * Capital pricing / business pricing is not smooth, (perhaps extending the bow too far…but I will) similar to what Mandelbrot espoused, markets / pricing jumps, it is wild, it is only over time does it look smooth. Which intuitively makes sense as prices movements are to a large extent the movement of the underlying flow of stock and as a result market moves cluster around short periods of time, such movements are fractal-like and the largest moves are responsible for the most gains and losses and cluster temporally.
  • Spitznagel and Austrian investing (broadly) sees government intervention as the cause of economic dislocations — this overwhelmingly comes in the form of monetary dislocations and the carry-on effects. The Austrian school broadly argues that the interest rate should be set by the intersection between the savings rate / the amount of savings in the economic and the demand from businesses for capital, therefore forming stationarity (essentially equilibrium). When the government intervenes via fiscal or monetary means they create a glut of capital that dislocates from the real rate creating a gap, drawing this to its conclusion, this consequently creates the liquidity gaps we see in trading and markets. E.g., when a particular stock or asset gaps up or down.
  • Human psychology is such that individuals gravitate towards immediate gratification (high Time Preference), but the greatest gains often come from deferring consumption now for greater consumption later (low Time Preference). A time preference for later and increased consumption is linked to higher rates of current production; resulting in lower interest because people appear to be saving and more eager to lend money. In contrast, a preference for immediate consumption is linked to less resources left over for production and higher interest because there appears to be less money to lend. For larger gains, investors must be willing to forego present consumption with the intended goal of greater consumption later.
  • When artificially low rates of interest pushed down by the inflation of the money supply (due to external intervention) market actors, investors and savers will instead gravitate towards riskier investments to reap more immediate gains vs the rate of interest on savings. As the cycle accelerates, eventually less capital is left for production, the economy is unable to progress, and investors are forced to liquidate, causing stock prices to plummet.
  • Traditional economics teaches that individuals discount intertemporally, favouring today over the future, whereas Spitznagel argues that regardless of when the cashflow occurs the individual feels the same in the future and therefore should weight it equally with today.
    — I.e. despite not receiving the reward for saving today for the future it should be viewed as such, money saved for the future should not be discounted.
  • Spitznagel looks at the MS ratio / Tobin Q ratio as a measure of value in market.
    — MS ratio / Tobin Q ratio: ratio of the market value of the companies/replacement cost of those business or total US corporate equity/total US corporate net worth.
  • Roundabout framework, position now for greater returns in the future. I.e. stay out of the market when its overvalued to purchase cheap equities in the future.
  • Spitznagel argues a higher MS ratios lead to more short termism in the market, higher preference for yield and cash today vs cash in future leading to a decline in capital investment and therefore a decline in future returns.
  • Spitznagel highlights, when investing and thinking about the economy capital must be viewed as stratified and a temporal structure with different constraints. Each layer / different category and subdivision of capital has different durations, fluidity, liquidity, allocations, sophistications, risk tolerances etc. It cannot be viewed as one blob.

Austrian investing framework 1:

  • Investment in an index + 30% OTM 2mth puts rolling monthly. pricing 0.5 delta.
  • MS ratio (0.7 undervalued, 1.6 overvalued) — Tobin Q ratio.

Austrian investing framework 2:

  • Filtering mechanism: ROIC & Faustmann Ratio (market cap / net worth)
  • Looks for high ROIC of >75% and Faustmann under 1.
  • Waiting for short termism from wall street to lead to dislocation in the filtered securities

Selected quotes:

  • “Because of the quirks of our human eagerness for the immediate reward, we are forewarned that what seems easy and straightforward is deceptively so; the roundabout is in practice a counterintuitive path — of acquiring later stage advantage.”
  • “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy.” (Henry Hazlitt).
    — It generally holds that policy that is accommodating in the short run has deleterious long-term effects on an economy.
  • “Those who studied human action would start from the premise that there is a purpose behind our behaviour, which in this instance was to commute from home to work via the train in the morning and then the return trip in the evening. However, the opposite approach by the “truly scientific” behaviorist, who uses only empiricism, would merely see people rushing around randomly, without any particular aim, at certain times of the day. By this example, Mises showed which of the two approaches to human behaviour would be most meaningful — clearly the deductive.”
  • “Feedback is crucial and must be continuously given by and within the system in order to make the necessary, typically small corrections to keep on course.”
  • “You have to love to lose money and hate to make money to be successful”
  • “Many shall be restored that now are fallen and many shall fall that now are in honor.” (Benjamin Graham)
  • “Although the future remains uncertain, the entrepreneur relies on “specific anticipative understanding,” which “can be neither taught nor learned”; he does not focus on what was or is but acts upon what he expects the future to be.”
  • “To model procrastination — where someone really does intend to do something, just not right now — involves not merely a discount on future enjoyments, but a more subtle problem of time inconsistency, of thinking that what is too onerous in the present will somehow be easier to endure in the future.”
  • “The real black swan problem of stock market busts is not about a remote event that is considered unforeseeable; it is rather about a foreseeable event that is considered remote”
  • “It was Böhm-Bawerk who defeated them so effectively with economic theories and critiques such that Marxism did not take root in economics to the degree that it has in other professions, such as sociology and history. Using impeccable logic, Böhm-Bawerk showed that the workers who are employed by the entrepreneur are paid immediately for the “full value” of their labor, so long as that value is correctly calculated by including the time element. After all, in most production processes the input of labor hours doesn’t immediately yield a finished good.”
  • “Without a functioning feedback loop, the system goes haywire like a faulty thermostat”

Thank-you for reading!

With gratitude,

Tom