In this week's Stansberry Investor Hour, Dan welcomes James Weatherall to the show. Unlike most of our guests, James does not come from a finance background. However, he has found interesting ways in which physics can change investing. You can check out his book The Physics of Wall Street here.

James kicks things off by sharing his background in physics and philosophy. He's interested in mathematics and how it can be applied to the markets. He's a firm believer in using mathematical models to assist in investing but says that it's important to examine your models and check your assumptions that result from them. If one model is good for a particular use case, trying to use it in a different area or within a larger scope than it was originally intended can yield different results than expected. James discusses the models that Louis Bachelier and Edward Thorp (whom he writes about in his book The Physics of Wall Street) created that would have a major impact on investing...

Bachelier is this really fascinating, way-ahead-of-his-time figure who, right around the turn of the 20th century, writes this dissertation in mathematics in which he applies ideas that we would now think of as stochastic calculus. [These are] the kinds of things that would go into areas of physics and thermodynamics to basically options pricing... [Thorp develops] the same idea that Bachelier has, except he takes it a step further and comes up with a formula for the fair value of... something like an option.

Next, James mentions extreme events similar to Black Monday and their probability of occurring. He notes that in the long term, investors with 401(k)s would be able to survive and even recover after major crashes. However, anyone who overleverages a trade or invests heavily in the short term is at a greater risk of having their portfolios be wiped out. James also mentions the Kelly criterion, a strategy developed by mathematician John Kelly. In short, this method involves having an understanding of what could happen with stocks better than the markets and using that to your advantage to make the optimized trades possible. And when asked if he would change anything about his ideas in The Physics of Wall Street, he remains adamant that his argument still holds up...

[The Physics of Wall Street] was written at a particular time where there were particular debates happening. So it was really a response to the 2007 to 2008 crisis. And I think as a response to how people were talking about that, I wouldn't change anything. I think I stand by what I wrote there. Maybe if I went and read it again, I would not feel that way. But I do think that a lot has changed in [the] market since then.

Finally, James mentions passive trading and volatility and how, over time, the addition of new passive investors will gradually increase market volatility. He adds that there's a scalability problem in the markets. In one example, he says that private markets "worked great 20 years ago" but only "worked OK" 10 years ago. Private markets are slowly becoming less able to sustain the growth they have. And James wraps things up by sharing his personal use cases of AI and his fears with the technology...

I use [AI] in my teaching in some ways. I try to incorporate into my teaching ideas about how AI works, but also what its limitations are, what it's good for, where it can cause problems. I've experimented with using it in research, and I have not yet had great successes... There are a lot of ways in which it can put [universities] out of work. One way is that if we can't figure out how to continue to make education a meaningful experience for students. So if it becomes a situation where students are using AI to do their homework and professors are using AI to grade the homework, what's the point? Why are any of us doing this?

Click on the image below to watch the video interview with James right now. For the audio version, click "Listen" above.

(Additional past episodes are located here.)

The transcript is coming soon.

This Week's Guest

James Weatherall is a Chancellor's Professor at the University of California, Irvine, where he focuses on physics, mathematics, and philosophy. He is also a member of the Center for Theoretical Behavioral Science, the Center for Cosmology, and the Jack W. Peltason Center for the Study of Democracy. Additionally, James has authored several books, including The Physics of Wall Street, Void: The Strange Physics of Nothing, and The Misinformation Age: How False Beliefs Spread.

James earned his PhD in philosophy from the University of California, Irvine and a Master of Fine Arts in creative writing from Fairleigh Dickinson University.