I spotted a little piece in last weekend's Wall Street Journal by Jason Zweig concerning Vanguard founder John Bogle's recent remarks on equity markets.
Bogle has written a clear and wonderful volume in the The Little Book series entitled Common Sense Investing. Bogle doesn't endorse active management of any equity portfolios- ever. The book explains why.
So it wasn't surprising that he spoke of equity market returns for the next decade averaging 7% per annum. He pointed out that this will double one's investment. It's reasonable to assume, knowing Bogle, that he would expect one to follow his advice by way of investing in a passive S&P500 Index fund.
Of course, many are fixated on the last decade's being a so-called 'lost decade' for equities.
Out of curiosity, then, I calculated the S&P500 Index annual average from January, 1970 through last Friday. Despite the flat performance during the last decade, the Index continues to have an average annual total return of 10.9%, before inflation.
One could do much, much worse than dollar-averaging into and out of the S&P over time. I suspect most retail investors have, indeed, done far, far worse.
And, to Bogle's point, paid handsomely for the privilege.
Showing posts with label Index Performance. Show all posts
Showing posts with label Index Performance. Show all posts
Monday, September 12, 2011
Monday, August 15, 2011
Last Week's US Equity Markets & P/E Ratios
On last Wednesday, I wrote this post discussing equity markets performances at the half-way point of the week. Since then, the S&P finished the week at a net loss of just -1.7%. But, of course, this grossly understates what actually transpired.
We saw a week of daily S&P returns of -6.7%, -4.4%, +4.6% and +4.7%. My own volatility measures jumped almost two-fold by the end of the week.
Yet at least one Bloomberg co-anchor attempted to assure viewers that it wasn't such a bad week after all, with such a modest net decline in the major equity averages.
Give me a break. The average retail investor probably bailed out somewhere near a bottom point, no doubt losing about as much as one could. This sort of behavior have been well-documented by Charles Schwab's previously-discussed research.
But I had to laugh at the Wall Street Journal's Money & Investing Section's lead article in this morning's edition. Clinging to hoary old notions of the importance of P/E ratios in a predictive sense, the article focused on recent declines in the 'P,' with forecasted declines in the 'E,' as well. Then there was the requisite nod to trailing versus forecasted earnings, etc.
Too bad none of this actually has anything to do with total returns. My proprietary research has convinced me that dwelling on P/Es is a mistake, since it's a product of primary drivers of performance, not a driver itself.
Further, it's a static measure attempting to capture time and trend. But it can't. Instead, various pundits and analysts ascribe all manner of benefits or drawbacks to using various massaged measures of the numerator or denominator in order to try to give it some rationale and technical luster.
I don't buy any of it.
Rather, I look at my market turbulence signal, and find that it is quite far from registering a market which one should leave, or short. My equity selections continue to nicely outperform the S&P.
For a lot of reasons, developed economies may be entering a period in which revenue growth for top performing firms slows. But, at least for now and the near future, it doesn't appear that it's time to panic if one holds the right equities, or even, for that matter, the S&P500.
We saw a week of daily S&P returns of -6.7%, -4.4%, +4.6% and +4.7%. My own volatility measures jumped almost two-fold by the end of the week.
Yet at least one Bloomberg co-anchor attempted to assure viewers that it wasn't such a bad week after all, with such a modest net decline in the major equity averages.
Give me a break. The average retail investor probably bailed out somewhere near a bottom point, no doubt losing about as much as one could. This sort of behavior have been well-documented by Charles Schwab's previously-discussed research.
But I had to laugh at the Wall Street Journal's Money & Investing Section's lead article in this morning's edition. Clinging to hoary old notions of the importance of P/E ratios in a predictive sense, the article focused on recent declines in the 'P,' with forecasted declines in the 'E,' as well. Then there was the requisite nod to trailing versus forecasted earnings, etc.
Too bad none of this actually has anything to do with total returns. My proprietary research has convinced me that dwelling on P/Es is a mistake, since it's a product of primary drivers of performance, not a driver itself.
Further, it's a static measure attempting to capture time and trend. But it can't. Instead, various pundits and analysts ascribe all manner of benefits or drawbacks to using various massaged measures of the numerator or denominator in order to try to give it some rationale and technical luster.
I don't buy any of it.
Rather, I look at my market turbulence signal, and find that it is quite far from registering a market which one should leave, or short. My equity selections continue to nicely outperform the S&P.
For a lot of reasons, developed economies may be entering a period in which revenue growth for top performing firms slows. But, at least for now and the near future, it doesn't appear that it's time to panic if one holds the right equities, or even, for that matter, the S&P500.
Friday, June 17, 2011
Banks, Capital Requirements & The S&P500
CEOs of large US banks have raised an alarm recently due to the recommendations by several regulators, including members of the Fed and FDIC, for higher capital requirements. Some have suggested an extra 3%, bringing the large-bank level to around 10% of risk assets, while others have mentioned 14%.
Predictably, the CEO of at least one large bank, Chase, has warned that higher capital levels will result in higher lending rates and overall operating costs, as well as lower profit levels. These comments are meant to scare regulators away from imposing higher risk capital levels.
However, Chase' Jamie Dimon, aside from having an obvious interest in lower capital requirements, also lacks perspective. He spent the bulk of his career assisting his one-time mentor, Sandy Weill, in the brokerage industry. The sorts of retail brokers at which Dimon cut his teeth didn't engage in much risk-taking activity, so they were highly-levered.
But a more appropriate perspective on the current debate involving large US commercial bank capital levels should take us back to the 1920s. The events of the 1930s, in which then-integrated commercial and investment banks, such as the forerunners of today's Citi and Chase, improperly sold questionable investments from one side of their bank to customers on the commercial side of the bank, resulted in the Glass-Steagal Act. The Act broke up banking into its investment and commercial pieces.
Up until the 1970s, commercial banks, the retail deposits of which were FDIC-insured, didn't typically engage in much risky activity outside of conventional lending. Even that resulted in the occasional large regional bank failure, such as First Pennsylvania, Seattle First and the like.
However, with the complete removal of Glass-Steagal, commercial banks were allowed to function as investment banks, but retained federal deposit insurance. This oversight effectively resulted in the federal government subsidizing, via deposit insurance, the risky activities of trading and underwriting in the investment banking side of these newly-integrated large US banks.
Earlier this week, I saw an analysis on Bloomberg predicting that as commercial banks divested or closed newly-prohibited trading businesses, their profits would fall, bringing down equity indices of which they comprise something in the neighborhood of 20%. This sort of statistic, combined with the specter of higher capital levels and resulting lower profits, is being trumpeted as the reason to reject such calls for more bank capital.
However, I believe this is incorrect reasoning. What I believe is correct is to ask why equity indices such as the S&P500 allocate so much weight to financials. As integrated, risky companies, financials may well have merited such weight.
But now, the large US commercial banks are more properly viewed as financial utilities. As such, they don't merit a large presence in the S&P, nor should they be expected to be engines of high and consistent total return delivery for their shareholders.
This may not be to the liking of Jamie Dimon and the CEOs of Citi, Wells Fargo or BofA. But it's reality.
After the tremendous cost to taxpayers of the financial crisis of 2007-08, in which large US commercial banks with insured deposits played a corresponding major part, even if they didn't initiate the crisis, it's understandable that capital requirements would be increased and risky activities prohibited.
As I have written in prior posts, the basic business of lending and safekeeping money, plus some ancillary trust and processing businesses, are the core of what large US financial utilities, a/k/a large commercial banks, perform. Those aren't a huge part of the American economy, nor should they be. Such businesses aren't high growth businesses, either.
Regarding interest rate levels, who's to say they should not be higher? Large bank profits rise with interest rates- why didn't Dimon mention that? Further, we didn't have a crisis three years ago because rates were too high- it was because they were too low. And still are.
Cries of 'foul' by large bank CEOs and analysts stem from a refusal to acknowledge reality- both recent past, current and future. The days in which banks such as Citi, Chase, Wells Fargo and BofA may be expected to rival Google or Apple as consistently high total return performers are over. They are now meant to be fairly safe, unexciting basic financial services firms which don't engage in overly-risky activities.
That's the reality of the new financial landscape. And it's consistent with such an environment that those large banks should carry more capital, the better to avoid needing taxpayer funds to rescue them from insolvency in the future.
Predictably, the CEO of at least one large bank, Chase, has warned that higher capital levels will result in higher lending rates and overall operating costs, as well as lower profit levels. These comments are meant to scare regulators away from imposing higher risk capital levels.
However, Chase' Jamie Dimon, aside from having an obvious interest in lower capital requirements, also lacks perspective. He spent the bulk of his career assisting his one-time mentor, Sandy Weill, in the brokerage industry. The sorts of retail brokers at which Dimon cut his teeth didn't engage in much risk-taking activity, so they were highly-levered.
But a more appropriate perspective on the current debate involving large US commercial bank capital levels should take us back to the 1920s. The events of the 1930s, in which then-integrated commercial and investment banks, such as the forerunners of today's Citi and Chase, improperly sold questionable investments from one side of their bank to customers on the commercial side of the bank, resulted in the Glass-Steagal Act. The Act broke up banking into its investment and commercial pieces.
Up until the 1970s, commercial banks, the retail deposits of which were FDIC-insured, didn't typically engage in much risky activity outside of conventional lending. Even that resulted in the occasional large regional bank failure, such as First Pennsylvania, Seattle First and the like.
However, with the complete removal of Glass-Steagal, commercial banks were allowed to function as investment banks, but retained federal deposit insurance. This oversight effectively resulted in the federal government subsidizing, via deposit insurance, the risky activities of trading and underwriting in the investment banking side of these newly-integrated large US banks.
Earlier this week, I saw an analysis on Bloomberg predicting that as commercial banks divested or closed newly-prohibited trading businesses, their profits would fall, bringing down equity indices of which they comprise something in the neighborhood of 20%. This sort of statistic, combined with the specter of higher capital levels and resulting lower profits, is being trumpeted as the reason to reject such calls for more bank capital.
However, I believe this is incorrect reasoning. What I believe is correct is to ask why equity indices such as the S&P500 allocate so much weight to financials. As integrated, risky companies, financials may well have merited such weight.
But now, the large US commercial banks are more properly viewed as financial utilities. As such, they don't merit a large presence in the S&P, nor should they be expected to be engines of high and consistent total return delivery for their shareholders.
This may not be to the liking of Jamie Dimon and the CEOs of Citi, Wells Fargo or BofA. But it's reality.
After the tremendous cost to taxpayers of the financial crisis of 2007-08, in which large US commercial banks with insured deposits played a corresponding major part, even if they didn't initiate the crisis, it's understandable that capital requirements would be increased and risky activities prohibited.
As I have written in prior posts, the basic business of lending and safekeeping money, plus some ancillary trust and processing businesses, are the core of what large US financial utilities, a/k/a large commercial banks, perform. Those aren't a huge part of the American economy, nor should they be. Such businesses aren't high growth businesses, either.
Regarding interest rate levels, who's to say they should not be higher? Large bank profits rise with interest rates- why didn't Dimon mention that? Further, we didn't have a crisis three years ago because rates were too high- it was because they were too low. And still are.
Cries of 'foul' by large bank CEOs and analysts stem from a refusal to acknowledge reality- both recent past, current and future. The days in which banks such as Citi, Chase, Wells Fargo and BofA may be expected to rival Google or Apple as consistently high total return performers are over. They are now meant to be fairly safe, unexciting basic financial services firms which don't engage in overly-risky activities.
That's the reality of the new financial landscape. And it's consistent with such an environment that those large banks should carry more capital, the better to avoid needing taxpayer funds to rescue them from insolvency in the future.
Tuesday, April 26, 2011
Indexing- What's In A Name?
In the Wall Street Journal's weekend edition of two weeks ago, Matt Phillips wrote a nice piece describing fund manager Joel Greenblatt's recently-initiated "value-weighted indexing" funds.
I've read the book Greenblatt, founder of Gotham Capital, wrote for the Little Book of Investing series. Frankly, I like Vanguard founder John Bogle's volume better. Perhaps because, as the developer and manager of a quantitative equity portfolio strategy, I'm biased. If I weren't using my own approach, I'd generally adhere to Bogle's. Greenblatt is a value style investor who relies on fundamentals which my proprietary research found to be relatively weak. It remains challenging for me to distinguish between a "value" equity and, well, a poorly-performing equity.
But, to each his own.
However, Phillips' piece described Greenblatt's latest creations. You can read the article for details. Basically, Greenblatt employs what he calls "value weighting," wherein the funds weight holdings based on value-oriented scores.
With all the buzz around broadly-based ETFs and concerns over expensive, actively-managed funds, one wonders whether Greenblatt hasn't just produced a sort of 'fighting brand' category of funds with an index label.
But, as Phillips quoted one observer,
"This is an actively managed quant fund. There's no indexing involved. Just beause you use math doesn't make you and indexer."
So true.
Perhaps Greenblatt is simply becoming a more astute marketer, while following an old brokerage habit- create new products when the older ones become too efficient, i.e., have declining margins. Or, in this case, perhaps become less fashionable as expensive actively-managed funds.
I've read the book Greenblatt, founder of Gotham Capital, wrote for the Little Book of Investing series. Frankly, I like Vanguard founder John Bogle's volume better. Perhaps because, as the developer and manager of a quantitative equity portfolio strategy, I'm biased. If I weren't using my own approach, I'd generally adhere to Bogle's. Greenblatt is a value style investor who relies on fundamentals which my proprietary research found to be relatively weak. It remains challenging for me to distinguish between a "value" equity and, well, a poorly-performing equity.
But, to each his own.
However, Phillips' piece described Greenblatt's latest creations. You can read the article for details. Basically, Greenblatt employs what he calls "value weighting," wherein the funds weight holdings based on value-oriented scores.
With all the buzz around broadly-based ETFs and concerns over expensive, actively-managed funds, one wonders whether Greenblatt hasn't just produced a sort of 'fighting brand' category of funds with an index label.
But, as Phillips quoted one observer,
"This is an actively managed quant fund. There's no indexing involved. Just beause you use math doesn't make you and indexer."
So true.
Perhaps Greenblatt is simply becoming a more astute marketer, while following an old brokerage habit- create new products when the older ones become too efficient, i.e., have declining margins. Or, in this case, perhaps become less fashionable as expensive actively-managed funds.
Thursday, March 13, 2008
GE's Earnings Report & Immelt's Equity Purchases
My last post on GE was just last week. The occasion was the release of CEO Jeff Immelt's 2007 compensation. For details, see my post. suffice to say, I found his latest year's compensation pretty much unrelated to GE's posting another year of total returns which under-performed the S&P500 Index.
This morning on CNBC, a network owned by GE, passages from Immelt's letter to shareholders were shown. Immelt is refusing to consider selling the entertainment sector of the conglomerate, while once again attempting to focus attention on his 'Ecoimagination' unit.
It was heartening to see one of the network's co-anchors clearly note that GE has under-performed the index during Immelt's entire reign, with a price chart to support the fact.
Immelt is to appear on CNBC tomorrow morning in an 'interview,' if you can call it that when the co-anchors interview the guy who can fire them.
But perhaps Immelt's most daring ploy this year is his announcement that he has bought $4MM of GE shares on the open market with his 'own' money, i.e., not via granted options.
Mike Holland, a guest host on CNBC's morning program today, noted the share purchase and touted the stock to viewers.
Here's my take on Immelt's GE share purchase move.The first Yahoo-sourced chart nearby depicts the price of GE stock and the S&P500 for the past twelve-month period. It's clear that both have fallen sharply since the mid-2007 credit market problems. The index has fallen about 15% in that period, while GE has fallen in the vicinity of 22%.
Thus, per Mike Holland's comment this morning on CNBC, it's a buyer's market in the index and probably GE for investors with money and patience. Jeff Immelt has the first, thanks to GE shareholders, and probably the second, again, thanks to shovelsful of cash and options compensation over the past seven-plus years.
Since the S&P rises in roughly 70% of months, and it just fell nearly 15% in eight months, it's a safe bet that it will be rising by the end of this year.
If Immelt bought $4MM of S&P Index fund shares, it would be a signal to investors, especially in GE, that even Immelt thought the index would be, as usual, out-performing Immelt's company this year.
By purchasing $4MM of GE stock, Immelt will likely get a return similar to, but lower than that of the index over a like period. The nearby Yahoo-sourced 5-year price chart for GE and the S&P500 Index demonstrates how closely together the two tend to move.Even if Immelt gives up some return on his $4MM by buying the lower expected return equity, he probably goes a long way toward saving his job, which is worth more like something north of $15MM/ year. If GE under-performed the index by 5 percentage points in the next twelve months, Immelt would only lose some $200K, but reap a public relations windfall that could easily stave off calls for his scalp.
I don't think Immelt is actually investing in GE as a vote of confidence in his management or the company's promising near-term opportunities and potential for a unique total return.
Rather, I think Immelt is simply making a very public bet on the direction of US equity markets for the remainder of this year, and probably next. After such a significant drop in price level of the S&P, there are several stocks with betas near 1 that would be relatively safe buys for a wealthy investor. GE's beta is .72, according to Yahoo.
I wrote in that linked post last week,
"As I have written in previous posts, when a CEO has been paid north of $10MM in cash, does anyone think he really cares what happens to the company's stock price anymore? Added to Immelt's prior $23MM of cash compensation, GE has now paid him over $30MM in just six years."
Immelt certainly has the money and, thus, the investing horizon to buy GE shares now and bet that, due to the broader market's recovery in the next twelve months, GE's share price will rise with the market, regardless of the company's actual operating performance.
I'd never say Immelt is not a smart man. In fact, he's extremely clever- for his own welfare. Too bad he hasn't been as smart or clever for his shareholders' benefit for the past six and a half years.
Monday, February 18, 2008
Last Week's S&P500 Performance
We seem to be in a period of weeks of indeterminate financial markets behavior.
For the evolving month of February, the S&P is down, with roughly a -2.2% return. That's including last week's +1.4% return, and the prior week's -4.6% return.
Looking at my newly-devised monthly standard deviation measure of daily S&P500 Index returns, it's hard to get excited about last week's return. That is because it falls within the confidence interval of 68% that such a return could occur, plus or minus, in one day for the S&P.
The daily returns last week were: +0.59%, +0.73%, +1.36%, -1.34%, and +0.08%.
Tuesday's rise was attributed to Warren Buffett's self-serving offer to reinsure municipal instruments. Wednesday's gain was allegedly due to positive corporate earnings reports and some positive sales data. This, by the way, amidst what more pundits, and a few economists, including former Fed chairman Greenspan have decided is, or is about to be a recession.
Thursday's large drop occurred as Treasury Secretary Paulson, Fed Chairman Bernanke and SEC Chairman Cox all testified before Congress. Given the typically-hostile attitude of the Democratic-chaired committee to the Republican administration officials, it's not all that surprising that the subsequent testimony roiled markets.
Some felt that Bernanke left the door open to a further rate cut of 1/4% point at the next Fed meeting.
Finally, on Friday, despite poor manufacturing data and a low Michigan Index of Consumer Confidence, as well as reported investor concerns about inflation, the index managed a small gain.
Confused about investors' reactions to various 'news' items? You're not alone. At least I'm with you.
So, as we head into the last half of this month, the S&P is so volatile that there is a good chance it will either slice most of the negative return, or add another -1.4% to it, on any given day. In any two day period, the index could turn positive, or more than double its negative return for the month.
After reviewing this past week's sample of putative causes and effects on the index's daily performance, it gives one pause to have any sense of which way it will finish this month.
It's so tentative that my partner and I are actually watching daily S&P performances, in order to keep up with the latest moves in this very unstable market. Until one of the major indicators which we monitor either confirms its current position, or moves significantly in another direction, we are unlikely to take any new positions in equities or options.
It's simply too difficult to discern a longer-term market direction for the next few months at this time.
For the evolving month of February, the S&P is down, with roughly a -2.2% return. That's including last week's +1.4% return, and the prior week's -4.6% return.
Looking at my newly-devised monthly standard deviation measure of daily S&P500 Index returns, it's hard to get excited about last week's return. That is because it falls within the confidence interval of 68% that such a return could occur, plus or minus, in one day for the S&P.
The daily returns last week were: +0.59%, +0.73%, +1.36%, -1.34%, and +0.08%.
Tuesday's rise was attributed to Warren Buffett's self-serving offer to reinsure municipal instruments. Wednesday's gain was allegedly due to positive corporate earnings reports and some positive sales data. This, by the way, amidst what more pundits, and a few economists, including former Fed chairman Greenspan have decided is, or is about to be a recession.
Thursday's large drop occurred as Treasury Secretary Paulson, Fed Chairman Bernanke and SEC Chairman Cox all testified before Congress. Given the typically-hostile attitude of the Democratic-chaired committee to the Republican administration officials, it's not all that surprising that the subsequent testimony roiled markets.
Some felt that Bernanke left the door open to a further rate cut of 1/4% point at the next Fed meeting.
Finally, on Friday, despite poor manufacturing data and a low Michigan Index of Consumer Confidence, as well as reported investor concerns about inflation, the index managed a small gain.
Confused about investors' reactions to various 'news' items? You're not alone. At least I'm with you.
So, as we head into the last half of this month, the S&P is so volatile that there is a good chance it will either slice most of the negative return, or add another -1.4% to it, on any given day. In any two day period, the index could turn positive, or more than double its negative return for the month.
After reviewing this past week's sample of putative causes and effects on the index's daily performance, it gives one pause to have any sense of which way it will finish this month.
It's so tentative that my partner and I are actually watching daily S&P performances, in order to keep up with the latest moves in this very unstable market. Until one of the major indicators which we monitor either confirms its current position, or moves significantly in another direction, we are unlikely to take any new positions in equities or options.
It's simply too difficult to discern a longer-term market direction for the next few months at this time.
Wednesday, February 13, 2008
The Dow-Jones Industrials: Out With The Old....
The Wall Street Journal reported this week on the change in complexion of its major market index, the Dow-Jones 30 Industrials.
Out went Honeywell and Altria, in came BofA and Chevron.
I suppose there are various reasons for the changes. One is that Altria is effectively going away shortly, as the company's offshore tobacco businesses are being split from the old Phillip Morris.
As for Honeywell's ouster, apparently the folks at Dow-Jones feel that oil now represents a greater component of US economic activity than the diversified, high-value-added manufacturing and distribution of engineered material and systems produced by Honeywell.
Curiously, BofA was added, again, on the pretext that financial services is now underrepresented in the 30 company group.
Out of curiosity, I produced charts of all four companies on Yahoo, over 2-year and 'maximum' year timeframes.
The nearby two-year chart shows all four companies moving more or less in a band together until early last year. Then things got interesting.Honeywell, one of the exiting companies, spurted ahead of two of the others, with Chevron slightly outperforming it, but with a similar pattern.
Altria, also exiting, also outperformed BofA, the worst of the lot. Of course, as the year wore on, and Ken Lewis had "about as much fun as (he could) take" in investment banking, BofA's performance slid sharply. In fact, so sharply that it nearly ended the two years back where it began.
The DJIA itself actually underperforms all the firms save BofA.
Turning to a much longer-term view of the four companies' stock prices, we see that all of them, except Altria, had remarkably similar paths for the past 38 years. There was a bit of untracking in the late '80s to mid '90s, and, as I noted above, in the last few years. And Honeywell declined noticeably from the path that Chevron and BofA shared for the early years of this decade.Amazingly, the outperformer of the bunch has been the tobacco-and-sometime-packaged-goods giant, Altria, once a/k/a Phillip Morris..
What does all this mean for the Dow? I guess the rough parity of the three non-tobacco firms means you might expect similar Dow-Jones performance going forward. Maybe there's even a sort of central-tendency play going on, wherein the outliers over time, Honeywell and Altria, are dropped, in favor of two more attenuated stocks, BofA and Chevron.
Since the DJIA, over this long timeframe, nests right in among BofA and Chevron, this would seem to be true, even if it's not actually why Dow-Jones made these specific replacements.
Being focused more on the S&P, I really don't pay any serious attention to the Dow. If anything, this sort of shuffling merely points out how sensitive to membership is any market index composed of only 30 companies. Did the staff at Dow-Jones have to work exhaustively to choose a mix of outgoing and incoming companies, such that their effects upon at least the recent past of the Dow's performance would be minimal?
Choosing a bank and an oil company in an era of huge write-offs among commercial banks, including BofA, and dwindling opportunities for oil reserves acquisition by US majors worldwide, poses an intriguing question about the real reasons behind these choices.
As a few pundits opined, you can bet the folks at Dow-Jones want the index to do better, not worse, over time. Thus, they must be placing an implicit "call" on BofA and Chevron and, by extension, financials and oil in the US economy. And an implicit "put" on tobacco and diversified manufacturing onshore.
That's not a view I would have expected them to take, all other things equal. It should be interesting to see what sort of comments are made on these changes in the months and years ahead.
Wednesday, May 16, 2007
Stephen Ross on Behavioral Finance: From the Ridiculous to the Sublime
Last night, my business partner and I attended a wonderful event hosted by the local alumni group of one of his alma maters, MIT. The occasion was a talk given by Stephen Ross, now the Franco Modigliani Professor of Finance and Economics at that august bastion of quantitative learning on the Charles River.
By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....
Anyway, back to last night's dinner and talk.
For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.
What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?
Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.
If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.
As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.
As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.
First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.
To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.
Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.
Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.
In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.
Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.
I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.
When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.
As I told my business partner, it was a dinner well worth whatever he paid for it.
By the way, for what it's worth, the far better University in Boston than its better-known, non-empirical neighbor in Cambridge, which shall go unnamed. The only clue being, the seasons changed, and Summers' gone now.....
Anyway, back to last night's dinner and talk.
For the ridiculous, the evening began with polite talk over drinks on the breezy, brick patio of a pleasant catering facility. We engaged in conversation with another couple, the woman of which was the MIT graduate. Her partner is a recently-retired businessman who has just sold his enterprise. Upon learning of my equity portfolio work, he eagerly began to describe his latest interest- a web-based trading site/system known as WiseTrade. Suffice to say, WiseTrade is to equity investing what 'no money down' home buying is to real estate finance.
What was humorous about the episode is that, while the man excitedly discussed how easy it was to buy or sell green- or red- shaded stock tickers, based upon their appropriately colored-lines on a chart, his MIT-educated partner pointedly asked whether the use of such a program by perhaps thousands of people at the same time might not affect the ability of "the program" to mint money at unheard-of rates?
Now, to the sublime. My partner and I were fortunate in being seated at "the finance" table, with about eight other alumni, and Prof. Ross. We caught occasional wisps of his conversation, seated, as we were, across a rather large table.
If I had been a little more aware, I'd be posting a (admittedly posed) digital picture of Prof. Ross and myself, with me, no doubt, looking pensive as he appeared to be making a sage remark.
As we worked through a very serviceable catered-style dinner, Prof. Ross gave a talk of incredible lucidity, insight, sensibility, and humor. MIT is very fortunate indeed to have lured him to its classrooms and research facility.
As concerns my interests, and this blog, Ross' remarks provided the following insights and reinforcements.
First, he clearly stated his belief that there are many unresearched anomalies in finance. Thus, he noted, simply because we do not know why an anomaly exists, or how it works, does not mean that neo-classical finance does not, or, in time, will not explain why.
To simply throw up our hands and resort to behavioral finance explanations in the absence of any other research is mistaken.
Second, Ross chose the anomaly of closed-end funds well-known pricing at a discount to their net asset value, to illustrate this point. He provided an excellent survey of the phenomenon, prior research, and conclusions by other finance academics. He then described his own simple, sensible hypothesis, and subsequent research which confirmed his hypothesis.
It turns out that simply quantifying and modeling the effects of management fees on the value of income and asset value to a closed-end fund-holder explained the difference between the market price and NAV of such funds.
Third, and perhaps most important, Ross remarked that, in his opinion, the best research into various anomalies typically is not overly-complicated, nor dependent upon 'fancy statistics,' but, rather, usually involves sensible ideas and relatively straightforward quantification of the phenomenon to resolve the apparent anomaly. Higher-level math or complicated statistical models are not necessarily indicative of reliable research, in his opinion.
Fourth, he consistently focused on the fundamental neo-classical contention that returns and risk are linked. Excess, or unexpectedly high returns, are invariably linked to added risk, whether that risk is explicitly known, measured, or described.
In that vein, during the post-talk Q&A period, he fielded my question regarding the newly-developed dividend "index" funds by Jeremy Siegel, now allied with Wisdom Tree funds. His thoughts are that one can construct many different weightings for funds, which he pointedly did not call "index" funds, which outperform classical indices such as the S&P500. However, when such constructed weightings lead to higher returns than those of indices, he attributes the excess to unrealized risks inherent in the constructed portfolios. As such, he effectively said, without engaging in any personal comment on Siegel, that the dividend-weighted index funds owe any above-average returns to risks which they seem not to have yet identified.
Finally, in a review of various other 'schools' of finance theory- behavioral, physics, and biological, he stressed two of the hallmarks of neo-classical finance that remain important. One is the field's clear-cut theory of efficient pricing of risk and information in markets. The other is its ability to quanitfy effects, which, specifically, he believes behavioral finance cannot. He likened behavioral finance, with its focus on overall behaviors of investors, to economics, rather than finance. That is, as a professor of both, he noted that economics is concerned with average behaviors of many market participants who effect prices, whereas finance is concerned with behaviors of a few 'sharks' who ferret out and capture price and risk inconsistencies, at the expense of the many who are not similarly motivated or informed.
I came away from Prof. Ross' talk feeling that my own proprietary equity research, and the conclusions resulting from it, on which my equity portfolio strategy is based, are on very solid ground. According to Ross' views, I have identified a heretofore unrealized anomaly which may well continue to exist for decades. Due to some of the specific ways in which I classify and measure various attributes of stock performance, there may never be many, if any, other finance researches who identify precisely the type of return opportunities which I have found. Further, the research I designed and performed is remarkably simple. I used some fairly straightforward concepts from my quantitative market research background, off-the-shelf point-and-click statistical software, and basic analytical tools to discover the phenomena which I use in my portfolio strategy.
When a finance academic of Stephen Ross' caliber provides me with information and insights which dovetail with my own work and methods, I feel reassured and confident in the strength and longevity of the underpinnings of my equity portfolio management approach. While it is theoretically possible for all anomalies to eventually be reduced to understanding and, perhaps, eliminated, in practice, it's not possible. Further, as Prof. Ross pointed out with several examples, often times, explaining the anomaly does not eliminate it. It simply provides the reason why the particular investment approach works as it does.
As I told my business partner, it was a dinner well worth whatever he paid for it.
Monday, March 12, 2007
After The Drop: Market Returns For The past Two Weeks
Since the US equities market dropped by 3.5% two weeks ago, tomorrow, there has been much punditry on the implications of the sudden decline.
One wonders how many investors headed for the sidelines, concerned over the sudden volatility and confusion among various market commentators on its imminent direction.
If you are curious, here are the daily returns for the S&P500 Index for the last two weeks, beginning with that Tuesday's decline.
-3.47%
0.56
-0.26
-1.14
-0.94
1.55
-0.25
0.71
0.07
The total return, excluding the first Tuesday's drop, ending with this past Friday, is +.30%.
For my own portfolio, here is the daily return series for the same period, again, beginning with the Tuesday loss two weeks ago.
-4.97
1.67
-0.75
-1.93
-1.18
2.63
-0.11
1.43
0.45
Our portfolio's return, following the initial Tuesday loss, is +2.21%.
I believe this reinforces an old adage I learned long ago, when I worked and consulted at Oliver, Wyman & Co. I don't recall the exact statistics, but went something like this: by being out of the market for only the best 10 days over a 10 year period, an investor could miss nearly half of the period's return.
In this case, the market's performance has been net positive for the period after the precipitous decline of that Tuesday. Given the S&P's negative return at this point, the +.30% return is a fairly large component of the year-to-date return.
For our portfolio, the aftermath of the sharp drop has been even better. We regained our year-to-date margin of outperformance over the S&P500, adding 2.2% to our return.
I wonder how many investors, even veteran institutional fund managers, missed out on returns by leaving assets unallocated to equities over the past two weeks? Trying to time the market by dumping shares and running to the sidelines means often missing positive returns in the market that cannot be made up. For most managers, missing only +.30% return in the S&P could well be the margin for underpeforming the index this year.
This recent period reinforces my use of a proprietary market signal for long/short allocation. By avoiding the tendency to bolt out of a market which has experienced a few bad days, my portfolio strategy remained in place and reaped a significant gain.
One wonders how many investors headed for the sidelines, concerned over the sudden volatility and confusion among various market commentators on its imminent direction.
If you are curious, here are the daily returns for the S&P500 Index for the last two weeks, beginning with that Tuesday's decline.
-3.47%
0.56
-0.26
-1.14
-0.94
1.55
-0.25
0.71
0.07
The total return, excluding the first Tuesday's drop, ending with this past Friday, is +.30%.
For my own portfolio, here is the daily return series for the same period, again, beginning with the Tuesday loss two weeks ago.
-4.97
1.67
-0.75
-1.93
-1.18
2.63
-0.11
1.43
0.45
Our portfolio's return, following the initial Tuesday loss, is +2.21%.
I believe this reinforces an old adage I learned long ago, when I worked and consulted at Oliver, Wyman & Co. I don't recall the exact statistics, but went something like this: by being out of the market for only the best 10 days over a 10 year period, an investor could miss nearly half of the period's return.
In this case, the market's performance has been net positive for the period after the precipitous decline of that Tuesday. Given the S&P's negative return at this point, the +.30% return is a fairly large component of the year-to-date return.
For our portfolio, the aftermath of the sharp drop has been even better. We regained our year-to-date margin of outperformance over the S&P500, adding 2.2% to our return.
I wonder how many investors, even veteran institutional fund managers, missed out on returns by leaving assets unallocated to equities over the past two weeks? Trying to time the market by dumping shares and running to the sidelines means often missing positive returns in the market that cannot be made up. For most managers, missing only +.30% return in the S&P could well be the margin for underpeforming the index this year.
This recent period reinforces my use of a proprietary market signal for long/short allocation. By avoiding the tendency to bolt out of a market which has experienced a few bad days, my portfolio strategy remained in place and reaped a significant gain.
Subscribe to:
Posts (Atom)
