Bear Territory

After every football victory, the California Golden Bears declare that the ground on which they stand is Bear Territory. “You know it! What? You tell the story! What? You tell the whole damn world this is Bear Territory!” Watch this particularly lively rendition after a win in The Big Game over Stanford (starting about 1:20 in; my youngest is at the top of the screen and was number 46 for Cal).

Lots of experts and alleged experts in recent days have been declaring that we’re in a different sort of “bear territory” as the market has gotten off to perhaps its worst start to a year ever. 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

You Can’t Outrun the Boulder

RealityBasedInvestingLogoThe idea behind tactical asset management is to make tactical shifts in asset allocation in order to take advantage of what is doing well and to escape what is doing poorly. The standard benchmark is a classic 60:40 allocation, of which VBINX is an excellent proxy. Had the whole concept of market-timing not been so utterly discredited (the latest data is here), it would probably still be called that. Such funds have broad discretion to move among stocks, bonds and cash and to move in and out of various sectors of the equity and fixed income markets in order (allegedly) to take advantage of market opportunities and to avoid market pitfalls.

From a marketing standpoint, the thrust of tactical management is to avoid market downturns (at least the significant ones) and to provide a lower volatility experience. That’s why, after almost disappearing, tactical managers returned with a vengeance after the 2008-2009 financial crisis. Visually, the idea is essentially that, like Indiana Jones, tactical managers can outrun the onrushing boulder of negative returns.

In reality, we can’t outrun the boulder, as the following video (using a plastic “boulder” – it looks like a blast) demonstrates clearly.

A Morningstar study from 2010, updated in 2012 and updated again in 2014 should put the matter to rest. During the pre-2010 period, tactical management underperformance averaged 2.6 percent per year. And over the three years through July of 2014, tactically managed funds underperformed a classic 60:40 portfolio by 3.8 percentage points per year.

The great William Bernstein states the key to that underperformance well as follows.

“There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know.”

Another reason for the underperformance is fees, which are the best indicator we have of performance success. Tactical funds on average charge an annual management fee of 1.48 percent as of 2014, according to Morningstar. That’s nearly double the mutual fund industry average of 0.77 percent, according to ICI.

Tactical management is yet another sort of “cargo cult” investing “solution” (thank you, Dr. Feynman) — an approach, model or system that is said to work somehow without adequate analysis, testing and safeguards. A data-mined but insufficiently authenticated “solution” will almost surely be a disaster for everyone but those collecting fees for it. Some of these “solutions” seem like a joke. Most are deadly serious. But there’s no reason to expect them to work.

You aren’t Indiana Jones. You’re not going to outrun the boulder.

The Market Timing Debacle

Investors looking to avoid the sharp downturns or to benefit from recovery rallies during a secular bear market via market timing are bound to fail.

One intuitive response to the cyclical swings of a secular bear market – such as we have seen lately –  is simply to try to time the market via active trading designed to buy (relatively) low and sell (relatively) high(er). Such market timing is a strategy of financial management which attempts to predict future market price movements over the near and intermediate-term. The prediction may be based on an outlook of market or economic conditions resulting from either technical or fundamental analysis, or some combination thereof. Unfortunately, there is very little evidence that such an approach works.

A market timing strategy is based on one’s outlook for an aggregate market, rather than for a particular financial asset. Without reviewing all the research, suffice it to say that both institutional investors (more here, here and here) and individuals consistently fail as market timers. As John Kenneth Galbraith famously pointed out, we have two classes of forecasters: those who don’t know and those who don’t know they don’t know.  Or, as Yoram Bauman, the Stand-Up Economist, has said in a similar vein, economists have forecast nine out of the last five recessions (for an interesting look at forecasting error, see here).

Where “true value” levels reside is not all that difficult to figure out, at least generally, but when and how the markets move is exceedingly difficult to ascertain and extremely frustrating for the trader. As Meir Statman pointed out in a recent Institutional Investor column: “Too many [investors] believe that they have a good chance to win the investment game, when, in truth, they are overconfident and unrealistically optimistic.”

Over most time periods, market movements are dominated by “noise” – random events that cannot be predicted with any degree of reliability.  As a result, most of the time, making shorter term market timing moves is a loser’s game – with outcomes dominated by luck rather than skill, and high transaction costs.

To illustrate, for most of us tennis is a loser’s game. We do not possess the skills to play well consistently.  Trying harder to make great shots only makes matters worse.  Most of us are far better off simply trying to keep the ball in play rather than trying to outclass an opponent.  If we keep the ball in play we give the opponent the opportunity to make errors.  That’s a loser’s game — the results are dominated by what the loser does.  On the other hand, professional tennis is a winner’s game, with the outcome based predominately upon the winner’s better shots.  A pro needs to do more than just keep the ball in play to succeed.

Since there is so little evidence that market timing works, trying it is like a week-end tennis player consistently trying to hit winners. Market timing is a loser’s game.  It simply does not work.