Hi Guys,
I was anticipating some heat from Forum participants challenging me for being far too presumptive and arrogant with regard to my personal risk control mechanisms during a market meltdown. My signals feature technically-oriented parameters.
So I braced for charges that never materialized. I steeled myself by recalling an old adage often cited by US airmen during World War II: “If you are not taking flak, you are not on target.” But the flak was totally missing. Perhaps I was off target.
I want to thank those Forum members who did respond in a reasoned, an informative and a kind way. I really do appreciate your contributions to the discussion. That type of interaction stimulates learning, and learning helps sharpen market understanding and decision making. That was my sole purpose. I was aspiring for far more diverse and energetic responses, accompanied with high emotions and sharp edges. In that respect, I fell short of my expectations.
While reading and reflecting on the few replies, I am reminded of a notable quote offered by Warren Buffett at one of his recent Berkshire Hathaway stockholder annual sessions. The quote went something like this: “There is so much that’s false and nutty in modern investing practice and modern investment banking. If you just reduce the nonsense, that’s a goal you should reasonably hope for.”
I suspect that much of what is “false and nutty” is related to overly complex modeling and imprudently assembled financial products. These models and products have generated false myths and uninspired (sometimes downright disastrous) portfolio performance.
Remember the heavily promoted Nifty-Fifty growth stocks in the late 1950s and their ultimate collapse in the 1960s. I fell victim to that irrational exuberance.
And remember academia-driven Portfolio Insurance in the 1980s that failed so miserably to protect portfolios in the October 1987 sudden equity crash. I escaped that trap.
Recall the Real Estate bubble in the late 80s with its heavy-handed S&L involvement and its subsequent dramatic unwinding in the early 1990s. I had enough reserves and geographic diversity to outlast that systemic failure.
The Long-Term Capital Management (LTCM) debacle in 1998 is yet another illustration of an academically encouraged strategy that resulted in the demise of that organization because of excessive leverage, and a failure to regression-to-the-mean modeling in a timely manner. I never even knew this problem existed before its final resolution.
Of course, we are still trying to recover from the current housing crisis that in part was encouraged by faulty Collateralized Debt Obligation (CDO) designs and sold by profit hungry institutional banking agencies. The holdings were not independent of each other as assumed, and the statistics were not normally (Bell curve) distributed as postulated. I avoided the specific CDO snake pit, but, of course, its synergistic impact of the overall economy persists.
Learning by doing is always the best classroom, especially when investing. As Jesse Livermore said about a century ago, “The game taught me the game. And it didn’t spare me the rod while teaching.”
Also, Jesse observed that “The game does not change and neither does human nature.” And finally, from Livermore, who experienced both the rewards of prescience market calls, and the destitute of bankruptcy from failed calls: “The speculator’s deadly enemies are: ignorance, greed, fear and hope.” The marketplace is a hard teacher.
By the way, it is a pity that Jesse Livermore committed suicide. He died a poor, lonely, broken man.
I believe that some of the industry’s and academia’s sophisticated models do offer some detailed structural insights, but they also often fail to capture the market’s major trends. At times, modeling simplifications can uncover that fundamental trending more successfully than more complex models. Also, these more simple formulations are accessible and deployable by private investors, thus permitting them to make their own judgments and decisions.
Several well recognized aphorisms nicely summarize my overarching viewpoints on this matter.
“Common sense is not all that common.” Continuous learning is a necessary ingredient to enlarge an investor’s financial and investment acumen and databases. It’s the price we pay for participation in the marketplace if we harbor any prospects for success in that enterprise.
“If it gets measured, it gets done.” Private investors must gain familiarity with a few market yardsticks if they expect to capture average or above average returns. Otherwise, they are an unexpected volunteer victim to the professional market hucksters and their media enablers who shamelessly tout them and their products. We can do better then that with just a little awareness and effort.
“None of us are as smart as all of us.” So let’s keep the communication links, open, on a friendly basis, and at a high, principled level. Your contributions will not only be helpful to others, but will focus and crystallize your own thinking on any investment issue that you address. Constructive group leadership is superior to individual leadership on any topic.
An early recognition and reaction to global market trends is an indispensable tool that serves to protect and preserve our retirement portfolios. Enough said; just apply history’s sometimes ignored lessons learned. Stay alert everyone.
Best Regards.
Comments
One thing is confusing to me though. From your past posts, I envisioned you as a stead-fast buy & hold, Modern Portfolio Theory investor. Trying to forecast pullbacks and recessions doesn't seem to fit my read on you. Not a bad thing. In fact, a very interesting exercize to me. Do you actually use this timing method to adjust your holdings?
Sometimes not getting feedback does not mean that your submission is being ignored. I did read and bookmark them for easy reference later. I have personally learned from your posts and they have led me to do some more reading and research of my own.
I do appreciate your submissions but for longer articles I do have to spare some time that I can focus on the content to give its due consideration.
I also appreciate your honesty of talking about your own investing mistakes. We all do have them but few of us really like to talk. It's probably painful and it is human nature. Hopefully, we are learning something out of each one and hopefully we can learn some of the lessons when our portfolios are smaller and when we have many years to recover.
Keep the articles coming....
Thanks for reading and responding to my postings.
Mike, your assessment of my basic investment philosophy and policy is spot-on.
Investor, your commitment to better understanding the investment universe is outstanding, and it pleases me that I am a small part of it.
I characterize myself as a buy-and-hold investor, with very few speculative tendencies. However, I am a student of Jack Welch’s 20-70-10 employee evaluation strategy. He granted disproportionate rewards to the 20 % of his workforce that likely generated 80 % of the firm’s output. He gave the central 70 % a cost of living increment. Finally, Welch enforced firing the bottom 10 % of performers each year. I fire one or two fund managers each year in an attempt to improve the overall quality of my portfolio holdings incrementally.
So although I trade infrequently (like once or twice a year), I do that task based on multi-year mutual fund performance assessments or fund management judgments.
When I started investing in the mid-1950s, I was a committed chartist. The very first investment book I bought, studied, and applied was Edwards and Magee’s “Technical Analysis of Stock Trends”. I now own an extensive economics/financial/investment library that is more heavily weighted with books that promote a more fundamentals-based approach.
I truly believe that there are 1001 ways to successfully participate in the marketplace. There is no dominating golden rule that guarantees success. The world changes, styles mutate, and established methods need updating, and sometimes major revision or even complete rejection.
A growing fraction of academia now favors a newly-minted Mean Reversion hypothesis instead of the honored Random Walk hypothesis to explain market return series. Change and understanding happens.
Since everything evolves, it is prudent to maintain a flexible mindset in all investment decisions. I attempt to ferret-out the most promising aspects of the various approaches, and integrate them into my policies and procedures. I do all this informally without rigid mechanical rules.
Many leadership gurus believe that the pathway to success to be emotionally energized with an edge. My edge is to adapt what I perceive as the best parts of technical analyses to augment a fundamental approach.
So my investment procedures are a mixed bag of both technical and fundamental factors. So as an illustration of this compromise, although I do not consider myself a chartist, I do employ charts to summarize data, and as an aid to the decision-making process. I scan rather then study and draw projection lines on a chart.
I am neither a technical purist or a fundamental purist. Elements of both these camps are in almost any selection criteria we choose to use. The basic components of my factors are composed of fundamental value elements, sometimes embedded into a technically-oriented framework. Often, definitions are confusing and puzzling.
For example, most would accept the S&P 500 Index P/E ratio as a fundamental value measurement of the equity marketplace. However, if you compare that against historical averages, or if you contrast the inverted P/E ratio against the 10-year corporate bond yield, some purists would claim you are deploying technical analysis. Both perspectives are valid.
Many parameters selected to complement investment decisions are bastardized in some manner. They represent a mixture of both fundamental and technical considerations. The industry’s tautology is kind of arbitrary, and serves no useful purpose. However, as I documented earlier, I do consider myself more fundamentally-inclined then technically-oriented. Even that loose and purposely vague admission morphs with time and circumstances.
I can not quote you the performance of my portfolio over time as a function of the six-factor model that I summarized in my earlier posting. I have not back-tested it. My dynamic X-factor model is under constant revision and has gotten more complex. However, I do use it to inform my investment decisions based on its current status at decision time.
For more then two decades, I reviewed the government Yield curve and the S&P 500 Index moving averages to guide equity allocation commitments. About a decade ago, I started looking at the Greenspan-Yardeni Inverted P/E ratio/10-year treasury relative return positioning to supplement my allocation decisions in a very informal way. For the last two years, I have monitored and added the AAII Sentiment indicator to my decision matrix.
Merely two months ago, I incorporated the M2 money supply signal into my decision-making array. Mine is an evolving tool kit. My knowledge, prejudices, and preferences are constantly maturing, and so have my market trend indicators.
I have adjusted my action plans as I have integrated these factors into my portfolio management efforts. Consequently, I have not calculated a track record relative to its incremental performance on my portfolio. I suspect that the procedure outperforms a pure buy-and-hold strategy, but I can not prove that assertion. Hope is eternal.
I have incrementally adjusted my portfolio asset allocations for a decade now based on the threshold signals and the strength of these guiding signals. Unfortunately the model itself has not been invariant during this timeframe.
I think everyone should endorse flexibility when managing their portfolios, and should also tolerate a huge array of management tools. Each has their separate and distinctive place in managing and mitigating portfolio risk.
Having a somewhat mechanical macroeconomic/investment model enforces a discipline and structure to the otherwise arbitrary and emotional investment decision process. I think it reduces the fear factor.
Best Wishes.
I appreciate your recent expositions. I realize now that I have tacitly assumed that you had in place a rigorous, entirely quantitative system for selecting investments and monitoring your portfolio -- a one man financial engineering approach. The nuanced account you give above (with historical perspective on your continuous modifications of your methods and investments) provide a perspective to which an individual investor of more modest experience and ambition can relate.
The models, Monte Carlo methods and the rest of your analytic apparatus help you take a deliberate approach. They enable you to "measure twice, cut once" in your portfolio construction. You have many analytic tools in your toolkit; you use them to assist your judgment, not substitute for it.
This is a useful insight for a person like me, who is a lot earlier on the learning curve.
Cheers.
gfb
Thanks for your perceptive and generous reply.
I suspect that many Forum and FundAlarm contributors interpreted my investment philosophy and style as being purely mechanical based on my heavy emphasis on mathematical skill building, Modern Portfolio Theory, and application of computer codes, such as Monte Carlo simulations, to investment decision making.
I highlighted those subjects just to encourage investors to be more open-minded to learn and apply them to financial issues. Americans have poor mathematic skills, especially with regard to probability theory and statistic understanding.
I also believe that the most unbiased research is generated within the academic community; the industry wizards are exposed to profit incentives that often distort their studies and opinions. Therefore, I often reference academic research findings.
Mechanizing the investment process by modeling does offer the advantage of removing emotions from the decision process. But modeling by definition is a simplifying process; the risk is that the model is not complete enough to capture all the nuances of complex market interactions. Also, changing market dynamics operate to invalidate current strategies. What worked today might not work tomorrow.
So although scientifically based concepts and tools can give an investor an edge (they do), these mechanical devices provide only part of the answer. The other part are human trait based.
A successful investor needs market knowledge, courage of conviction, patience, persistence, a skeptical mindset, honesty, and a host of other attributes to fully engage the challenging investment marketplace. For example, an investor must honestly evaluate the success or failure of his investments against an appropriate benchmark. For example, an investor must have courage when he has a contrarian’s perspective of market trends. The herd is only right until it is wrong.
The human skill set is composed of many very personal characteristics. Initially, I felt a need to suppress my preferences and prejudices from Forum members. I didn’t want to bias my technical submittals with emotional contamination. Perhaps, that was shortsighted on my part.
I believe complete investors are both reflective and reflexive. The key is to properly balance both contributors. My postings always emphasized only the reflective considerations. If you concluded that I was one-dimensional because of that emphasis, I apologize. That was only half the story. Now you have the other half.
Thank you again for seriously reading my numerous rants and for your many informed contributions to this forum. I greatly respect your opinions, and your unwavering commitments.
Best Wishes.