It took nearly 4½ years, but the cumulative wealth of an S&P 500 strategy with dividends reinvested finally reached an all-time record (measured on a month-end basis) in March 2012, and finished the year 3.3% above the previous high-water mark set in October 2007. Results were slightly better for a small-company Russell 2000 strategy: As of December 2012, cumulative wealth was 8.5% higher than the previous peak in May 2007.
The table below shows how many years were required to achieve a new high in terminal wealth during some of the major market cycles in the past. Although many investors have expressed frustration with stock market fluctuations in recent years, the time required to recover losses from the peak in October 2007 appears broadly consistent with past cycles. We can draw some measure of solace in acknowledging that past generations of investors often found their patience sorely tested, as well.
The book entitled “The Quest For Alpha” by Larry E. Swedroe presents comprehensive evidence documenting the futility of active portfolio management by examining the quest for money managers that are capable of delivering alpha1. Swedroe references academic studies on mutual funds, pension plans, hedge funds, private equity/venture capital, individual investors, and behavioral finance. He demonstrates that markets are indeed highly efficient and makes the ultimate conclusion that the only winning move is not to play the game. Girolamo Cardana who was a sixteenth-century physician, mathematician, and quintessential Renaissance man made the same conclusion for gambling (which is quite similar to active management) when he said “The greatest advantage from gambling comes from not playing at all.”
Referenced in the book, Philip E. Tetlock, a professor of psychology, business and political science at the University of California (Berkeley) found that the so-called experts who make prediction their business – appearing as experts on television and talk radio, being quoted in the press, etc. – are no better than the proverbial chimps throwing darts. His research indicates that it makes no difference whether forecasters are PhDs, economists, political scientists, journalists, or historians; whether they had policy experience or access to classified information; or whether they had logged many or few years of experience in their chosen line of work. The only predictor of accuracy was fame, which was negatively correlated with accuracy. The most famous made the worst forecasts. All of these so-called experts seem to fall victim to hindsight and/or confirmation bias.
I strongly encourage you to read the book for the deeper discussions and supporting research that examines the dismal results of active management in its multiple forms.
1. If an asset's return is even higher than the risk adjusted return, that asset is said to have "positive alpha" or "abnormal returns". Investors are constantly seeking investments that have higher alpha.
According to the headlines, "Dr. Doom" - Nouriel Roubini, is predicting another disaster for the global economy. Roubini became famous after making a prediction in 2006 that there would be a catastrophic global financial meltdown. After the events of 2007-2009, he made a lot more predictions - but none that have proven to be correct. Our friend, Eric Tyson, deconstructs the Roubini myth here.
This week, I noticed a slew of headlines about Roubini's latest prediction of another looming disaster. But, what's most interesting about this is what the headlines seem to imply versus what he actually said. Every news article focused exclusively on the "perfect storm" that's surely headed our way:
- Nouriel Roubini says "perfect storm" may threaten global economy - The Washington Post
- It's more than a "soft patch", says Roubini - Business Times (Singapore)
- Dr. Doom predicts 2013 gloom - New Zealand Herald
- Roubini's crystal ball forecasts... much more doom! - Barron's
- Outlook for global economy bad or worse says Dr. Doom - Straits Times (Singapore)
- Roubini sees risks fiscal woes will converge in '13 - Boston Globe
But, that was only one scenario that he proposed. There were
two others - "anemic, but OK" growth and an optimistic scenario in which the economic expansion improves. In other words, things will either get worse, stay about the same, or get better. I'm fairly sure that he'll be right this time.
There are a couple of important points to be made here. First, the press loves to create shocking headlines that will sell newspapers or magazines or that will convince you to tune in to their news channel. They are often taken out of context or they are incomplete. Most people never bother to read the text of the article. In fact, in this example, many of the articles written about this prediction ignored everything except the worst case scenario. Second, most predictions, even from "experts" aren't worth the paper that they are printed on and certainly should not be used to determine how to position a portfolio.
I just updated our website with the portfolio performance numbers through the end of 2010.
US stocks turned in pleasing results for the full year in 2010, with investors earning significant rewards for the equity, small cap and value risk factors. But, capturing the market rate of return required plenty of patience: eight months into the year the S&P 500 Index was still down 5.8% and the tepid economic recovery appeared to put a lid on any significant upturn in prices. Nevertheless, stock prices surged over the subsequent five months and the S&P 500 ended the year at 1257.64, up 12.78% (price only), recouping all of its losses since the collapse of Lehman Brothers on September 15, 2008.
Results were generally similar in non-US markets, with 37 out of 45 countries tracked by MSCI achieving positive returns in both local and US dollar terms. The US ranked 22nd in dollar terms and 23rd when expressed in local currency. Peru and Thailand vied for the top spot (up 53% and 56%, respectively) while Greece and Spain landed in the cellar.
Throughout the year, investors had no trouble finding reasons to fret about the future and remain on the sidelines:
• A prominent researcher who had predicted the Great Recession was expecting the "biggest co-ordinated asset bust ever."
• An Economist cover story in January warning of asset price bubbles asserted that US stocks were "nearly 50% overvalued."
• The "January Indicator" signaled poor stock market performance for the remainder of the year.
• A tragic drilling rig explosion in April produced a disastrous and hugely expensive oil spill in the Gulf of Mexico.
• A bewildering "flash crash" on May 6th saw the Dow Jones Industrial Average plummet over 1100 points in the course of a few frantic minutes.
• Hundreds of bank failures revealed continued weakness in the financial system.
• A divided Congress passed a complex and potentially expensive healthcare reform bill.
• Residential housing remained weak, with monthly sales of new homes falling at one point to the lowest level since tracking was initiated in 1963.
• An obscure technical indicator dubbed the "Hindenburg Omen" generated a "sell" signal in August.
• North Korea launched a deadly artillery barrage in November against South Korea's Yeonpyeong Island.
• A financial crisis with no clear solution gripped governments in Greece, Portugal and Ireland.
But, for those investors who stuck to a plan, the results were very good. The all equity Talis 100 portfolio model achieved a 21.29% return for the year, net of our highest advisory fee. To view the rest of our performance data and important disclosures, click here.
Dow 3800 in 2010? That's what famous prognosticator Harry Dent predicted on CNBC last year. It didn't quite work out that way. But, Dent is no stranger to being spectacularly wrong. He predicted Dow 40000 (yes, that's forty thousand!) by 2009. Despite this abysmal track record, he still appears regularly on talk shows, sells millions of books, and runs a successful investment firm.
The list goes on: Peter Schiff (has this guy ever been right about anything?), Nouriel Roubini, Henry Blodgett, Gary Schilling, et al. They are wrong far more often than they are right. In many cases, they got it right once and were annointed as prophets by the financial press, but they never got it right again. Was the one correct prediction due to luck or skill? Considering that the prescient predictions almost never repeat might suggest that it was due to the former, not the latter factor.
So, why do investors continue to pay attention to predictions that almost always turn out to be wrong? For one thing, the financial press continues to spotlight these ridiculous guesses because it garners ratings or sells magazines. And, we've found that people love a good story. They may even take comfort in an "expert" opinion instead of listening to the truth - that no one can accurately predict short-term capital market behavior.
Of course, it's now time for the excuses to start. The "I would have been right if not for... blah, blah, blah." Or, the "I am still right, it just hasn't quite happened on the schedule that I expected." These people have an amazing ability to believe their own hype and to spin it in a way that makes others believe it, too. I once got into an argument with a famous trader who made the statement that he had never been wrong about a stock pick - just off on his timing. Of course, that's absurd. But, I'm convinced that he actually believed it.
Here are some predictions for 2011 that I'm fairly sure you can count on:
- Markets will do something unexpected. We don't know what it will be, but the odds are that something will happen that no one is predicting at the moment.
- Some obscure economist or analyst will have guessed it right and will have their 15 minutes of fame.
- A six to twelve month track record will be used to define the next "great investment opportunity."
- Most individual investors will underperform the market.
- Most mutual fund managers will also underperform the market.
- The fiduciary standard will continue to be be a point of contention between Registered Investment Advisors and brokers. The regulators will sit on their hands and investors won't understand what any of it is about.
- Unscrupulous salesmen will continue to pitch bad investment products and ideas on the radio.
- No matter what happens, Jim Cramer will claim that he knew it was going to happen before it did.
Happy New Year and best wishes for a prosperous 2011 from Talis Advisors!