Seems to make much more sense than the index-chasing, asset-driven investment approach that everyone’s buried their heads in for the past couple of decades. The concept is not new, and was first introduced to satisfy asset-liability match in large pension plan metrics. Vanguard talks about it (pdf) here in a 2008 paper. When it comes to your personal pension savings, why not invest according to anticipated liability that is specific to your age, risk tolerance, and expected liability profile?
Scientific America explores why so many of us readily subscribe to conspiracy theories and draw conclusions from questionable patterns. It turns out we prefer type I over type II errors.
When our ancestors still hunted in the woods, it’s better to assume that rattle came from a poisonous snake and run, than to take your chances and get bitten. As a result, natural selection favoured those that assumed all patterns were real.
In other words, evolution hearted paranoia.
[via Freakonomics]
Yesterday I talked about how the market is far, far from efficient. Today, I want to point you in the direction of a Wharton interview with Robert Stambaugh and Jeremy Siegel, who discuss the idea of stock volatility in the long run.
In the long run, instead of falling volatility, we are in fact faced with more trend uncertainty that compounds the short-term volatility problem. Uncertainty about the trend itself becomes more important than the actual volatility itself. More specifically:
That uncertainty about the trend itself becomes more important the further into the future you project investment outcomes. […] to an investor with a long horizon, stocks actually are riskier per period. That is, the rate at which risk grows over the horizon such that it makes the investment riskier over the long run.
The other feature of the stock market that contributes to uncertainty is the fact that at some points in time we think the expected rate of return is higher than at other points in time. In other words, over time the rate of return that you can expect to earn over the short- and intermediate-terms fluctuates. The fact that the expected return fluctuates also adds to uncertainty because we do not know — for example — if expected returns are currently high, which many of us would guess they are. We don’t really know how long they’re going to stay high.
Using global warming as an example of uncertainty a long term horizon is subjected to:
It provides an interesting analogy to this concept because we might be very uncertain about how quickly the Earth is warming, but that uncertainty doesn’t much impact our uncertainty about crop output and economic output next year. But if we look 50 years down the road, uncertainty about the rate [at which the Earth is warming] has a much bigger impact on our overall uncertainty. Read more...
HT to my friend James, for bringing this to my attention today. In the last hour, the market ran up dramatically, then quickly dropped.
This kind of price movements is hardly an unique occurrence in the world of stock charts, where institutional investors by and large dictate pricing with their gargantuan orders. The market has been relatively quiet for the whole day, with little data released, nor shocking announcements made. So either there’s a large investor (or several) out there running up prices, then quickly dumping them. Alternatively, there’s information or rumours swerving around, privy to a few.
This happens, regularly.
Plus, Joe Nocera is poking holes in the efficient market hypothesis.
Jeremy Grantham from GMO rails:
“The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. ‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.”
Academia has largely accepted the theory within the vacuum of its constructed economies, with little challenges.
As Mr. Fox describes it, much of the early academic work that led to the efficient market theory was aimed at simply showing that most predictive stock charts were glorified voodoo — just because a pattern had developed didn’t mean it would continue, or even that it had any real meaning. Dissertations were written showing how 20 randomly chosen stocks outperformed actively managed mutual funds. (Hence the phrase “random walk,” to connote the near impossibility of beating the market regularly.) Mr. Thaler, the Chicago behavioralist, says that evidence on this point — “the no free lunch principle,” he calls it — is clear and convincing.
Addressing market volatility over the 30 years, Grantham says: Read more...
Don Coxe is one of the godfathers of commodities investment. His recent investment letter highlights some market developments over the past half year, and is delivered with some commentaries.
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Interbank lending heading back to normalcy:
TED spread had fallen from 110 to 72.
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The Chicago
Volatility Index (VIX): high of 86 on October, 48 in mid-March, now at 32.
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Commodities as measured by
CRB Index: low of 200 in February, down from 460 last June, now at 232.
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On the surprising performance of copper: not likely to see strong correlation between copper and industrial activity as some would suggest.
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China is stockpiling on industrial metals as a result of low LME prices. Even with copper’s sales surge, copper inventories on the LME has not shrunk. Investors are advised from drawing broad conclusions, instead, watch for decisive recovery of
Baltic Dry Index.
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Base metals and steel stocks are the most economically sensitive group, followed by energy and agriculture; precious metals are responsive to fears of dollar or banking collapse, and inflation.
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Agriculture stocks are driven by demand on the ground. The economic slowdown has reduced demand for wheat and feed grains, but it will not to the same level as the fall in metals and oil.
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Skepticism on Obama’s initiatives on Clean Energy: jobs (estimated 4 million) will be created in universities and laboratories, but other than political goodwill, it’s far from certain his investment will provide good returns.
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Long gold, short bond, short the dollar.
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Once economic outlook improves, may boost base metal exposure and return to more exposure to oil refiners.
Some other things that caught my attention today: Read more...
- The Dutch becoming “euro-skeptics” (opens to video): I live in the Netherlands, but this is news to me. The Dutch do not seem overly political, and are painfully aware of the symbiotic, and highly dependent relationship it has with greater Europe. The pragmatists are truly concerned over money (and really, that is the one unwavering theme that will always bring the country together), and the populists are throwing the usual immigration, insecurity and border issues around. Not sure why the FT focus is on the Netherlands this time, perhaps there are French and German segments coming up also?
The New York Times has gone Oprah! Remember last year when she fronted her magazine O with the big “How could I have let myself go” headline? The Times is attempting the same cheap populism with its personal finance focused magazine this past weekend.
One article that stood out and subsequently got a lot of attention was a personal credit crisis “confessional” from one of its own economic reporters. He has a book to promote, so naturally, the paper is there to serve as the springboard.
Many bloggers have applauded the “insight” and “braveness” of the writer, while heaping a string of other nauseating superlatives to the lengthy excerpt. I cannot share the same sentiment.
First of all, the irony of an economic reporter having financial difficulties is just screaming for a movie deal, right? Oh wait, the movie had already been made, it was a box office bomb called Confessions of a Shopoholic. Granted, the story in this case is slightly less vapid, but equally inexcusable.
As far back as the early 2000s, Andrews had been reporting on the economy, including alarming signs of predatory lending practices emanating from the housing and mortgage industries. In June 2004, a mere two months before his purported new chapter in life kicked off with an unaffordable mortgage, Andrews wrote the following gem titled “The ever more graspable, and risky, American dream”. Summarized by the Times in its archive, it says:
Array of mortgages for people with little cash or overstretched budgets has enabled families of modest income to take on debt once beyond their reach to buy homes, spurred by low interest rates and confidence that house prices will continue to rise. Some experts worry that recent first-time buyers will be squeezed by rising interest rates on adjustable-rate mortgages, possibly causing housing prices to wobble in some high-price markets on East and West Coasts. Read more...
Water is perhaps the most scarce resource on earth. Yes, there is water everywhere. But most of the water is not drinkable, not accessible, nor is the resource evenly distributed. It’s not unlike the oil situation, where a small percentage of the earth holds the majority of crude. But unlike oil, water is not replaceable.
So how bad is it?
A study by the University of New Hampshire shows that some 41% of the world population live in river basins under “water stress” – meaning the region is subjected to frequent shortages.
The most readily consumer able source of water, the freshwater variety, occupy less than 1% of the earth surface, yet it plays vital roles in agriculture, industrial productions, and our domestic lives. Over 70% of water is used for agriculture, making population increase a squeeze on all aspects of our natural environment, particularly water.
The need and the necessity of water
On top of basic agricultural needs, the rise of a genuinely more affluent class in the developing worlds are consuming more meat. As we know, animals require much more water to raise than its caloric equivalent in grains. Additionally, industrialization and mass urbanization have placed unprecedented strains on infrastructure. Thus, the accessibility of clean water has been compromised by rapid growth in many parts of the world.
High pollution and habitat degradation makes clean water increasingly inaccessible to the poorer regions. Many demographers, geologists and political scientists have attributed the root of war and violence in conflict regions to the lack of resources, particularly water availability.
Businesses stepping in
If there’s demand, then the market will find a way to meet the need. And it is hardly difficult to point to the existing challenging global eco-system, draughts and the ensuing human devastation to see some potentially lucrative opportunities. The explosion of bottled-water businesses is only the start. Up and down the water security chain, from bottling rights, purification and treatment, to distribution of the product, the water business is big. Read more...
A couple of days ago, a fellow blogger commented on this rather unfortunate Fortune article on his blog. It is interesting for several reasons.
First, the ideas are cookie-cutter and stale. Us Gen Yers had been told (to a certain extent) that we were on the cusp of a great demographic shift, where baby boomers’ impending departure would wreak havoc on corporate health. True, some of us were led to believe that our contribution would be valued at a premium, which would in turn translate into lots of choices and result in us hopping through the corporate environment at break-neck speed. In reality? Highly unlikely. The smart ones among us always knew that good jobs are competitive, and supply almost always outstrip demand, especially at the bottom rung. But the media kept up the propaganda – to what end, I don’t know. Every once in a while, articles like this appear.
Second, the timing is totally off. Because of economic realities, many boomers simply can’t afford to retire. More and more Gen Yers find themselves in a much more competitive environment than they were led to believe. Now everybody is learning to make do with less and to compromise. Exactly who is out pandering to those misunderstood geniuses, I’m not sure.
The somewhat hilarious prescriptions thrown around by the Fortune writer, and the kick my blogger friend got out of it, reminds me of a book I heard about recently. In this book, the authors address the various social and consumerist constructions of the Gen Y generation. I took some notes, here’s a broad overview of the ideas.
School: the obsession with feeling good at all cost
According to the book, the ME culture evolved over several decades, but found its decisive start within the school system. The baby boomer generation struck out, rejected authority and tried to find its own path. In their children, they instituted and obsessed over instilling self-esteem. Subsequently, various forms of formal, or informal self-esteem programs were introduced in school. They generally aim to make children feel good about themselves at all times and at all cost, with messages like: you are special, you are unique, you are fine just the way you are. Read more...
Bloggers Unite declared today Unite for Hunger and Hope day. I’m sure many posts are going up to get you to donate, to sign some kind of petition for debt relief, or in the least, just to care. Do you care? And with so many problems plaguing our lives, and the world in general, should you care? It’s not a rhetorical question. I am not sure I can overcome apathy.
To say that one doesn’t care about world hunger or poverty, is like saying one doesn’t care about the environment or basic tenements of human rights. But the images of starving children, whether they are of of the skeletal child brides variety out of India, or children with extended bellies with flies around their faces out of Africa, never really resonated with me.
There are two reasons for this.
Studies have shown that anti-smoking campaigns in schools largely fail if the program is overly reliant on the shocking the test subjects into giving up. If overly graphic images are shown – of black lungs, or the inside of a sufferer of throat cancer, students become so repulsed by the imageries, that they become detached from the message altogether. Similarly, when I see those pitiful pictures of hungry children, their plight seems so fundamentally wretched, my sympathies and emotional triggers are overwhelmed, and I block out the situation altogether.
Secondly, I have come to realize that images of humanitarian crises are constructed by professionals with an agenda. This is not to imply that journalists and photographers that take those pictures have malicious intentions. But it is important to know that behind every still and live image, there are a team of people actively managing our responses. The media create a range of identities so selective and arbitrary – us versus them, victim versus saviour, they effectively create a disaster when they decide to recognize it. Read more...
Investing is hard for professionals, and even harder for amateur investors. Especially when success is not measured in a cumulative manner – a dozen years of good work can be undone by a bad quarter.
I have written about the many difficulties of achieving consistent good performance: from minding the myriad of intersecting forces in order to stay above the water, the skills needed to balance long-term investment principles with technical knowledge, to blocking out noises that only confuse investors. On top of all that, it also serves to see the big picture, particularly forces related to social and demographic shifts. There is a lot to take in – which would explain why so many of us delegate the task to other people.
Yet for all those financial advice we consume from both paid and free sources: advisors, newspaper columns, personal finance and investment magazines, business TV programs and water-cooler conversations, most small investors find themselves unprepared and worse yet, unprotected from the financial storm that swept through much of the world in the past half year. After coming across Jeffrey Goldberg’s recent article, I am more convinced than ever that it is next to impossible for a small investor to make it in the stock market.
The small fish gets Jiffy Lube advice
Most of us have assets less than, say, $10 million. And that’s about the threshold that determines whether one gets the attention of a top-flight money manager, or a print-out from a cookie-cutter computer program.
In the article, Goldberg highlights the pressure to provide conventional advice.
Advisers only recommend what’s conventionally palatable. They tend to say 60 percent stocks, 40 percent bonds, and they’re not likely to move away from that, no matter how extreme valuations are. They’re not likely to move away from it when the market is really high, or really low. A big part of the problem is that there isn’t a perfect answer to any of this. No one can tell you how to allocate your assets 100 percent of the time. The average investor is not getting Warren Buffett to look at his portfolio; he’s getting a printout from a computer model. Read more...
Don Coxe is an investment strategist. But unlike most investment strategists that flaunt degrees in mathematics or quantum physics, Coxe is a curious historian. At 73, his curiosity has yet to wane, and his quarterly newsletter Basic Points has followed him from his old employer BMO to his new investment advisory business.
He makes investment a fun pursuit, not only of numbers, but of knowledge. In his own word, he studies history to “compare popular views about economics, finance, geopolitics with evidence of what has happened in various eras.” And making money is merely a financially rewarding byproduct of that pursuit.
In his March edition of Basic Points, Coxe drew my attention to a few points rarely discussed by investment advisors and analysts in the mainstream. Let’s see what they are.
Lack of sunspot activities and possible crop failures
Most of us are aware that the earth has been warming up in the last couple of centuries. The rise of environmentalism makes sure of that, and Gore’s Inconvenient Truth enforces that belief. As humans, we are no doubt responsible for the unprecedented level of pollution and degradation to our natural habitats. But the feverish pitch of the environmentalists has become dogmatic in recent years, and any dissent over either methodology or the validity of data that supports their belief is deemed treasonous.
As much as environmental awareness is a more than commendable cause, the sensationalism and the selectivity over the type of news and data that make it to the front page has been astounding. Bloopers are swept into the background, and wildly pessimistic and sensationalistic pieces inject more fear and exaggerated claims into mainstream conversations. We are all for a better living environment, but no end justifies the means if facts and truths are misrepresented in the process. The public will turn their backs on the cause, no matter how noble it may be. Read more...
When it comes to investing, the general public has been steadily moving away from the old adages that called for set allocation between the (perceived) safe bonds/cash and the (supposedly) more risky stocks. Nowadays, we have all become heavy investors in the stock market, whether it’s outright ownership or group purchasing through our work-sponsored pension plans.
Last week, I talked about the importance of market timing, particularly when it comes to market entrance or exit points. When we choose to enter or exit have the largest impact on overall portfolio return, much more than the year-on-year growth, diversification, asset allocation and all the detailed balancing and fine-tuning. Today, I want to continue the thought on market timing, and address the issue of long-term riskiness of stock market investment.
We have been conditioned to believe that in the long run, the market goes up consistently. Certainly, there are occasional dips, but many of us have probably heard of the success stories achieved by market-illiterate pensioners that retired comfortably by holding steadfastly to their basket of stocks for decades. Does this much-embraced truism still ring true in face of such market carnage? In addition to my guest post at GenX, here are more thoughts on what we can learn from the market bust.
Imperfections of diversification
One of the major cornerstones of modern portfolio theories is the benefit of diversification. Most of the time it worked. This time it didn’t, at least when applied to the stock market. There are many reasons why it didn’t. But unless you’re an octogenarian and a historian with a succinct understanding of the intertwined global financial and consumer market, and foresaw the implication of mass de-leveraging and forced liquidation, and allocated a substantial portion of your portfolio in non-stock investments, you probably didn’t benefit from diversification this time around.
In fact, long-term, buy-and-hold, value investor guru Warren Buffet, had gradually shaved his 73.5% stock holding in his portfolio in 1995, to just 25% in June, 2008. Because even he didn’t believe that diversification offered him any protection when the overall market was massively over-valued. Read more...
This might seem like a pretty out of the character subject for me to discuss, since I write about sensible, non-hype, and long-term investing principles. Those would be exceedingly prudent and timely given the market onslaught. If you are at all familiar with general investing terms, then you would most likely associate technical analysis with the image of someone hunched over multiple LCD screens, fixated by indecipherable charts and graphs in a range of neon colours, and occasionally yell “Buy!” or “Sell!” with a touch of craziness into the phone. Needless to say, your average value investor would not approve of this behaviour. In fact, Warren Buffet famously dismissed technical analysis and quipped, “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” So far not great, then why am I talking about it?
But first, what is technical analysis and why the bad rep?
It all depends on what you believe in.
Belief numero uno: Efficient market
At the crust of the matter, technical analysis is deemed the opposite of fundamental analysis. Where fundamental analysis make buy or sell decisions based on intrinsic value of a stock compared to market valuation; technical analysis disregards intrinsic value (since it assumes the market is efficient enough) of the stock, and focuses purely on supply and demand in the market.
In modern finance, this rests in something called the efficient market hypothesis (EMH). Most economists believe in a weak version of EMH, which is to say that the market does a pretty ok job when it comes to incorporating public information into the stock prices. But it’s not perfect, since insider information may still exist. On the other hand, technical analysts assume the market is perfect in incorporating valuation related information as well as market psychology into the stock price, or at least accurate enough for its purpose. The rest of the market movements are determined by more immediate demand and supply, as well as market psychology.
Belief numero dos: History tends to repeat itself Read more...
The human mind cannot grasp the causes of phenomena in the aggregate. But the need to find these causes is inherent in man’s soul. And the human intellect, without investigating the multiplicity and complexity of the conditions of phenomena, any one of which taken separately may seem to be the cause, snatches at the first, the most intelligible approximation to a cause, and says: “This is the cause!”
Leo Tolstoy, War and Peace [via The Big Picture]
The populist pitch-forking movement has duly commenced, and fingers are pointed in all directions. In a classic case of pot calling the kettle black, all the players are now seizing populist rage to divert attention from itself. The momentum must be maintained, should the public calm down and re-assess, everyone is culpable.
Government
The whole debacle surrounding the AIG bonus is ridiculous. The government passed the legislation with the inserted lines that allowed for bonuses in the first place. Even if Chris Dodd is the culprit, surely it only serves to highlights the incompetence and indifference of the system. If what he’s saying is true (that the administration made him do it), then it shows complicity. This indignant outrage shown by politicians from both sides is nothing but political grandstanding to placate mass anger. Better this mess is channeled towards the evil executives than at the government, right?
The de-regulation of US financial system started with Clinton, and continued with the Bush administration. Policies from ten years ago directly contributed to the California black-out (Enron), and the current mortgage crisis. Without the government’s collusion in both banking deregulation and predatory lending practices, corporate greed would’ve had little opportunity to spread.
It doesn’t take much digging to see the hypocrisy of politicians now railing against exorbitant executive compensation or incompetence. For the most part, those very politicians were responsible for the rise in reckless risk-taking behaviour of those financial Einsteins. Members of the public are beginning to see the thinly-guised witch hunt as a way to deflect blame and secure public support. This kind of shameless and ingratiating behaviour from publicly-elected officials is insulting and condescending: because it pushes accountability away from itself, and props up effigies of greedy corporate executives for the public to burn. Read more...
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