May 12, 2021

Too Smooth To Be True

This time, we're going to talk about how market trends are all too often too smooth to be true. What might that mean? Well, life isn't as predictable as it might first appear, meaning those unpredictable events may have been planned all along. "Great...

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This time, we're going to talk about how market trends are all too often too smooth to be true. What might that mean? Well, life isn't as predictable as it might first appear, meaning those unpredictable events may have been planned all along. "Great expectations", as Dickens once wrote, "need to be met with better than expected results."

Bubble Trouble is hosted by economist and author Will Page and financial analyst Richard Kramer. It is produced by Magnificent Noise,

More information is available at


Richard Kramer: One strange element of the market commentary is all about meeting or beating expectations, and the reality in the those situations is that the deck is really stacked in the favor of the companies themselves because not only do they get the chance to set those expectations, they also have a lot of leeway in how they can deliver on them.

Will Page: Welcome to Bubble Trouble. Conversations between the economist and author Will Page, that's myself and the independent analyst Richard Kramer, that lay out some inconvenient truths about how the financial markets really work.

This time, we're going to talk about how market trends are all too often too smooth to be true. What might that mean? Well, life isn't as predictable as it might first appear, meaning those unpredictable events may have been planned all along. "Great expectations", as Dickens once wrote, "need to be met with better than expected results". More on that in a moment.

So we're back again to unearth more trouble that's causally linked to more bubbles. So far so good. Last week we got stuck into the Sycophants and Stenographers, the cheerleaders who surround a company and ask its leaders, "How should I think?" About a recent trend or event. That of course reminded us about the Keynesian beauty contest, where the conflict of interest kicks out, as the contest kicks in. No longer are you judging a market by who you think will rise and fall, but who the judges think will rise and fall. And those judges being the Stenographers and Sycophants themselves. This week, we flip the lid wide open on how those numbers the Sycophants and Stenographers are reporting on, are so remarkably smooth. "Great expectations", as Dickens once wrote, "need to be met with better than expected results". Who sets those expectations? Who marks their homework?

So, Richard, this sounds like we're going to be unearthing a long held suspicion of yours. And it's a suspicion that sounds similar to a famous quote by Donald Rumsfeld about what people know, what they don't know, and what they shouldn't know but they do know. A case of asymmetric information in the market.

Richard Kramer: I think that Rumsfeld quote was about the known unknowns, and those aren't really a big problem. You know what you don't know, but it's the unknown unknowns that are the real problem. The things that can come and get you, but you haven't thought of. And, a- a fundamental issue when looking at the markets is that investors have so much less information than the companies they're following.

You have some of the world's largest companies which are able, in almost any circumstance, whatever their business mix, the geographical mix, their, the foreign exchange rates. They're able to land their margins in ranges of less than a percentage point, quarter after quarter. And how do they do that for four, five years running? I have to think it's due to a smoothing that they agree on with their accountants, in terms of the revenue recognition policies, the, the arrangements they have with their suppliers and so on. Because otherwise, I can't explain how these impossibly large companies all deliver such consistent results, in such varied markets, with so many fluctuations in the wider environment.

Will Page: Flag on the play, flag on the play. You just said Revenue recognition. That sounds like common sense make complicated, can we just take the jargon out of this? Is this like when you decide when to drop a number into a spreadsheet because you've got that discretion?

Richard Kramer: When you think about the nature of contracts, uh, a lot of times they involve delivering something that you promise to have in the future. If you buy a piece of software, it's gotta run on your computer, or work in your enterprise environment for many years to come. Now when you choose to recognize that your customer has paid you for that, may or may not be the same time that they hand over the cash to you. There's really a dark art to revenue recognition, there are rules and guidelines around it, but oftentimes those are interpreted at the discretion of the chief financial officer of a company. And a lot of times they involve very complex, multiple-element arrangements, that decide when a customer has signed off on a particular piece of equipment, or when they've accepted that a piece of software works as expected, or when they think you've completed a service that you were contracted to provide to them. And that's really very much at the discretion of the auditors who are looking over the shoulder of the companies' managements.

Will Page: From markets to manholes, what you're describing there takes me back to cycling round the streets of London right now, where these cash-strapped local governments, who are desperately short of money, have somehow, surprisingly in the month of February and March, just before the close of the accounting year, have all this excess money to spend on road repairs. So the roads are being dug up, and it just reminds you of those who control the budget, control how and when it's going to be spent. Is this what we're saying? If you control the accounts, you control how and when that revenue appears.

Richard Kramer: What you've described with your local council, is something that the corporate world all the time. Because when they have more money to spend, by God, they spend it. What person is going to hand back the marketing budget and say, "We really didn't need that, we've got plenty of sales already"? So the pressures on these companies are to spend what they've promised investors they would, and largely to do what they've promised investors they'd deliver. And naturally, sometimes they'll work with their accountants to make sure that what they deliver fits what the expectations were.

Will Page: So what we're dealing with here is a dance. A courtly dance if you like, between the management and the accountants. Back to that adage of no conflict, no interest.

Richard Kramer: Yeah. I-I think what we're talking about is an extension of the conflicts of interest that we described with the analysts covering the companies. And I think you had a lovely phrase about it, that those analysts are, are there to praise, not appraise the companies. And now you have another conflict. The accountants themselves are paid by the companies they audit. These companies are hugely complex enterprises, in which the accountants might have a very short period of time to sign off on a wide range of op-operations. And then you have any number of adjustments, what they call non-GAAP, or non Generally Accepted Accounting Principles, and you might step back and say, "Why are so many companies reporting under what are not generally accepting accounting principles?", and the honest fact is that most companies do offer some sort of adjusted set of earnings. And that adjustment is usually done to suit their own interests. To exclude things that otherwise would be considered costs in their business, or to give them more leeway over when they could recognize revenue on parts of their business that might not reflect the cash that they've actually collected from their customers.

Will Page: Is this what's known as cooking the books? I've heard that expression before, but is this an example of book cooking?

Richard Kramer: Uh, no. I think there are many examples of book cooking out there, and it feels as if we have one or another major accounting scandal, or misreporting scandal with a large listed company every few months. There was a prominent one in Germany late last year, a company called Wirecard. There's one going through the UK right now, a finance company called Greensill. Those happen where, in many respects, the company itself is willfully misrepresenting its business. What I'm talking about here is something much more common, and, and something you spot in many companies, which is this... phenomenal smoothing out of their operations, whereby instead of seeing gyrations and fluctuations like you would imagine was happening with large enterprises dealing in... around the world with complex interest rates and supplier relationships and customer issues, you see this incredibly, uh, consistent pattern of margin improvements, or very narrow ranges of performance. And that's what seemed so unusual, it, cooking the book implies that there's some malfeasance, what I'm talking about here is something much more prosaic, and much more common which is this smoothing factor.

It's like in, if you look at China, they report their national GDP statistics two weeks after the end of every quarter, and they never revise the number. So they've just decided what the number will be, they've said it's going to be around this much, they'll come in slightly above or below, and they'll never bother to look back whether that actually proved to be the correct number.

Will Page: That reminds me of a great story about a former Chancellor of the Exchequer, that will remain unnamed on this podcast, he got fired because the British economy entered a recession, but that was based on the GDP's first round of estimates, and 2 rounds of estimates later, which is approximately 9 months after the 3 months after the event, they revised those estimates and the economy was actually growing just fine. But he didn't get his job back. So the value of accepting you're wrong, and revising, to get something that's closer to the truth.

In our first episode we discussed Sycophants and Stenographers, now we're talking about trends that are too smooth to be true. And the way you're describing it for me, and I'm sure for many of the listeners, is when you hear this language, and what you've done Richard is introduce us to the language that we can spot on the market, when you hear of a new management coming into a company and it's a safe pair of hands that will steady the ship, that's what you're making me think about, that language of steadying the ship.

Richard Kramer: Hmm.

Will Page: Tell me more about how we can join the dots between those who are praising, as opposed to appraising the companies, and those who are producing those trends that are too smooth to be true, who are steadying the ship as it were.

Richard Kramer: Well, one strange element of the market commentary is all about meeting or beating expectations. And the reality in those situations is that the deck is really stacked in the favor of the companies themselves, because not only do they get the chance to set those expectations, but as we've talked about with the accountants, they also have a lot of leeway in how they can deliver on them. And maybe not over the long run, but certainly over specific quarterly numbers, or short periods of time. There was a great Wall Street Journal article a few years ago about how one of the largest companies in the US, one of the big Telecoms companies, how every quarter, just before the quarterly report, in the few weeks prior, analysts reduced their expectations, which allowed the company to say they beat expectations.

So they're all really playing a game here, of dampening expectations, and then beating their chests about how they can beat them. A decade ago or so, the old CFO of IBM, which has, in part of its business a lot of these very complex contracts which allow themselves to, a lot of leeway for recognition. The CFO would say to analysts on the conference call, "I've told you what the EPS work are going to be for next quarter, it doesn't really matter how I get there, just that I beat the number".

Will Page: [laughs]

Richard Kramer: And so, it, it turned out that IBM had a lot of accounting malfeasance, and it crops up regularly, uh, with disturbing regularity really, across many companies and sectors, but also very commonly on these very large projects, and project accounting. And I know not far from your house they're building the HS2 project, which I think started out at something like £50 billion cost to the UK taxpayer, and has now mushroomed to £80 or £100 billion costs and how can they get their sums so wrong? And, but that's a great example of where the accountants are operating with less perfect information than the companies themselves, but the companies may not want to let on to the true cost of the project, until they've already passed the stage where sunk costs are so great that they can't give up on it.

Will Page: You're haunting me there. All this taxpayer money being spent here in London so that you can get to Birmingham even faster. Or maybe it should be so you can get out of Birmingham even faster, depending on your view of that place.

Richard Kramer: [laughs]

Will Page: Anyway, what you've done in this illuminating conversation here, is you've reminded me of that great, uh, Scottish columnist, John Kay. His famous quote which is that, "To be a fan of markets, is not necessarily the same thing as to be a fan of business, markets are one thing, that's a resource. Business is another, that's about extracting profits over costs".

Back after this bubble, with even more trouble, where we'll learn how to spot these trends which are too smooth to be true. Stay close, Richard Kramer, I'm Will Page, and you're with Bubble Trouble.

Back again with more Bubble, and even more Trouble. And this time, we're discovering trends that are too smooth to be true. We're dealing with asymmetries, stuff the accountant knows, that's working inside the company, that the analyst knows, that's sitting outside. Richard, I'm from a horse racing family, claim to fame my Great Grandfather won the Grand National twice, as a Jockey, not as a horse, just to be biologically clear there. But there's a lesson I've learnt from being taken to horse racing for many a years is that the bookie never loses. You go into a racetrack, you have a paddock, you can inspect the horses before they run, then you go out to the bookmakers in front of the main stand and you place your bets, but the bookie always comes up good. And that always makes me think that the odds are stacked in their favor, therefore they're not in your favor. There's a, there's an imbalance here.

What you're talking about with trends that are too smooth to be true, and the way that you can mark your own homework, manage your own expectations, set your own bar as it were. Is it similar to what I'm talking about when I think about the bookmaker always coming up good?

Richard Kramer: Well, I'll tell you, when I started as a financial analyst over 25 years ago, in the city of London, I was amazed to find out there were prohibitions against what was called front-running. I.e buying shares in a company before you knew some particular piece of news was going to come out that might have been positive, that might have sent the stock price up. There was, however, a little-known regulation, which allowed market makers to acquire shares in a company, to meet anticipated market demand.

Will Page: [laughing]

Richard Kramer: And they just had, so happened, and this was of course before all the Wall Street scandals, and Spitzer-Blodgett-Grubman, all that stuff. But if they just so happened in the director's dining room, or the lunch line or what have you, to chat with one of the bankers that might have mentioned casually that they were helping out a particular company in one way or another, well maybe that traitor would have been able to buy shares of a company in the morning, when they suspected that an announcement might be coming out in the afternoon.

And if you look at the history of the last 10-20 years of looking at large investment banks, they have been phenomenally profitable enterprises, despite paying 10s or 100s of billions of dollars of fines, repeatedly, for various forms of malfeasance, and many deferred prosecution agreements, but they keep getting fined and keep making bucket loads of money. So that has to remind me a little bit of the casino, which obviously we all know that casinos have the odds stacked in their favor, yet people still walk in and convince themselves that they're going to be the ones that'll walk out wealthier. Even though, obviously, many people don't.

So how does that work, and how do people convince themselves that they're gonna walk out wealthier? That's something for you or your behavioral psychologist, or behavioral economist friends to come and enlighten us.

Will Page: Richard, at this point in the podcast I'd like to give the audience some smoke signals to spot. So when we can see Bubble Trouble ahead, how can we avoid them? How can you help the audience, you know, see around corners essentially? What smoke signals can you throw out here which can help us spot these trends that are too smooth to be true?

Richard Kramer: The first one is to be aware of just how expectations get managed by companies, a-a-around their results. We see this regularly where companies give guidance that says, "We're gonna have a really large loss", or "We're gonna spend a lot of money on something", and then celebrate the fact that the losses they had, while jaw-droppingly large, were not as large as people had expected. Or, they simply weren't able to spend all the money, maybe because they weren't able to find enough talented people to work for them, to hire, that they promised that they would. Equally, companies always have a ready set of excuses, and again back to this notion of Sycophants and Stenographers, some of the analysts which have conflicts, and may wish to be supportive of the company, come what may, will take those excuses and pass them on to investors.

So you really have to watch how these expectations are set, how companies can routinely give you a more dismal outlook than they know they're going to be able to deliver, and so that they can engineer a beat, or a positive surprise every quarter. This is a form of misdirection, of ensuring that they always have positive news to give you every 90 days, and again, back to my overarching point that any company that really changed it's strategy every 90 days would likely be doomed to fail, because strategy takes years to play out.

Will Page: This is, uh, this point we mentioned earlier of marking your own homework I guess. This is like setting your own bar to produce the beat. And I guess this plays into what we discussed on the last week's episode of Bubble Trouble, which is the oversupply of news. If you have an oversupply of 24 hour click bait news stories, then you're desperately demanding stories to fill that inventory if you want. And I guess this is a way of doing it, which is just constantly producing new stories by managing the bar in order to produce the beat. It's making sense for me now, it's helping a lot. Let's go to your second smoke signal.

Richard Kramer: Another good check that you can use to think about how companies are actually performing, is ask what would you do yourself as the management of that business? One of my aims as an analyst is try to put myself in the shoes of the companies themselves, and look at things from their perspective. Bearing in mind, of course, that any 90 day period isn't really emblematic of the whole company's performance, and to decide any real strategic direction takes years of effort. So when you think about feeding this beast of uh, the 24 hour market news cycle, you realize why companies are so keen to engineer positive news, and the sense that they can deliver on expectations every 90 days, because to fall into a group that is disappointing, or misses expectations, is to consign yourself to the dustbin of history.

Will Page: So we've got two smoke signals there that we can spot. What about those signals that we cannot? That is, what sort of issues are we going to be dealing with regardless of about how we are dealing with Bubble Troubles. What are the 2 undercurrents that just never go away?

Richard Kramer: Well, I think, a couple of things to always bear in mind. First I'd say is to be very attentive to the language the companies are using. Because, it's never going to tell you the whole picture, but remember I mentioned last time about how companies like to call their own performance strong. What does strong really mean? Does it mean you can bench press 400 kilos? Or, you smell like old socks, or what does it mean?

You remember they had a UK election and the PM kept using the phrase, "strong and stable", and obviously, didn't turn out to be either. Because she lost her job, and her position after that.

So, growth rates inevitably slow down. Especially in industries that aren't cyclical, they will go through periods of slow down at eventual disruption, and then they never recover. So you always have to bear in mind for a company, while it's talking about how strong its performance is, it's gotta be mindful of the risks. And it should be giving honest, forthright answers, if, in the unlikely event that they actually get posed tough questions on their staged, quarterly conference calls, about what those risks are, and what they could do to the business.

Will Page: Do you have a second signal that's, a second undercurrent that's not gonna go away there?

Richard Kramer: I think another undercurrent that, you always want to be mindful of, is the, the tendency of analysts and investors generally to extrapolate from their own experience.

Hey! We went into a pandemic. And, I'm having food delivery ordered a lot more often. Isn't everybody going to be doing that? Or, hey, I like this particular tech product, won't everybody be like me, and appreciate it as well? It's a classic that we all extrapolate our own behavior not only to the market, but to the wider world. Because of course, we're convinced of our own correctness.

But just because we might buy every tech gadget, that doesn't mean it's going to be a massive hit. And so, stepping outside of your own experience, to understand what the mass market might be experiencing, or might be buying, is a very difficult thing to do, especially in areas like content consumption because we all have our very own unique tastes.

Will Page: I guess, our way of joining this all together is to think about a pertinent question many of our listeners will be asking right now, which is, they'll be looking at a stock, perhaps in the tech sector, and saying, "How much longer has this stock got left to run?" That, I, again, that kind of physical analogy, that athletic analogy, and I guess the point you're bringing us towards here is, part of the answer is driven by the market fundamentals, demand, supply, pricing power, competition, and part of it is how much more stories have they got left to run, as well. It's a combination, it takes two to tango, right?

Richard Kramer: Indeed. And I think we can, we're gonna talk about that on a subsequent episode, but clearly, companies, as I described last episode, are marketing their equity stories to investors, in the same way they're marketing their products to consumers.

And that's a critical part of what management is supposed to be doing when it gets on these conference calls. They're going to be telling you the good news about how their company is, is new and improved, every 90 days. The same way as if they're selling washing powder, they've got to come up with a reason why that washing powder is new and improved.

Will Page: That word, marketing, it really resonates. Back home in Edinburgh, we have the world's biggest arts festival in the month of August, hopefully will be resuming again this year. But I always remember a golden rule of thumb of picking out a good show, a needle out of the haystack of the thousands of shows happening in Edinburgh in August is, if a show can sell out without marketing, it's a good show. Like the show speaks for itself. And it's, okay, it's a cultural event in northern Europe, but it's a great analogy to apply here, which is why do you need marketing if the product itself is good enough? It just raises questions about what the purpose of marketing is, and reminds us of that famous Bill Hicks sketch which is, if you work in marketing, kill yourself.

Richard Kramer: [laughs]

Will Page: But we won't go into that, because we don't want to lose our listeners yet. Okay, so we've got our building blocks here, let's tie it all together. So we've covered our Sycophants and Stenographers, those who ask management how to think about an event or a trend, and now we've hacked into these trends that are too smooth to be true. Sounds like we've got a recurring theme here, Richard. Where do you want to take us next week?

Richard Kramer: I think, just to wrap up this week, I think you need to be watching the changes and expectations like a hawk if you really want to be trading the market. But the reality is, you just need to step back, and understand that whole dance around expectations is a game. And it's a game which is rigged where it, really against your favor. Because you're not going to be sitting in the seat of the analyst, or in the seat of the management, who has all of the extra cards to play.

And then I think the other key thing is to step back, and to ask yourself some basic questions about what companies say, along the lines of, "Does that sound right?", "What's the source of profits here in the long term?". And I think this is the process of getting back to looking at the trees or the forest, not just the bark or the leaves. I think the minutiae of a lot of quarterly earnings reports really falls away if you start to look deeply over the long term cash flows companies generate. And it's much harder to gain a cash flows statement than it is, than a quarterly profit and loss accounting statement.

There's a lot of basic questions that are worth asking, and, and ignoring all the noise around the latest hype around a particular set of quarterly earnings, but looking at those trends over a much longer period of time.

Will Page: And that's what I want to get the audience to really be equipped with here, is just that ability to step back from the hype, the hyperbole, the hysteria around the markets, and just spot the dance that's being conducted in front of themselves. To spot the trends that are too smooth to be true. Spot the role of Sycophants and Stenographers. If we can give the audience that, then it makes them less likely to find themselves getting caught up in Bubble Trouble next time it rears its ugly head.

Richard Kramer: Hmm.

Will Page: Where do you wanna go next week, Richard?

Richard Kramer: I think next week we should really talk about the concept of the total address for market.

Will Page: The themes and the dreams.

Richard Kramer: The themes and dreams out there. And that everyone wants a short hand handle to latch onto with stocks and investments. What's that new and improved version of yesteryear's washing powder that's gonna become the next generation of software or artificial intelligence or some other new life changing invention? And maybe to walk through some of the Nvidia statistics that are thrown out there to justify investing in these, in these new technologies. Imagine the toothbrush that gets your teeth 37% whiter. Who wouldn't want that toothbrush? How do you know how large the market is for that 37% more efficient toothbrush? And really, to understand when a, a claim is being thrown out there, where is really needs to get that sense check. And we'll come up with some good examples of those as we go forward.

Will Page: And working backward, you need a nice, large, fat, juicy addressful market so you can base a trend that happens to be too smooth to be true, in order to those Stenographers and Sycophants to be able to do their special dance, correct?

Richard Kramer: Absolutely.

Will Page: I want to thank my colleague Richard Kramer, and remember, this week's Bubble, is next week's Trouble. I'm Will Page. Bubble Trouble is produced by Eric Nuzum and Jesse Baker at Magnificent Noise. You can learn more at See you next time.