Understanding Outliers

Depending on your perspective, people are either loving Amazon or having some cognitive dissonance. It’s shopping out for the second headquarters across America on the potential host cities dime, it “legally” paid zero dollars in federal taxes in 2017 (in 2016 it paid $8.4 Billion), the stock is up 50% in the past few months, and just about everyone you can think of has amazon prime, at least according to “the Four” author Scott Galloway:

In the latest interesting Amazon statistics, for the first time ever, Amazon has released the median salary of its employees at $28,446. Interpret that as you may, but what Barry Ritholtz of Ritholtz Wealth Management found most interesting is how much Amazon CEO Jeff Bezos is worth compared to his lowly employees:

Bezos, according to the proxy, had a salary of $81,840 in 2017. The rest was in the form of perks, much of it for “security arrangements” and travel. But Bezos’s pay, which seems rather modest when stacked up against the obscene earnings of many other corporate chiefs, is almost irrelevant. That’s because Bezos is the world’s wealthiest person, with a fortune now estimated at about $129 billion (depending upon the price for Amazon’s stock).

So that ratio, although accurate, means next to nothing. If you really want to understand the gap between CEO and worker, consider instead the ratio between the net worth of the boss and his employees: I did, and it’s beyond measure. Seriously, 100 billion-to-1 is not an outlandish estimate.

Mr. Bezos is the outlier of all outliers, existing so far over on the right side of the bell curve of American Net Worth readings that he’s likely a 100 sigma event, or so, as we would say in the business. Meaning he’s 100 standard deviations above the average American’s net worth with that 100 Billion to 1 number, as Mr. Ritholtz says. He should literally not exist in a world which is normally distributed, being that many standard deviations above the average. But he does exist, and those $129 Billion are really his, making it painfully obvious for those of us down there within a few standard deviations of the mean that the world, especially when it comes to money and markets and everything else financial – is not normally distributed.

Nassim Taleb, author of the fabulous book Black Swan separates normally distributed and non-normally distributed by saying that which belongs to normally distributed curves exists in mediocristan, and everything else exists in a place called extremistan. Unfortunately, for the efficient frontier and VaR calculations and other financial models assuming a normal curve – we live in extremistan! Take the above example from the distribution of wealth (extremistan) as compared to the distribution of human height (mediocristan) as an example. Consider that the tallest human ever recorded was 8’ 11”, or about 1.6 times the average of 5’6”, and 10 standard deviations outside of the average. How tall do you think a person would have to be so that they are as much over the average in height, as Bezos is over the average in wealth? 10ft tall? 50? 1000? Assuming an average household net worth of $130,000 in the US, Bezos is 1 million times that wealthy, meaning he would be about 1,000 miles tall, or about the distance between Chicago and Jacksonville, or New York and St. Louis. That’s a tall man!

Why do we care? Well, because too much of the financial world is still modeled under the assumption that we live in a normally distributed world.  And what’s the problem with that?  Well, consider the investor who believes financial markets are normally distributed and modeled the worst loss that could happen the next day as something like 1 tenth of 1 percent chance of losing -90%. Say they modeled it out that they would have seen a 1 in a million years or so chance of the VIX spiking over 100% on February 5th. With that quote/unquote knowledge, they may have bought into the falling knife that was the $XIV ETF, or sold way out of the money VIX options, comforted by the very small possibility of such a large one day spike ever happening.

And they would be broke now, because in the markets – there’s always another 1,000 mile tall Bezos equivalent just around the corner. There’s so many of them, when looking across markets, asset classes, and companies –  that it becomes quite clear that we’re inside of something much different than the normal distribution.

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