The WSJ has crunched the numbers and concluded that:
In nearly 200 years of recorded stock-market history, no calendar decade has seen such a dismal performance as the 2000s.
Investors would have been better off investing in pretty much anything else, from bonds to gold or even just stuffing money under a mattress. Since the end of 1999, stocks traded on the New York Stock Exchange have lost an average of 0.5% a year thanks to the twin bear markets this decade.
I think the authors should have stopped right there, scratched their heads and wondered how the words “twin bear markets” and a tiny loss of just 0.5% a year could appear in the same sentence. But they did not, they plowed on with such statements as, “From 2000 through November 2009, investors would have been far better off owning bonds.”
The answer, of course, was a bubble-fueled bull market of low volatility and cheap credit coupled with a decade of unprecedented volatility in general. If we assume for a moment that instead of being a horde of mindless idiots, investors are shrewd market timers, they could have returned 100% just by buying the S&P 500 basket from 2003 to 2007. They would have had not one but two (“twin”) opportunities to reap the same profit shorting the market in 2001 and 2008.
This is why the exercise of boiling arbitrary time periods down to a first order statistic – the average return – is such a meaningless exercise if performed without context. It fails to capture the full texture of the decade – the ups, the downs, the in-betweens. The richness and texture of the last 10 years are to some extent by the S&P’s chart. It’s not useful, instructive, or even a proper comparison to compress the decade. Show me an investor who purchased the index at the start of the decade and hasn’t traded since, and I’ll show you someone who actually might find long term bonds a more suitable alternative.
The second order measure is the real story of the decade: in 2008, the VIX hit 80!! And as late as January 2007, it was under 10!
But enough with the decade retrospectives, with the sensationalist headlines comparing this decade’s average return to that of the 1930’s (here’s a hint: Black Friday was in 1929). You want a story? Focus on the twin bear markets – look at how amazing it was that you could have two in such a short span and still only lose 0.5% a year on average!
But the next time I find someone who only invests on January 1 of years ending in zeros, I’ll be sure to pass this along.
After finding former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin not guilty of misleading investors, one juror revealed just how convincing the defense had been:
[Juror] Hong said that if she had money, she would invest it with Cioffi and Tannin.
The WSJ’s top story this morning was one titled “The Cruel Math of Big Losses” – an article written as if it were an eye-opening expose into a little-known piece of financial wisdom rather than a blatantly obvious restatement of basic math: when you lose X%, it takes a gain of more than X% to get back to even.
Nonetheless, I’ve seen the mistake time and time again – and it is exactly what leads people to chase levered ETFs despite their downward bias. It is especially amusing that many of the comments on the article fall in two camps: either the article is a waste of time because percentages don’t matter, only dollar amounts, or it’s a waste of time because its a boilerplate nascent recovery article.
To the first point, percentages are all that matter. Yes, if you lose $50 you need to make back $50. But what if you started with $100? What if you started with $1,000 – or $51? The risk (both future and encountered) on those three portfolios is very different and must be considered as such. It remains beyond me why we insist on reporting stock changes in terms of dollars or points. Is it relevant to me that the S&P is up 12.8 and the Dow is up 124.2? Of course not! – but saying that both of them are up 1.26% is actually useful information. At least with individual stocks you could do some mental arithmetic, taking the numbers of shares you hold times the dollar change – but that doesn’t work with the indices. Let’s beware this “dollar price” fallacy: if you don’t have a spreadsheet (and even if you do!) dollar prices should not be your primary concern.
To the second point, a wise investor would keep in mind that this math works both ways (neither of them helpful): gains can quickly evaporate when the market drops a relatively smaller amount.
This article serves a useful purpose: it reminds us of the basic temperament of the market. It forces us to confront the difficult nature of the investing exercise. But it should never come as a surprise.
In a post that caught my eye because it was titled “Smart Risk, Stupid Risk” – but then failed to elaborate in any way – CNBC chimes in with a few caveats about investing during earnings season:
- You snooze, you lose If you’re waiting to find out the earnings before you make an investment in a company, you’re already too late the party.
- Listen to what the market is saying by watching what it’s DO-ing Successful trading is about watching the price action and reacting to it. It’s far less about trying to outsmart the markets.
- TMI (Too Much Information) Earnings season is exciting to watch and fun to talk about, but so what? It just creates more confusion than clarity. My Advice: Pick a few companies in play and focus on them rather than spreading yourself too thin.
- Mix it up a bit Here’s a news flash: Just because you have always traded US equities does not mean you should only trade them. In reality, there are lots of different ways to make lots of money, like metals, oil and currencies.
In other words (which is to say, my words):
- You need to trade before anything happens.
- You need to wait for something to happen before you trade.
- Focus on what you know.
- Focus on what you don’t know.
Then again, the post does come with a healthy disclaimer: “[Author] Doug Hirschhorn’s expertise is in the psychology of achieving peak performance. He is not a financial advisor and does not make trading or investment recommendations or provide trading or investment advice. He is an expert on the mental game. Although Doug Hirschhorn has a Ph.D. in Psychology with a specialization in sport psychology, he is not a licensed psychologist and does not provide therapeutic, clinical or counseling services.”
Buyer beware.
In a recent profile of KKR, Breakingviews.com (via the NYTimes) attempted to value the company by taking a look at Blackstone’s operations. I don’t have any comment on the analysis itself, but two excerpts stood out in my mind:
[Blackstone] didn’t do as well collecting performance fees and investment gains because its holdings have been falling in value. But if history is any guide, its investments should rebound.
…
So, although it sounds generous given the last year’s market conditions, it’s not unreasonable to assume those [illiquid assets] might gain 20 percent annually from their current valuations for the next five years.
Does anyone else shudder a little when reading sentences like these?
More on Taleb: CNBC is running a piece called “Swan Song: Why Nassim Taleb is Still Wrong.”
The crux of the argument seems to be this paragraph:
Arguing against Taleb is a little embarrassing; who among us wants to side with the plodders when for the price of a paperback you can join the elect? But the experience of the markets here is important because it shows that neither consistently discounting the chance of unforeseen risks, as AIG did with such gusto, nor betting day after day on unforeseen catastrophes is a reliable way to make money.
And why isn’t it a “reliable way” to make money? Because it doesn’t make money every day! CNBC points out that “the problem with catastrophism, however, is that it’s very difficult for anyone in the market to wait around for the unexpected.” Why is it hard to wait? I’m going to guess it’s because CNBC wouldn’t attract many viewers if they ran segments called “Day 145: Hang in there, the black swan is coming!”
Further exemplifying their short-sightedness, CNBC’s piece takes a few jabs at Taleb for not being an “investor” (read: person who can make you money all the time). They note that “little of his 2004 book, Fooled by Randomness, and even less of The Black Swan talks about investing directly” and also how “he moved through several trading jobs without much success.” It makes you wonder why CNBC is wasting space on this bad trader’s strategy? (All in the name of sensationalism, of course).
The most bizarre thing is the comparison of Taleb and AIG:
But the failures of the Niederhoffers and AIGs do not translate to a validation of Taleb-style catastrophism because these two approaches turn out to be linked. They are mirror images. In noncatastrophic times, the Niederhoffers and AIGs make money consistently and quietly and then end up losing it conspicuously and painfully. The Talebs make money rarely, amaze everyone because they do it when everybody else is getting killed—and so make it easy to forget about years of steady losses.
They aren’t mirror images! If they are, then how can only one side be out of business and “responsible” for the black swan of 2008? CNBC actually thinks that losing small amounts of money 90% of the time and making massive amounts 10% of the time is the flip side of AIG-style investing? Have they never heard of a skewed distribution? The very goal of “portfolio management” is constructing portfolios with positive mean and positive skew – and now that Taleb has achieved that, they are slamming him because the majority of the time he loses relatively small amounts of money – an intentional characteristic of his portfolio? AIG would kill not to have held a negatively skewed portfolio in 2008.
Aside from the rest of their strange take on statistics, CNBC is forgetting that there is a limited amount of capital at play, and when you run out you’re done. This is a common gambling mistake. When you sit at a casino table and have a 48% chance of winning each hand, your chances of losing are actually much higher across many hands than you’d think. This is because it only takes a few bad hands before you lose all your money and have to walk away – at some point, you surrender your ability to make more money.
So it is with investing. If you lose all your money in a catastrophe, you’re done. The effort to earn back your losses will be extremely difficult if not impossible. However, is you lose a small amount of money steadily, then you don’t have to worry about hitting the zero-capital floor so long as periodically you experience an event that nets you a gain.
Taleb’s point in The Black Swan is not to illustrate a manner of investing; it’s to point out that we discount the frequency of those unlikely events. His decision to put his money where his mouth is is admirable – and not just because his strategy works.
AK points out a story from our favorite financial journalist, Jeff Goldberg, regarding the Palestinian Electric Company’s surprising 2008 profit of $6mm. What Goldberg fails to note (citing instead a quote on nebulous “corruption”) is that the PEC is paid an unconditional annual fee of $29mm by the Palestinian Authority, meaning they actually hemorrhaged $23mm. In fact, the PA even pays for the plant’s fuel, which makes me incredibly curious where the money goes, seeing as their primary cost is waived and they have no competitors. Dare I suggest it gets funneled to… someone else?
And how is this bizarre subsidy justified? According to the PEC executive managing director’s laughable quote:
When people are investing, they should get a return.
Sort of turns the whole risk/reward thing on its head, doesn’t it?
The headlines today said it all: Obama: Buy stocks now. The full statement is this:
What you’re seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.
Is he out of his mind? This is perhaps the most irresponsible, dangerous statement we’ve heard from Obama yet. Is a man whose words can move markets actually advising people to buy stocks? He unquestionably has access to material non-public information, which would qualify as some sort of insider information (unless, like Mark Cuban, he has no fiduciary duty).
Moreover, what happens if someone invests on his advice and loses money? Is he a qualified investment advisor (qualified being an extraordinarily relative term)? Has there been any sort of “investing involves risk” disclaimer? Does he really think that the problem here is that people aren’t buying enough stock? And if so, what was that $1 trillion stimulus bill — why not just take that money and buy stocks?
Not surprisingly, the Press Secretary could not back off Obama’s statement fast enough, after one reporter asked if he is becoming the “first stockbroker:”
Realizing that the president shouldn’t be giving advice to investors, [Press Secretary] Gibbs tried to laugh it off. “I will ask him if he’s got any particular tips for you,” he said. “Maybe I should have cornered him and gotten a few of my own.”
But the questions about it kept coming at Gibbs at his afternoon briefing for reporters.
“He basically said stocks look like they’re good deals,” said one journalist. “Is he encouraging people to buy stocks?”
“I will ask him,” said Gibbs.
Despicable though his character may have been, Keynes said some remarkable things, the title of this post among them. He also uttered the cliched investing mottos regarding animal spirits and beauty contests — true statements all, but widely abused by financial textbooks. My favorite, which remains somewhat unknown despite its enormous relevance, is:
The market can stay irrational longer than you can stay solvent.
An important second is this, in response to an accusation that he had changed his position on monetary policies during the Great Depression:
When the facts change, I change my mind. What do you do, sir?
And recently, I came across this one, which is a stunning insight into the last few years:
If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.