Mean Reversion, Small Sample Size and the Mets

Mets1Nobody saw it coming before the season and even well into the season (see, e.g., here, here and here). But, as of tonight, the New York Mets will be playing in the World Series for the first time in 15 years. Sports is so entertaining in large part because the combination of luck, skill and variation involved creates an unpredictable stew of drama, intrigue, greatness and disappointment. Today, that stew smells a lot like the Mets and, so far, it smells pretty tasty.

While their pitching has been sublime this postseason and is the team’s overall key to success, Met second baseman Daniel Murphy’s bat is the big story.

Prior to this postseason, Murphy was a good-but-not-great player whose career highlight was being a reserve All-Star selection in 2014. But this postseason has been one for the ages and the record books to this point thanks to his having homered in six straight games and having hit .421. We’re talking about a player the owner of the American League champion Kansas City Royals recently called “the reincarnation of Babe Ruth” but who never previously hit five home runs in a month. Continue reading

The Advice Business: Make It Personal

res-1015-coverThe October edition of Research magazine is now out and it once again carries my regular column. I hope you will read it and the entire issue. Here’s a quick taste.

We should give our best advice as convincingly and as comprehensively as possible. Yet best practices aren’t always followed. A stellar advisor will recognize when the case for the best approach is lost (but won’t give up too soon) and move on to offer an acceptable alternative. Significantly, a perfect approach, portfolio or product is useless if and when the client refuses to use it or — crucially — stick with it when the going gets rough or when something else comes along. “Pretty good” beats “not at all.”

The Advice Business: Make It Personal

In Memoriam

I originally posted this on the tenth anniversary of 9.11. It remains applicable today.

September 11 is one of those “Where were you?” events which, for me, also include the Kennedy assassination (my second grade classroom), Neil Armstrong’s “giant leap for mankind” (my parents’ den) and the falling of the Berlin Wall (a New Orleans hotel room).

Ten years ago I was sitting in front of my Bloomberg terminal here in San Diego when I saw a headline scroll across the bottom of my screen about a plane crashing into the World Trade Center. Since I had been on a trading floor in the World Financial Center in 1993 trying to do a trade with a client near the top of Tower One when it had been bombed previously and remembered the earthquake-like rumble I felt vividly, thoughts of a dreadful accident involving a small private plane quickly turned to fears of terrorism and consequences that were far, far worse.

As it happens, I still spent a fair amount of time at the World Financial Center (which is adjacent to the WTC) back then and had a reservation at the World Trade Center Marriott for September 11, 2001. Fortuitously, I decided not to go to New York so as to attend a Back to School Night presentation for my kids.

Much has happened since that day, obviously. We are a different country today than we were a decade ago, and not all the changes are for the better. To paraphrase C.S. Lewis, progress isn’t always forward. But our advances are real and important as well.

The memories of September 11, 2001 linger — as they should — and still offer lessons for those of us who remain. But today, first and foremost, let us remember those who died that day and honor their memories.

2013 Addendum: I have visited The National 9/11 Pentagon Memorial and the 9/11 Memorial in New York City multiple times. Both Memorials provided experiences that were both moving and powerful. I encourage all of you to visit them. Other personal 9.11 stories worth reading are here and here. My 9.11 pieces relating to markets and our behavior are here and here.

It Can’t Be Wrong When It Feels So Right

“What ails the truth is that it is mainly uncomfortable, and often dull. The human mind seeks something more amusing, and more caressing.”

H. L. Mencken

Hooray for our sideDebby Boone released “You Light Up My Life” in 1977 and it became a #1 hit, the most successful single of the 1970s and won her a Grammy. Hard to believe, isn’t it? Anyway, at the song’s climax, she proclaims her love for the unnamed object of her desire and earnestly intones that “it can’t be wrong when it feels so right.”

Any parent of teenagers recognizes how dangerous such a claim can be and anyone who ever was a teenager and has the slightest bit of self-awareness can recognize that the claim is utterly false. Lots of things feel really, really right at the time but are really, really wrong. Yet no matter how ludicrous the claim obviously is and how clearly we see its falsity in moments of sanity, we follow its dictates time and again. As John Junor famously expressed it, “an ounce of emotion is equal to a ton of facts.”

On our better days, when wearing the right sort of spectacles and by tilting our heads just so, we can be observant, efficient, loyal, assertive truth-tellers. However, on most days, much of the time, we’re delusional, lazy, partisan, arrogant confabulators. The problem is what Stephen Colbert (who began his new late-night television venture this week) described as “truthiness” on his first episode of The Colbert Report a decade ago (watch it here). It’s the quality of seeming or being felt to be true, even if it’s not necessarily true or perhaps false.

Continue reading

The Misplaced Faith in Optimizing Portfolios

xx-optimizing-portfolios-res0915-annuityanalytics-27-resize-600x338My September Research magazine column is now available online. A taste follows.

Once we recognize that our portfolio modelling efforts have an R-squared of less than 1.00, we must accept the possibility that optimism based upon portfolio optimization is necessarily misplaced. When the R-squared is less than 1.00, the crucial element in the decision at issue is not the likelihood of being right and what we get out of it, it is the consequences of being wrong. As the great Peter Bernstein put it: “There is no certainty. Rational people do not bet the ranch on a model with an [R-squared] of less than 1.00, that works out only for the most part. And God forbid it works out only for the minor part! Consequences, not probabilities, determine the decisions that matter.”

In the real world, outcomes are inherently uncertain, but we still have some control over what is going to happen or at least some control over the consequences of what is going to happen. Dealing with such inherent uncertainties is what risk management is all about. The current environment for guaranteed income isn’t great. But don’t be too quick to bank on portfolio optimization to save the day. As the Roman Stoic Seneca expressed it, “Our minds should be sent forward in advance to meet all the problems, and we should consider not what is wont to happen, but what can happen.”

I hope you’ll read the full article as well as the entire issue of the magazine.

The Misplaced Faith in Optimizing Portfolios

The Argumentative Theory of Reason

From Rationally Speaking:

The traditional story about reason is that it evolved to help humans see the world more clearly and (thereby) make better decisions. But on that view, some mysteries remain: why is the human brain so biased? Why are we so much better at defending our pre-existing views than at evaluating new ideas objectively?

In this episode of Rationally Speaking, Julia talks with guest Dan Sperber, professor of cognitive and social sciences, who is famous for advancing an alternate view of reason: that it evolved to help us argue with our fellow humans and convince them that we’re right.

Dan Sperber is a social and cognitive scientist. His most influential work has been in the fields of cognitive anthropology and linguistic pragmatics. Sperber currently holds the positions of Directeur de Recherche émérite at the Centre National de la Recherche Scientifique and Director of the International Cognition and Culture Institute.

Listen to the podcast here.

In Times Like These

“My Mama told me there’d be days like this.” – Van Morrison

Stock markets are in turmoil all over the globe. Monday was especially violent and what passes for financial television was awash in bluster, doom and gloom. Markets were gapping down in China, in London, in Japan and elsewhere. Emerging markets were getting crushed. Here in the States, the S&P 500 dropped about 4 percent, with the other major benchmarks performing similarly. The next day, on what appeared to be “Turnaround Tuesday,” a day-long rally was overcome by a major sell-off just before the close, pushing all the major indexes underwater for yet another day. Today has opened well, but (obviously) we don’t know what’s coming.

Over the previous six trading days, the benchmark S&P index has lost well over 200 points, or roughly 11 percent, putting it on track for its worst August in 17 years. But since the markets haven’t seen a significant correction (a loss of at least 10 percent) since 2011, we have been due for one. When financial markets are free-falling, and all correlations seem to converge on 1.0, analytically we move into the realm of the physics of landslides, where things are inherently complicated and unpredictable (which is not to say that more “normal” times are somehow simple and predictable). Continue reading

A Musical Lesson for Investors and Advisors

res-0815-annuityanalytics-mi600-resize-600x338The August edition of Research magazine is now out and my column is now available online and is linked below. Here’s a taste.

Sometimes near Christmas Phil would slip out of Avery Fisher Hall after a performance with the Philharmonic, change jackets, and join some Army brass in front of a kettle. He didn’t hear “Bravo!” there. In that context, people who had just paid a lot of money to applaud his virtuosity would routinely ignore him and his music. It was as if he was hiding in plain sight.

In nearly every context and situation, we routinely hear, see and perceive exactly what we expect. No more and no less. Since concertgoers (or more precisely, concert-leavers) didn’t expect a world-class performer to be playing with the Salvation Army on a street corner for free, they didn’t notice when one was doing just that.

I hope you’ll read the whole thing.

A Musical Lesson for Investors and Advisors

Happy Blogiversary to Me

HappyBlogiversaryI have been now been writing Above the Market for four years. I began on August 1, 2011. I started and still write largely to clarify my own thinking and to force and enforce commitment on my part. Actual readers are a lovely bonus I didn’t expect when I started and that I never take for granted. After many hundreds of thousands of visitors from nearly 200 countries, I remain astonished at the level of interest Above the Market has received — it is far beyond what I thought possible, much less likely. I appreciate each and every reader. Anyone who writes wants to be read most of all.

As always, a few people deserve special mention and thanks.

Tom Brakke (his terrific blog is The Research Puzzle) generously offered outstanding help and guidance before I even had any readers to speak of and continues to offer wise counsel whenever I ask. Tadas Viskanta provided my first distribution (exactly one month in) to the expert community he serves via his blog, Abnormal Returns, which remains the standard for its type. I have now appeared there an astonishing 206 times — essentially once a week — and am extremely grateful for having done so. Joe Calhoun upped my exposure tremendously via Real Clear Markets, in which I have appeared almost as often (179 appearances). I am grateful and humbled to be featured often at these and other excellent sites, including Cullen Roche’s outstanding Pragmatic Capitalism (75 times), the indispensable The Big Picture from Barry Ritholtz (62 times), Bill Zimmer’s The Prudent Trader (59 times), Charles Kirk’s The Kirk Report and Josh Brown’s wonderful The Reformed Broker (59 appearances each). Other regular linkers include the CFA Institute, Ben Carlson’s fantastic A Wealth of Common Sense, Michael Kitces (the authority on financial planning), Wade Pfau (the authority on retirement income planning) and the previously mentioned Mr. Brakke. Jason Zweig and Morgan Housel — giants in financial journalism — have provided much help and inspiration. And finally, but in no way least, I greatly appreciate Research magazine publishing my monthly columns. Thank you all.

My “top ten” posts this year, based upon reader numbers, follow in order of popularity. I hope you will give them a look (or another look).

  1. A New Kind of Investment Outlook
  2. Crash Ahead!!!
  3. Pants on Fire: 10 Big Lies in the Financial Services Industry
  4. Follow the Money
  5. The Maleficent 7
  6. Kobayashi Maru and the Forecasting Follies
  7. Make Fewer Decisions
  8. Math is Different
  9. Everybody Plays the Fool (Sometimes)
  10. You Can’t Outrun the Boulder

My all-time “top ten” posts, again based upon reader numbers, follow in order or popularity. I hope you’ll check them out (or check them out again).

  1. Investors’ 10 Most Common Behavioral Biases
  2. Financial Advice: A Top Ten List
  3. Establishing Your Top 10 Investment Default Settings
  4. My Investing Checklist
  5. Math Suckage and Dave Ramsey
  6. Top Ten Ways to Deal with Behavioral Biases
  7. Investing Successfully is Really Hard
  8. Saving Investors From Themselves
  9. We Suck at Probabilities
  10. Is the Yale Model Past It?

Finally, I’d like to focus on the following “not top ten” posts that didn’t get nearly as much attention — sometimes because they appeared before I had many readers — but which I think are worth reading. I encourage you to check them out.

  1. Beguiled By Narrative
  2. Financial Products are Sold, Not Bought
  3. It’s Not You, It’s Me
  4. Just Put the Ball in Play
  5. Gaming the System
  6. The Semmelweis Reflex
  7. Bias Blindness and Political Polarization
  8. Demand for Hitmen and Yield
  9. Luck, Skill and Jim Harbaugh
  10. Librarius Booker, Confabulation and Choice Blindness

I have enjoyed a nice holiday from blogging this past month and a vacation to boot. I welcomed my first granddaughter and got a good rest. Now I’m ready to get back to it. To everyone who has read, supported and helped me with this effort: Thank You! I hope four years leads to many more.