The Great Myths of Investing

GreatMythsAs the great Mark Twain (may have) said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” That’s particularly true in the investment world because we know, to a mathematical certainty, that avoiding errors provides more bang for the buck than making correct calls and generating outperformance. Fixing what we “know for sure that just ain’t so” provides a remarkable opportunity for investment success.

On the other hand, it simply doesn’t make a lot of sense to spend enormous amounts of time and energy looking for a strategy or a manager that might (but probably won’t) outperform by just a little bit. As the great Spanish artist Pablo Picasso put it, “Every act of creation is first of all an act of destruction.” What we want to do is to find the next great investor, the terrific new strategy, the market sectors that are about to heat up or the next Apple. But what we should do is eliminate the things that make it so hard for us to get ahead. Accordingly, I will highlight some of the great myths of investing — ideas that lots of people, alleged experts even, claim to be true and act as as though are true “that just ain’t so.”

There are lots of myths at work in our lives, of course, falsehoods that are often believed and which are used to further a favored narrative. But George Washington didn’t really cut down a cherry tree and wax eloquent about not telling a lie as a consequence. Isaac Newton didn’t come up with his theory of gravity because an apple fell on his head. Columbus didn’t discover that the earth was round (that had been established centuries before). Ben Franklin didn’t fly a kite in a storm and discover electricity. And Einstein never flunked math. If any of these are news to you, I’m sorry to have had to break it to you.

Such myths persist because they “work” in some way. Their story elements — ease of recall, readily adaptability, explanatory power — make them useful and even important.  But utility and truth are hardly the same things and neither are utility and helpfulness.

So here is my list of the top ten great myths of investing. Since they aren’t true and are indeed damaging, if you can eliminate them from your mind and your investment process, your results will necessarily improve. Continue reading

Here We Go Again: Forecasting Follies 2016

Forecast 2

Image from xkcd

In a great scene from the classic film, The Wizard of Oz, Dorothy and her friends have — after some difficulty and fanfare — obtained an audience with “the great and powerful Oz.” When, during that audience, Dorothy’s dog Toto pulls back a curtain to reveal that Oz is nothing like what he purports to be, Oz bellows, “Pay no attention to that man behind the curtain,” in an unsuccessful effort to get his guests to focus their attention elsewhere.

Like the Wizard, the great and powerful on Wall Street would have us pay no attention what is really there — “behind the curtain.”  Yet once in a great while the Street rats itself out so that we get to find out, beyond a shadow of doubt (if you still had any), what the big investment houses really think about what they do and who they do it to.

The now-defunct Bear Stearns won a noteworthy 2002 legal decision involving former Fed Governor and then-Bear Chief Economist Wayne Angell over advice he and the firm gave to a Bear Stearns client named Count Henryk de Kwiatkowski (really) after the Count lost hundreds of millions of dollars in a just a few weeks (really) following that advice by trading currency futures on margin. The Count had been born in Poland, escaped invading Nazis, been banished to Siberia by the Soviets, escaped and travelled across Asia on foot to Tehran, talked his way into the British Embassy, became a renowned RAF pilot, moved to Canada, became an engineer, and made a fortune trading used airliners, most famously selling nine 747s to the Shah of Iran over a game of backgammon in the royal palace (really). He also became the owner of the famous thoroughbred racing institution, Calumet Farm (really).

Bear offered the Count “a level of service and investment timing comparable to that which [Bear] offer[ed its] largest institutional clients” (which is not to say that they were any good at it). The key trade was a huge and ultimately disastrous bet that the U.S. dollar would rise in late 1994 and early 1995. At one point, the Count’s positions totaled $6.5 billion nominally and accounted for 30 percent of the total open interest in certain currencies on the Chicago Mercantile Exchange. The jury awarded a huge verdict to the Count but the appellate court reversed. The appellate judges determined, quite conventionally, that brokers may not be held liable for honest opinions that turn out to be wrong when providing advice on non-discretionary accounts.

But I’m not primarily interested in the main story. Instead, I’m struck by a line of testimony offered at trial by then-Bear CEO Jimmy Cayne that does not even show up in subsequent court opinions, despite extensive recitals of the facts of the case. The generally “cocksure” Cayne apparently thought that his firm could be in trouble so he took a creative and disarmingly honest position given how aggressive Bear was in promoting Angell’s alleged expertise to its customers. Cayne brazenly asserted that Angell was merely an “entertainer” whose advice should never give rise to liability. Continue reading

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

Hot Pants Investing

I watched Mike Krzyzewski’s first Duke win from the stands in Cameron Indoor Stadium as a student in 1980 and his fifth national championship victory earlier this month at home, on television, with my grandchildren. I’ve probably seen a majority of the games in-between one way or another. Coach K is an icon, and widely regarded as perhaps the best college basketball coach of all-time. He is the winningest college basketball coach of all-time. But when has hired 35 years ago, he wasn’t even generally considered to be in the running for the job. During the entire month-long coaching search, Krzyzewski’s name never appeared in any North Carolina newspaper as even a long-shot candidate for the job. No radio station nor any television station suggested him as a possibility.

Then Duke Athletic Director Tom Butters insisted that he was getting the “brightest young coaching talent in America” to lead his basketball program (video from the hiring news conference here – notice how “Krzyzewski” is repeatedly mispronounced in the report) when he hired Coach K. There was no live coverage of any kind. The local morning paper had reported that one of “three Ws” – Bob Weltlich of Ole Miss, Old Dominion’s Paul Webb or then top Duke assistant Bob Wenzel – was going to get the job. But Butters hired the West Point graduate, then just 33 years old and coming off a losing season at his alma mater. Butters had ultimately listened to Bob Knight, who told him that Krzyzewski had his own good attributes without the bad.  The headline in The Chronicle (Duke’s student newspaper) was “Krzyzewski: This is Not a Typo.” Ironically, the local afternoon newspaper got the scoop several hours before the press conference, but it was after deadline and there was nowhere to report it.

This story seems quaint today, with the idea that a major college basketball hiring could remain unreported and largely secret until the press conference and that the coach hired had not even been considered a candidate is appropriately presumed to be impossible in this digital age. Obviously, times have changed. To get at what that sort of change means to our culture and to the financial services business, we have to go back into ancient history, even before 1980. Continue reading

Follow the Money

Hedge funds per CarlHal Holbrook had a wonderful supporting role in the Watergate saga All the President’s Men, a 1976 Alan J. Pakula film based upon the book of that name by Pulitzer Prize winning reporters Bob Woodward and Carl Bernstein of The Washington Post. Holbrook played the conflicted, chain-smoking, trench-coated, shadowy source known only as “Deep Throat” (over 30 years later revealed to have been senior FBI-man Mark Felt). Woodward’s meeting with his source when the investigation had bogged down is a terrific scene.

Sadly, Holbrook’s iconic line – “Follow the money” – was never spoken in real life and doesn’t appear in the book or in any Watergate reporting. Still, Woodward insists that the quote captures the essence of what Felt was telling him. “It all condensed down to that,” Woodward says. More importantly, it provides a profound truth. Indeed, when asked 25 years later on ”Meet the Press” what the lasting legacy of Watergate was, legendary Post editor Ben Bradlee replied with the words of screenwriter William Goldman, if not Mark Felt: ”Follow the money.” It provides good guidance for reporters generally and really good guidance when one is looking at the financial advice business.

With this important touchstone at the forefront, it’s crucial to recall that the financial advice business generally builds products and portfolios for marketing purposes rather than investment purposes. For the industry as a whole, “results” relate to sales far more than to what investor-clients end up getting. Accordingly, the idea is to play to people’s hopes, fears and prejudices rather than speak the (less marketable) truth. Moreover, if something can be positioned as new, novel or complex — and thus offering a plausible justification for a high fee — so much the better.
Continue reading

Should We Pay the Shakedown Artists or Not?

Before being closed down by the Federal Trade Commission, a revenge porn site called “Is Anyone Up” came up with a creative but disgusting twist on the sleazy genre by including a link to a phony “independent third party team” that would get the offensive pictures taken down for a fee.1 In other words, the site and its proprietor horribly violated peoples’ privacy and then extorted them for money to stop violating them. That sick scheme provides a perfect lead-in to a discussion of the San Diego Chargers and the recently announced joint stadium proposal made by the Chargers and the Oakland Raiders that would involve both teams leaving their current cities and moving to the Los Angeles area.

Continue reading

A New Kind of Investment Outlook

Outlook212015 Outlook2014-2015

Forecasting Follies

Nobody’s perfect.

That universal truth is easy to prove, of course, and no sane person would deny it. Indeed, even the smartest of us are far from immune even in our areas of expertise when we’re actively trying to do our best. A famous study by the U.S. Institute of Medicine concluded that up to 100,000 people die each year due to readily preventable medical errors. Since physicians are among the smartest and most highly trained professionals imaginable, being stupid is obviously not a prerequisite for making mistakes, even horrible mistakes.

It’s also easy to prove how error-prone we are in the investment world. Every year I take a look at various predictions for the year that’s ending and they are uniformly lousy in the aggregate. Moreover, when somebody does get one right or almost right, that performance quality is not repeated in subsequent years.

2014 provided more of the same in this regard. The median S&P 500 forecast among 50 top-end investment experts called for a year-end level of 1,950, up 6.44 percent on the year. As noted above, the actual closing level was 2,059, up 11.39 percent, essentially five full percentage points higher. That’s a miss of monumental proportions.

Last January, analysts called for far higher oil prices, firmer inflation, a worse jobless rate and higher interest rates. The exact opposite happened in each of those areas. The consensus crude oil price forecast was nearly $95 per barrel (up a bit) and 72 out of 72 economists were anticipating higher interest rates and lower bond prices. Advisor magazine reported that bond market sentiment was utterly bearish, leading pundits to recommend that investors limit their bond holdings to the shortest maturities in 2014. Meanwhile, 30-year U.S. Treasury bonds returned nearly 30 percent. Last April, Peter Schiff of EuroPacific Capital made the bold prediction that the “Federal Reserve’s quantitative-easing program will push gold to $5,000 an ounce.” The shiny yellow metal closed 2014 at just under $1,200, 80 percent or so lower than Schiff’s target.

Alleged experts miss on their forecasts and miss by a lot. Let’s stipulate that these alleged experts are highly educated, vastly experienced, and examine the vagaries of the markets pretty much all day, every day. But it remains a virtual certainty that they will be wrong often and often spectacularly wrong. On account of hindsight bias, we tend to see past events as having been predictable and perhaps inevitable. Accordingly, we think we can extrapolate from them into the future. But the sad fact is that we can’t buy past results. Continue reading

Signing Day and the Investment Process

davidYesterday – the first Wednesday in February and thus the so-called National Signing Day – was the first day that high school seniors could sign letters of intent to accept an athletic scholarship to play Division I college football in the fall. It’s the culmination of a long recruiting process and crucial to the success of teams and coaches. It can get more than a bit ridiculous.

Some players announced their intentions using live animal props, or worse. One recruit picked Texas over Washington based on a coin flip. At least it wasn’t for the gear, officially anyway. And Snoop Dogg will be giving up his support for USC to cross-town rival UCLA because his son picked the Bruins, where he’ll join P. Diddy’s kid on the team. Cornerback Iman Marshall, a big-time USC signee, has a self-styled “commitment video” that’s particularly absurd.

But the coaches and the media outlets that cover college football recruiting (of which there are an astonishingly high number) take it all very seriously indeed. As the parent of a DI player (at Cal, see above), *I* took it very seriously.

These various publications generally rate high school players being recruited via a “star system” of from two to five stars, with five stars being reserved for top 50 players, four stars for the next 250 (numbers 51-300), three stars for the next 500, and two stars for players who are considered “mid-major” and thus not good enough for the top conferences and teams. Alabama’s current recruiting class is usually reputed to be the nation’s best, for the fifth straight year, averaging out to 4.08 stars. And while it’s not much ado about nothing, it’s much ado about a lot less than you’d think, and in a different way than you probably think. Continue reading

It’s the waiting part that’s hard

Hedge Funds 3CalPERS, the highly influential California public employee pension agency, announced in September that it would no longer invest its dollars via hedge funds. That decision is not altogether surprising in that the annualized rate of return of the hedge funds in the CalPERS portfolio over the past decade was only 4.8 percent. The behemoth pension plan sponsor was careful to note that not all hedge funds are bad, but that “at the end of the day, judged against their complexity, cost, and the lack of ability to scale at CalPERS’ size,” the hedge fund investment program “is no longer warranted.”

In essence, CalPERS recognized and acted upon what should be apparent to everyone: hedge fund returns have simply not lived up to their hype. As Victor Fleischer famously put it, “hedge funds are a compensation scheme masquerading as an asset class.”  Continue reading

Whole Foods Quackery

Source:  The Quackometer

Source: The Quackometer

Fortune has a puff piece out on Whole Foods Market (WFM, a stock in which I have no interest and no intended interest), the up-scale purveyor of excellent prepared food, overpriced groceries with multiple claimed but unsubstantiated benefits, phony health remedies, and the oxymoronic concept of “healthy indulgence.” It made its reputation by pushing healthier living and selling food that doesn’t contain the pesticides and additives that are often staples of “regular” food.

The Whole Foods approach has worked in that its share price is up about 12-fold since its November 2008 recession-era low versus 130 percent for the S&P 500 index. “Great brands impose a view on you,” WFM consultant Kevin Kelley says, and Whole Foods is no exception. “One of the faults that traditional groceries have is they believe the customer is always right.” Today, Whole Foods has a list of 78 banned ingredients, ranging from aspartame to foie gras to high-fructose corn syrup. You may want a Coke, but you can’t get one at Whole Foods.

However, when I took a look at the ingredients that provided Whole Foods its success, the whole thing became far less appetizing. The Whole Foods emphasis on “natural” foods is obviously silly. There is no such thing as non-natural food. Moreover, at least in the United States, it has no consistent meaning. Indeed, the federal Food and Drug Administration explicitly discourages the food industry from using the term. But that doesn’t stop Whole Foods. After all, it’s working.

Oh that a bit of silliness were the only problem. Despite broad scientific consensus that genetically modified food poses no greater health risks than other types of food, Whole Foods says it will require all its vendors to label products with GMOs by 2018 and suggests (at least by inference) that such food isn’t really good for you. Whole Foods would also have you believe that organic produce (which is, not so coincidentally, much more expensive than “regular” produce) will help you stay healthier, even though a major study published in the Annals of Internal Medicine (nicely summarized here) examining hundreds of scientific studies over many years found no evidence of health benefits from organic foods. “There’s a definite lack of evidence,” emphasizes Crystal Smith-Spangler of the Stanford University School of Medicine and an author of the study.

But these issues aren’t all that much to be really upset about. If people want to overpay for something they think will make them healthier, the fact that it doesn’t isn’t too big of a deal. Nobody’s getting hurt and people are stupid all the time. However, the Whole Foods story gets still worse – much worse.

As reported by Michael Schulson in The Daily Beast, Whole Foods pitches homeopathic remedies (such as homeopathic remedies for allergies, homeopathic remedies for colds and fluBoiron homeopathic medicines and even cures for cancer) as well as other foods and “drugs” that make medical claims that are simply false. Homeopathy is, after all, pure quackery. Whole Foods also sells probiotics — live bacteria given to (allegedly) treat and prevent disease – but it’s a total scam: “If you are a normal human, with a normal diet, save your money. Probiotics have nothing to offer but an increased cost.”

Phony claims such as these are far more damaging than simply pushing “natural” and organic foods. That’s because such fake remedies often cause people to forego substantive medical care that might actually help. For example, such an approach may well have cost Steve Jobs his life, to his obvious regret.

Sadly, it isn’t just customers who have fallen for the Whole Foods hype. “They’re a leading national authority on health and nutrition,” says BB&T Capital Markets analyst Andrew Wolf, “and unequivocally the leading retailer on the link between food and health.” As if.

My friend Josh Brown even fell for the WFM nonsense: “There’s a lesson in the Whole Foods brand that I think carries a great example for my organization and possibly yours as well: The customers are not always right and, more importantly, they sometimes wants [sic] to be told what’s best for them and to have harmful options taken away from within their grasp.” Unfortunately, what customers are told is all too frequently in error and obviously bad for them, as Whole Foods so aptly demonstrates.

Happily, I have every confidence that Josh is doing right by his clients. And I completely agree with Josh’s conclusion: “Zealous advocacy is not fascism, and steering a customer away from something they don’t need or shouldn’t want is just as important as the actual suggestions you are making.” But Whole Foods is far from a good example of “doing [what] is superior and in the clients’ best interest.” In fact, Whole Foods should be a cautionary tale rather than an exemplar.

Maybe there really is a sucker born every minute and Whole Foods will continue to survive and even thrive despite its bogus marketing. But I’d like to think that truth will out, at least eventually.