Author Archive for Robert Seawright

There’s No Substitute for Good Judgment

By Robert Seawright, Above the Market

“P.T. Barnum was right.”

So says Commander Lyle Tiberius Rourke in the Disney film Atlantis: The Lost Empire, referring to the famous expression attributed to the great American showman: “There’s a sucker born every minute.” Even though Barnum didn’t say it, we get it. In talking about the scientific method in his famous 1974 Cal Techcommencement address, Nobel laureate Richard Feynmanemphasized the point: “The first principle is that you must not fool yourself – and you are the easiest person to fool.”

Accordingly, we’re right to be skeptical about our decision-making abilities in general because our beliefs, judgments and choices are so frequently wrong. That is to say that they are mathematically in error, logically flawed, inconsistent with objective reality, or some combination thereof, largely on account of our behavioral and cognitive biases. Our intuition is simply not to be trusted.

Part of the problem is (as it so often is) explained by Nobel laureate Daniel Kahneman: “A remarkable aspect of your mental life is that you are rarely stumped. … you often have [supposed] answers to questions that you do not completely understand, relying on evidence that you can neither explain nor defend.” We thus jump to conclusions quickly – far too quickly – and without a proper basis.

We aren’t stupid, of course (or at least entirely stupid). Yet even the smartest, most sophisticated and most perceptive among us make such mistakes and make them repeatedly and predictably. That predictability, together with our innate intelligence, offers at least some hope that we can do something meaningful to counteract the problems.

One appropriate response to our difficulties in this area is to create a carefully designed and data-driven investment process with fewer imbedded decisions. When decision-making is risky business, it makes sense to limit the number of decisions that need to be made. For example, it makes sense to use a variety of screens for sorting prospective investments and to make sure that such investments meet certain criteria before we put our money to work.

It’s even tempting to try to create a fully “automated” system. However, the idea that we can (or should) weed-out human judgment entirely is silly. Choices about how to create one’s investment process must be made and somebody (or, better yet, a group of somebodies*) will have to make them. Moreover, a process built to be devoid of human judgment runs grave risks of its own.

Take the case of Adrionna Harris, a sixth grader in Virginia Beach, Virginia, for example.

Last week, Adrionna saw a classmate cutting himself with a razor. She took the razor away, immediately threw it out, and set out to convince him to stop hurting himself. By all accounts, she did what we’d all want our own kids to do. The next day she told school administrators what had happened. The school wouldn’t have known about the incident (and the boy’s situation) if Adrionna hadn’t come forward.

For her troubles, Adrionna didn’t get a parade. She didn’t get congratulated or even get offered thanks. Instead, she received a 10-day suspension with a recommendation for expulsion from school on account of the district’s “zero tolerance” policy. She had handled a dangerous weapon after all, even if just to protect a boy from harming himself. Only after a local television station got involved and started asking pesky questions did common sense prevail – school officials then (finally) agreed to talk with Adrionna’s parents and, in light of the bad publicity, lifted the suspension. When and where discretion is removed entirely, absurd – even dangerous – results can occur despite the best of intentions.

As noted, because our intuition isn’t trustworthy, we need to be sure that our investment process is data-driven at every point. We need to be able to check our work regularly. Generally speaking, it seems to me that the key is to use a carefully developed, consistent process to limit the number of decisions to be made and to avoid making “gut-level” decisions not based upon any evidence but also flexible enough to adjust when and as necessary.

No good process is static. Markets are adaptive and a good investment process needs to be adaptive. Approaches work for a while, sometimes even a long while, and then don’t. Markets change. People change. Trends change. Stuff happens. As Nobel laureate Robert Shiller recently told Institutional Investor magazine, big mistakes come from being “too formulaic and bureaucratic. People who belong to a group that makes decisions have a tendency to self-censor and not express ideas that don’t conform to the perceived professional standard. They’re too professional. They are not creative and imaginative in their approach.” The challenge then is to find a good balance so as to avoid having to make too many decisions while remaining flexible.

Several years ago, the Intelligence Advanced Research Projects Activity, a think tank for the intelligence community, launched the Good Judgment Project, headed by Philip Tetlock, University of Pennsylvania professor and author of the landmark book, Expert Political Judgment, which systematically describes the consistent errors of alleged experts and their lack of accountability for their forecasting failures. The idea is to use forecasting competitions to test the factors that lead analysts to make good decisions and to use what is learned to try to improve decision-making at every level.

The Project uses modern social science methods ranging from harnessing the wisdom of crowds to prediction markets to putting together teams of forecasters. The GJP research team attributes its success to a blend of getting the right people (i.e., the best individual forecasters), offering basic tutorials on inferential traps to avoid and best practices to embrace, concentrating the most talented forecasters onto the same teams, and constantly fine-tuning the aggregation algorithms it uses to combine individual forecasts into a collective prediction on each forecasting question.

Significantly, Tetlock has discovered that experts and so-called experts can be divided roughly into two overlapping yet statistically distinguishable groups. One group fails to make better forecasts than random chance and its decisions are much worse than extrapolation algorithms built with the aggregate forecasts of various groups. However, some of these experts can even beat the extrapolation algorithms sometimes, although not by a wide margin. Interestingly, what distinguishes the good forecasters from the poor ones is a style of thinking.

Poor forecasters tend to see things though one analytical (often ideological) lens. That’s why pundits, who typically see the world through a specific ideological prism, have suchlousy track records. Good forecasters use a wide assortment of analytical tools, seek out information from diverse sources (using “outside” sources is especially important), are comfortable with complexity and uncertainty, and are decidedly less sure of themselves. Sadly, it turns out that experts with the most inflated views of their own forecasting successes tended to attract the most media attention.

“Given the impressive power of this simple technique, we should expect people to go out of their way to use it. But they don’t,” says Harvard psychologist Daniel Gilbert. In a phrase created by Kahneman and his late research partner, Amos Tversky, they often suffer from “theory-induced blindness.” Per Michael Mauboussin, the reason is clear: most of us think of ourselves as different, and better, than those around us. Moreover, we are prone to see our situation as unique and special, or at least different. But in almost all cases, it isn’t.

“My counsel is greater modesty,” Tetlock says. “People should expect less from experts and experts should promise less.” The better forecasters are foxes – who know lots of little things – rather than hedgehogs – who “know” one big thing and who consistently see the world through that lens. For example, reading the first paragraph of a Frank Rich op-ed makes it possible to predict nearly everything the column will contain without having to read another word of it. In systems thinking terms, foxes have many models of the world while hedgehogs have one overarching model of the world. Foxes are skeptical about all grand theories, diffident in their forecasts, and always ready to adjust their ideas based upon what actually happens.

The very best performers are great teams* of people who create careful, data-driven statistical models based upon excellent analysis of the best evidence available in order to establish a rules-driven investment process. Yet, even at this point, the models are not of the be-all/end-all variety. Judgment still matters because all models are approximations at best and only work until they (inevitably) don’t anymore — think Long-Term Capital Management, for example.

Everyone who lives and works in the markets learns to deal with the inevitable – failure, uncertainty, and surprise. Some are better than others. But we can all still improve our decision-making skills and do with proper training.

According to Tetlock, the best way to a become a better forecaster and decision-maker is to get in the habit of making quantitative probability estimates that can be objectively scored for accuracy over long stretches of time. Explicit quantification enables explicit accuracy feedback, which enables learning. We need to be able to check our work quickly and comprehensively. If we can find a basis to justify our poor decisions – if we can find an “out” – we will. Those “outs” need to be prevented before they can be latched onto.

Going through the effort consistently and comprehensively to check our work requires extraordinary organizational patience, but the stakes are high enough to merit such a long-term investment. In the investment world, long-term performance measures provide this sort of accuracy feedback, much to the annoyance of money managers. But it’s hardly enough. Astonishingly, Berkeley’s Terry Odean examined 10,000 individual brokerage accounts to see if stocks bought outperformed stocks sold and found that the reverse was trueSo there is obviously a lot of room for improvement. As in every field, those who make poor decisions propose all sorts of justifications and offer all kinds of excuses. They insist that they were right but early, right but gob-smacked by the highly improbable or unforeseeable, almost right, mostly right or wrong for the right reasons. As always, such nonsense should be interpreted unequivocally as just-plain-wrong.

A quick summary of some of the (often overlapping) ways we can improve our judgment follows.

  • Make sure every decision-maker has positive and negative skin in the game.
  • Focus more on what goes wrong and why than upon what works (what Harvard Medical School’s Atul Gawande calls “the power of negative thinking”).
  • Make sure your investment process is data-driven at every point.
  • Keep the investment process as decentralized as possible.
  • Invoke a proliferation of small-scale experimentation; whenever possible, test the way forward, gingerly, one cautious step at a time.
  • Move and read outside your own circles and interests.
  • Focus on process more than results.
  • Collaborate – especially with people who have very different ideas (what Kahneman calls “adversarial collaboration”).
  • Build in robust accountability mechanisms for yourself and your overall process.
  • Slow down and go through every aspect of the decision again (and again).
  • Establish a talented and empowered team charged with systematically showing you where and how you are wrong. In essence, we all need an empowered devil’s advocate.
  • Before making a big decision, affect a “pre-mortum” in order to legitimize doubt and empower the doubters. Gather a group of people knowledgeable about the decision and provide a brief assignment: “Imagine that we are a year into the future. We implemented the plan as it now exists. The outcome has been a disaster. Take 10 minutes to write a brief history of that disaster.” Discuss.

Per Kahneman, organizations are more likely to succeed at overcoming bias than individuals. That’s partly on account of resources, and partly because self-criticism is so difficult. As described above, perhaps the best check on bad decision-making we have is when someone (or, when possible, an empowered team) we respect sets out to show us where and how we are wrong. Within an organization that means making sure that everyone can be challenged without fear of reprisal and that everyone (and especially anyone in charge) is accountable.

But that doesn’t happen very often. Kahneman routinely asks groups how committed they are to better decision-making and if they are willing to spend even one percent of their budgets on doing so. Sadly, he hasn’t had any takers yet. Smart companies and individuals will take him up on that challenge. Those that are smarter will do even more because there’s no substitute for good judgment.


Teams are much better than individuals (sorry, Bill Gross) and teams of really good forecasters (who, ironically, will almost always be prone to thinking they’ve screwed up) are really, really good (though still often wrong); in GJP tests, they beat the unweighted average (wisdom-of-overall-crowd) by 65 percent; beat the best algorithms of four competitor institutions by 35-60 percent; and beat two prediction markets by 20-35 percent.

We Was Robbed

By Robert Seawright, Above the Market

On June 21, 1932, after Max Schmeling lost his heavyweight boxing title to Jack Sharkey on a controversial split-decision, his managerJoe Jacobs famously intoned, “We was robbed.” It’s a conviction that hits home with every fan of a losing team and thus every sports fan a lot of the time. It’s also a point of view that has received a surprising amount of academic interest and study (note, for example, this famous 1954 paper arising out of a Dartmouth v. Princeton football game).

Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. As if. We are remarkably crazy a lot of the time.

Behavioral finance examines that craziness by way of the cognitive and behavioral biasesthat impact the investment and economic decisions of individuals and institutions. We like to think that we’re rational actors carefully examining and weighing the available evidence in order to reach the best possible conclusions. Instead, we are much more like spin-doctors, running around looking for anything we might use to support our pre-conceived notions, irrespective of truth.

Confirmation bias is our tendency to notice and accept that which fits within our pre-existing commitments and beliefs. Optimism bias means that our subjective confidence in our judgment is reliably greater than our objective accuracy. And the self-serving biaspushes us to see the world such that the good stuff that happens is our doing while the bad stuff is not our fault. Perhaps worst of all, because of our bias blindness, it isextremely difficult for us to see that there might be something wrong with our own analyses, perspectives and processes.

If you doubt these realities, think about how fans react to wins and losses by their favorite teams. For example, it’s easy to recognize that fans of losing teams will frequently be critical of the officials and that the winners will see the very same calls as appropriate and perhaps necessary. It’s as if the fans of each team watched an entirely different game.

In an effort to provide useful analysis for the maximum number of American sports fans – those whose teams lost over the first week-end of the NCAA Tournament (and I’m one) aren’t likely eagerly to accept the proposition that their criticism of the referees might be a tad misplaced, for example – I will focus on something a bit under the radar in the USA if not elsewhere, a huge soccer (football to the rest of the world) match in Spain Sunday between two perennial powers and perhaps the two best teams in the world today, Barcelona and Real Madrid. Barca won 4-3 to pull within a point of Real and Athletico Madrid at the top of La Liga on the strength of three goals by Lionel Messi and at least as many controversial decisions by referee Alberto Undiano Mallenco. Most neutrals (see here and here, for example), including the Spanish press centered in Madrid, saw the referee as fair if perhaps imperfect.

Not surprisingly, Real partisans saw things differently. Star Cristiano Ronaldo, after the match: “It obviously bugs certain people if Madrid are successful and winning. …I’ve been here for a long time and it seems to generate a lot of envy if we are doing well. People wanted Barcelona back in the title race and now they have that. We aren’t treated equally.” Moreover, “Real Madrid is the biggest club and that creates a lot of envy around it. You can say that the treatment is the same, but it’s not.” He also told his club’s official website: “We are sad because we knew we deserved more, but the fight goes on.”

Sergio Ramos, who was given a red card ejection in the second half, ominously told reporters that “somebody” had wanted Madrid to lose. “It is clear that when you are the best team in the world there is envy in some places. We at Real Madrid suffer from that and must fight against it. Even though there are some things against which you cannot fight.” Real coach Carlo Ancelotti was more tactful but no less clear: “We played well. We did not deserve to lose.” Moreover, “[w]e have to be happy with the way we played this game, luck was not on our side….” Predictably, the protests went nowhere.

Notice the losers’ refrain. They did what they could but bad luck controlled the outcome. They saw what they wanted to see. And so did the referee community, as Spain’s referees committee (El Comité de Árbitros) “denounced” the conspiracy theories, filed an official complaint with league officials and – in an odd move – called to congratulate the game referee on a job well done.

Predictably, Barca thought the officiating was just fine. Star midfielder Xavi Hernandez: “…I believe the referee was fair. They told me later that the penalty [that Ronaldo won] by Alves is outside, and we practically did not even protest. I would have whistled what [the referee] whistled, that’s the truth. I saw clear penalties. We need to focus on the analysis that Barcelona were superior to Madrid, played better and the result is there.”

Notice the winners’ contrasting theme. They deserved to win and the result followed. They too saw what they wanted to see.

Meanwhile, Athletico Madrid president Enrique Cerezo, whose club is now tied with Real and just ahead of Barca, could afford to try to put himself above the fray. “To complain when something is immovable is not worth the effort,” Cerezo said. “You cannot change anything at that point. I saw the Madrid-Barcelona game and if in one of the penalties whistled, even after seeing the replays, we did not know exactly what happened, how can you ask something different of the referee? They get things right the majority of times.” Somehow I doubt that his response would have been so magnanimous if his club had been playing and some tough calls had gone against them.

Everybody else may be biased, but we remain convinced that we routinely come to careful and objective conclusions for ourselves, even about the officiating in a game we care passionately about. We’re certain of our own abilities and objectivity. We aren’t flawed. We was robbed. In short (and as I routinely note), we remain convinced that we routinely see things as they really are. The sad truth is that we do nothing of the sort. Instead, we see things the way we really are.

A Reason to Worry

By Robert Seawright, Above the Market

Last week we passed the five-year anniversary of the post-financial crisis lows. The ongoing bull market, fueled by decent economic news and an activist Fed, may well continue for a long time yet. I don’t have a crystal ball.

But I saw a reason to worry this morning: this article at Benzinga (also highlighted at MSN Money and Yahoo! Finance). Yup. We’re back to seeing arguments that people should take out home equity loans in order to buy stocks – because that tactic has worked out so well in the past!?! It’s as if leverage doesn’t come with major inherent dangers, especially at the retail level.

If an advisor were to pitch such a scheme, the regulators would be all over it. Note, for example, this Investor Alert from FINRA.

We are issuing this alert because we are concerned that investors who must rely on investment returns to make their mortgage payments could end up defaulting on their home loans if their investments decline and they are unable to meet their monthly mortgage payments. In short, investors who bet the ranch could lose it.

As Felix Salmon put it, “it’s pretty much always a bad idea to borrow money and invest it in the stock market — and it’s an even worse idea to borrow money against your house and invest it in the stock market.”

Maybe this article is signalling a market top. Or maybe it’s just silly and dangerous. But it surely shows that we have been in a very good market cycle for a long time now. And that makes me nervous.

Yale Model Heat Check

By Robert Seawright, Above the Market

With a new report out from the Yale Endowment, now is a good time to do a heat check on how the so-called “Yale Model” of investing is doing. I have written about the Yale Model numerous times (see herehere,here and here, for example). It emphasizes broad and deep diversification and seeks to exploit the risk premiums offered by equity-oriented and illiquid investments to investors with an investment horizon that’s sufficiently long – in Yale’s case, essentially forever. It has worked exceptionally well for Yale. For others…not so much.

The newest report from David Swensen and the Yale Endowment was released last weekand demonstrates that the university has been well-served by its Endowment and the investment approach it (and he) pioneered. For fiscal 2013 (ending June 30, 2013), Yale earned a 12.5 percent return, well ahead of the 11.3 percent average for foundations and endowments, if lower than domestic public equities (that should be expected in a year when one investment class dramatically outperforms).

With annual net ten-year investment returns of 11 percent and 20-year returns of 13.5 percent, the Endowment has grown substantially, despite significant institutional expenditures therefrom. Perhaps most significantly, if Yale’s assets had been invested in a classic 60:40 portfolio since 1988, the Endowment’s value today would total $9.11 billion, far less than its current value of $20.78 billion.

For the current year, target allocations to real estate (19 percent) decreased by 3 percentage points and private equity (31 percent) by 4 percentage points, reflecting Yale’s view of the relative opportunities in those sectors. Approximately one-half of the portfolio is illiquid. Roughly 95 percent is allocated to equity and equity-like investments.

I have questioned whether the Yale Model is “past it” – whether its approach is now so often copied that the “trade” is crowded and alpha is dissipated. This year’s report strongly contends that such alpha remains available, but reiterates that it isn’t available to everyone. As the report points out, “Yale has never viewed the mean return for alternative assets as particularly compelling.” The key to success for Yale is access to the best managers, at the best price, with a careful alignment of interests. Since Yale is aligned with the best managers – who are not taking on new investors – the Endowment believes that it is healthy and needn’t alter its strategy.

For investors who came later to the party, the prospects aren’t nearly as good. “While alpha is not dead, opportunities to access it may not be available to all investors.” For example, with respect to private real estate, the report notes that “[t]he illiquid nature of private real estate and the time-consuming process of completing transactions create a high hurdle for casual investors.” Thus “[t]he costly game of active management guarantees failure for the casual participant.”

According to Yale’s own analysis, an “average endowment” runs a 28 percent chance of losing half of its assets (in real terms) over the next 50 years and a 35 percent chance risk of a “spending disruption” over the next five years, on account of asset allocation decisions. That’s far greater risk than most investors (and nearly all individual investors) can bear. The newest report also includes an explicit warning to investors who aren’t Yale.

“Few institutions and even fewer individuals exhibit the ability and commit the resources to produce risk-adjusted excess returns.

“… No middle ground exists. Low-cost passive strategies suit the overwhelming number of individual and institutional investors without the time, resources, and ability to make high-quality active management decisions. The framework of the Yale model applies to only a small number of investors with the resources and temperament to pursue the grail of risk-adjusted excess returns.”

In other words, the first people to the buffet table get most of the tasty stuff. Everybody else would be better off eating elsewhere. Significantly, and by way of example, Cambridge Associates estimates that three percent of venture capital firms — which have provided a huge proportion of Yale’s excess performance — generate 95 percent of the industry’s returns and adds that there is little change in the composition of those three percent of firms over time (more here). Yale has ongoing access to that three percent. Few others do (and if you aren’t sure, you don’t).

Note Swensen’s own words of warning.

“At the active end of the spectrum, you’ve got institutions like Yale and Harvard and Princeton and Stanford and others, who’ve really built high-quality investment teams that have a shot at making consistently good active management decisions. But there’s a vanishingly small number of such investors. Those on the passive end of the spectrum have figured out that they don’t know enough to be active. The passive group is not nearly as big as it should be. Almost everybody should be there.”

The Consensus Portfolio

By Robert Seawright, Above the Market

Every year Barron’s reports on the Penta asset-allocation survey of 40 leading wealth management firms (such as Barclays, Fidelity, Goldman Sachs, JPMorgan, LPL, Morgan Stanley, Northern Trust and the like), which outlines in broad terms what those firms’ base recommended portfolios look like. The new survey is noteworthy in that overall allocations to stocks rose to an average of 51.1 percent, up from 48 percent at this time last year and 45 percent in early 2012; fixed-income holdings continued a two-year decline, now at an average 25.8 percent, down from 29 percent last year and 34 percent in 2012; and recommended hedge fund and private-equity allocations, recently “the expensive disappointments of the portfolio” and subject to widespread criticism, are up to an average of 14.1 percent from 12.5 percent last year, with all alternatives (including real estate and commodities) now weighing in at an average allocation of 20.4 percent. A more detailed breakdown is charted below.


Bringing the Stupid

By Robert Seawright, Above the Market

Earlier this week I wrote about the growth of the sports analytics movement, particularly in baseball, as an inevitable outgrowth of trying to make one’s beliefs data-driven and thus reality-based. “Arguments and beliefs that are not reality-based are bound to fail, and to fail sooner rather than later.” I also noted that the investment world needs similar growth and development.

But despite the exponential growth in the use of analytics (earlier this year the Phillies became the last Major League Baseball team to hire a full-blown stats guy), not everyone in baseball (as with investing) has gotten the message. For example, The Book goes into great detail about the percentages and when it makes sense to execute a sacrifice bunt and finds — conclusively — that sacrifice bunts are grossly overused and rarely make sense. Simply going back over previous games so as (a) to calculate how many runs each team scored when it had a runner on first and nobody out, and (b) to compare those results to when teams had a runner on second and one out, makes the general point pretty well. In fact, Baseball Prospectus has a report that shows that sacrifice bunting reduced a team’s run expectancy for innings that played out that way from .83 runs to .64 runs in 2013. The same is generally true in previous years.

Note too that we’re not talking here about difficult concepts or high-level math. It’s just a simple calculation — more teams scored and scored more with runners on first and nobody out by not-bunting than by bunting. Easy.

But not to Texas Rangers manager Ron Washington. Washington likes to sacrifice bunt. In response to a question about the dubious nature of that strategy based upon the math, Washington took offense.

“I think if they try to do that, they’re going to be telling me how to [bleep] manage,” Washington said. “That’s the way I answer that [bleep] question. They can take the analytics on that and shove it up their [bleep][bleep].”

Wow. He even went third person.

“I do it when I feel it’s necessary, not when the analytics feel it’s necessary, not when you guys feel it’s necessary, and not when somebody else feels it’s necessary. It’s when Ron Washington feels it’s necessary. Bottom line.”

Double wow. No matter one’s chosen ideology, if the data doesn’t support it, the risks of continuing on that path are enormous. It’s not the percentage play (by definition). And it’s not the smart play.

Insisting upon a course of action that is shown to be wrong is, quite simply, a recipe for disaster. A good investment strategy, like good baseball strategy, will be – must be – supported by the data. Reality must rule. When it doesn’t, we’re simply bringing the stupid.


Big Buy Signal

By Robert Seawright, Above the Market

Now marketing himself as a “rogue economist,” Harry Dent is forecasting “gold down to $750 an ounce, housing down 35%, oil down to $10 a barrel, the Dow down to 6,000, [and] a war between inflation and deflation” this year. The headline is indeed shocking:

If Only HALF of Harry’s Forecasts Come

to Pass, the American Life We Know Will

Disappear for Good!


So is the headline immediately above (from his personal website — the brazen self-promotion is shocking too).

Of course, Harry can show you how to avoid and even profit from this impending catastrophe. Amazing. More importantly, unlike most of his ilk, Harry has perhaps offered something actionable, if not in the way he intended. You don’t even need to buy anything to learn what to do.

 Let me explain.

Despite the hyperbole about his swami-like predictions in the headline above, Dent’s actual track record is truly dreadful. In December of 1993, Dent published Great Boom Ahead: Your Comprehensive Guide to Personal and Business Profit in the New Era of Prosperity. Dent was more than a bit early as the market rose just 1 percent in 1994. However, over the following five years the S&P rose almost 29 percent per annum, giving him a plausible platform for the success of his next book.

In October of 1999, Dent wrote the bestselling The Roaring 2000s Investor, wherein he claimed that the Dow would rally big, to 44,000 by 2008, due in large part to changing demographics. He was only off by 35,000 points or so. And he was especially positive on NASDAQ stocks, predicting that “the technology revolution will favor internet-oriented companies.” Within three years, the NASDAQ had lost three-quarters of its value and the leading index of internet stocks plummeted 89 percent.

Undaunted, in early 2006 Dent published The Next Great Bubble Boom: How to Profit from the Greatest Boom in History: 2006-2010. This time he called for 40,000 on the Dow by 2009. Again, Dent was dead wrong. By the spring of 2009, the Dow had dropped below 6,500.

Still, Dent persisted, although he changed course. From calling for an immense boom he shifted to predicting imminent doom.  The Great Crash Ahead: Strategies for a World Turned Upside Down, was released in September of 2011, calling for 3,800 on the Dow which, as I write this, has moved above 16,000.

It’s bad enough that his books are a joke. But those who invested with Harry really got hurt. The AIM Dent Demographic Trends Fund was launched on June 7, 1999 with Dent’s name and him acting as a consultant to the fund. The fund was up 54 percent for the remainder of that year. However, the fund’s results were dreadful thereafter. From 2000 through 2004 the fund lost over 11 percent per annum and underperformed the S&P 500 Index by almost 9 percent per year. In 2005 its sponsor put investors out of their misery by merging the fund into the AIM Weingarten Fund.

Undeterred, in September of 2009, Harry tried again. The AdvisorShares Dent Tactical ETF (with the ticker symbol “DENT”) was launched, with Harry himself as co-manager. Unfortunately for investors. the fund’s track record was so poor it was put out of its miseryin 2012.

Of course, the usual caveats apply. Even a stopped clock is right twice a day and even a blind squirrel finds an acorn once in a while. The market is beholden to no man, even one as apparently powerful as Harry. But it seems to me that Harry is as fantastic a contra-indicator as is available. Past performance is not indicative of future results, but just look at that past “performance.” Since Harry Dent is calling for catastrophe, maybe it’s time to buy….

Investing Successfully is Really Hard

By Robert Seawright, Above the Market

Investment Belief #1: Investing Successfully is Really Hard

Investing successfully is really hard. Investors are necessarily exposed to so much uncertainty, so much randomness and so many variables that it simply isn’t reasonable to expect to succeed routinely. In fact, it’s surprisingly easy based upon the available data to wonder if it’s reasonable to expect to succeed at all.

To put things into perspective a bit (based upon some research by David Yanofsky for Quartz and beginning at the start of 2013), if you had picked the best stock to buy every day and put all of your money in it at the beginning of the day before selling it at the end of the day, you could have turned $1,000 into $264 billion by mid-December alone. Therefore, if you didn’t achieve a 100 percent return for 2013 you didn’t get even 4/10-millionths of what was available for the taking. In other words, nobody is getting remotely close to what the market offers. None of us is all that good.

It’s easy to dismiss the Yanofsky research as silly, of course. Nobody expects to pick every winner even if the research offers a helpful reminder of just how sub-optimal our investing inevitably is.

Yet investment performance still fails in the aggregate even when more reasonable benchmarks are used. While it’s easy enough to falsify the Efficient Markets Hypothesis, it is still maddeningly difficult to beat the market, no matter how smart and diligent you are. A few simple examples – far more than should be needed to make the point – follow.

  • As I have noted before, in 2006, the TradingMarkets/Playboy 2006 Stock Picking Contest – involving Playmates and professionals alike – was won by Playboy’s Miss May of 1998 and a higher percentage of participating Playmates bested the S&P 500′s 2006 returns than active money managers. Thus over the course of a full year, a bunch of Playmates outperformed a whopping majority of highly trained and experienced professionals with vast resources who spend all day every day trying to beat the market.
  • As Charley Ellis has pointed out, “research on the performance of institutional portfolios shows that after risk adjustment, 24% of funds fall significantly short of their chosen market benchmark and have negative alpha, 75% of funds roughly match the market and have zero alpha, and well under 1% achieve superior results after costs — a number not statistically significantly different from zero.”
  • Morgan Housel recently discovered that the companies with the most Wall Street sell ratings in January of 2013 outperformed the market for the year by a median 25 percentage points while those with the most buy ratings underperformed by more than seven percentage points.
  • The S&P Dow Jones Indices most recent year-end report confirms once again that actively managed funds — where managers try to beat the market by making good investment choices — tend to underperform their benchmarks. Similarly, the S&P Dow Jones Indices latest persistence report shows yet again that even those few funds that come out on top can’t consistently (persistently) stay there.
  • The latest Dalbar QAIB data shows that over the past 20 years, the average equity investor has suffered an aggregate underperformance of nearly 50 percent while the average fixed income investor has suffered an aggregate underperformance of nearly 85 percent.
  • Hedge funds, the least regulated and most highly compensated area within the finance sector, seem to have performed worst of all.  In his book, The Hedge Fund MirageSimon Lack showed that the hedge fund industry as a whole lost more money in 2008 than it had made in all of the previous 10 years. Even worse, “if all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good,” especially since nearly all the hedge funds’ gains went to managers rather than clients.

Not only is it really hard to succeed at investing, it’s getting harder all the time. As Michael Mauboussin explains in his excellent book, The Success Equation, as overall skill improves, aggregate performance improves and skill becomes less important to individual outcomes. Indeed, good research suggests that our industry has become ever more sophisticated and complex over the past three decades or so but to little effect. In other words, the ever-increasing aggregate skill (supplemented by massive computing power) of the investment world has come largely to cancel itself out.

Perhaps worse, when you actually do make a smart investing move (purchasing an investment that will outperform, however you define that), its impact is reduced every time somebody else follows suit.  It is axiomatic in the investment world that as an asset class becomes more popular, it suffers from both falling expected returns and rising correlations.  Good trades get crowded and their advantages tend to disappear.

While lots of really smart people are using essentially all their time and vast resources trying to get ahead in the markets, a vanishingly small number of people are actually succeeding. Being really smart and diligent has demonstrated surprisingly limited upside overall. The appropriate conclusion is unmistakable. Investing successfully is really, reallyhard.

The Culture of Charade

By Robert Seawright, Proprietor, Above the Market

We’ve all seen them, and they’re dreadful.

“Business television” – CNBC, Fox Business and the like – often bring on lower tier would-be experts from the hinterlands to fill time by opining on the latest news, the newest data release, or the ongoing market action in response to an anchor’s softball set-up.The interviewee typically ignores the set-up and plows ahead to pre-scripted and mundane (at best) talking points as quickly as possible. Such appearances are often arranged by PR firms, who brag about such “placements” and are paid well for doing so. These hits are worth doing for the networks because there is nothing like 24 hours per day of actual business and market news on offer. They have lots of time to fill.

Even so, YouTube videos of this silliness tend to show up like clockwork that same day on the websites of the interviewees to be promoted both as a badge of inclusion in the universe of experts and as a marketing tool. It’s all about establishing and building a brand. They provide a veneer of supposed expertise even though the entire exercise is bogus. The “news” is effectively meaningless and the “analysis” adds nothing to the story. However, the interviewee’s Muppets won’t know that nobody who matters pays these appearances any mind and won’t recognize how lousy they are. It won’t even matter that almost nobody was watching. It’s a charade, but everybody plays along.

So these interviews, weak-sauce though they are, offer a win-win – the network gets its airtime filled and the interviewees can pretend they are big shots with important opinions. But in no time, they all begin to sound the same, like those junior high oral reports most of us had to give and endure. Even worse, they are fundamentally phony.

The entire conceit is ridiculous because the “news” being reacted to is almost always functionally irrelevant to any meaningful investment process. The latest capacity utilization number may become a helpful piece of the economic puzzle, but it is highly unlikely to suggest any major change in the economy. Yet CNBC and its ilk roll with the charade that something urgent must be reported. The idea is to feign hotness, newness and originality in order to attract eyeballs.

Talking about long-term ideas, opportunities and trends as well as substantive issues related to the markets might actually help people, but the purveyors of business television largely assume that immediacy and urgency are necessary to capture viewers – and they may be right about that. But it’s still a charade. Even traders, who actually do have to make moment-to-moment decisions about the markets, don’t rely on television for actionable news. If it’s on the air, it’s too late to act on it meaningfully.

Indeed, nearly everything that gets a lot of attention in our business today is focused upon faster and phonier. The interviews noted above are quick-hits tied to an immediate event but without value. That said, I’ve hardly scratched the surface of the game-playing that goes on, much of it far more troublesome and damaging than the relatively harmless interviews I have been describing. And the problem extends well beyond finance, obviously.

Part of the aggregate charade is the tameness of the business press and bloggers alike. As pointed out by Dean Starkman, among others, the U.S. business press utterly failed to investigate and hold Wall Street players accountable in the years leading up to the financial crisis of 2008-2009. Few bloggers did either. Nobody wanted the music to stop. That’s why the crisis came as such a shock to the public and to the press itself.


In a March 2009 interview that would go viral, Jon Stewart confronted Jim Cramer by asserting, in effect, that business journalism presents itself as providing wall-to-wall, 24/7 coverage of Wall Street yet had somehow managed to miss the most important thing ever to happen on that beat. “It is a game that you know is going on, but you go on television as a financial network and pretend it isn’t happening.” Cramer’s excuse essentially was that he and the business press merely give the public what it wants. So whether the error was intentional (Stewart’s view) or negligent and stupid (the view of James Surowiecki ofThe New Yorker – a view I share because, via Occam’s Razor, I tend to expect stupidity first), the public was still horribly underserved.

Indeed, our industry is replete with examples of the culture of charade. Examples follow (off the top-of-my-head; it’s hardly a complete list).

  • Ongoing conspiracies to hide excessive fees, poor performance (among clients,managers and the hedge fund industry), and the value of indexing.
  • Advertising white papers, research reports and educational events that are nothing but marketing exercises.
  • Fear-mongering and/or bandwagoning for business.
  • Touting products and services as being original, innovative and valuable that arenothing of the sort.
  • Failing to present all sides of an argument fully, fairly and honestly.

The pressure to “build a brand” at the expense of depth, accuracy and nuance is enormous.

In the real world, of course, longer-term and more substantive thinking is actually winning where it matters, as Felix Salmon pointed out recently, in that money is leaving funds and approaches that aren’t working at record rates – a phenomenon that terrifies Wall Street and leaves much of the financial media unsure of what to do. Moreover, there are many blogs and sites that are consistently excellent – I mention them often, some in this very post. Consistent with that progress, I will try to avoid the various charades that the investment world is so fond of and to point them out when I see them. Moreover, when I fail (and I will), I invite you to call me on it and pledge that I will try to own up to my mistakes quickly and publicly. We all need to be held accountable.

My overarching goal at Above the Market is to provide articulate, helpful, fully formed analysis. That ideal stands in sharp contrast to the culture of charade that permeates the financial services industry.

Mostly, it boils down to trying to tell the truth, the whole truth and nothing but the truth, so help me God. Sadly, that doesn’t often seem very hot or original. While originality is invaluable, it is much rarer yet also more accessible than we tend to assume. C.S. Lewis, the renowned literary critic and medievalist who later became famous as an author of children’s literature and as a Christian apologist, perhaps said it best in Mere Christianity. “[N]o man who bothers about originality will ever be original: whereas if you simply try to tell the truth … you will, nine times out of ten, become original without ever having noticed it.” Therefore, my intent is always to tell the truth and let the chips fall where they may. Our culture of charade doesn’t value truth-telling, which explains why it is so rare, but it is the best way to be original and to impart value that I know.

Bob Seawright’s Recommended Reading List

Bob Seawright is a great thinker and I respect his opinions. If you don’t read his site (see here) you should.  So when he puts out a recommended reading list I pay attention. The following are some of his favorites.  With the exception of one person on this list, I totally agree with his recommendations:

    • The Monoliths. There are lots of (probably too many) huge and would-be comprehensive sites covering the financial world.  My favorites are AdvisorOne, which is geared toward retail advisors and other professionals as well as The Wall Street Journal‘s MarketWatch and the Financial Times, which are more broadly focused.


    • The Aggregators. Having reliable sources to sift through everything and point me to what I need to read is absolutely crucial to my day.  For my money, the best are Tadas Viskanta’s Abnormal Returns and Real Clear Markets.  Tadas focuses on the blogosphere and is especially good at finding terrific stuff I wouldn’t otherwise have seen, often from new and off-the-beaten-path voices.  Real Clear does some of that while providing more must-reads from traditional journalistic sources. A number of other excellent bloggers provide some of this as well (Barry Ritholtz, Lauren Foster, Michael Kitces and Josh Brown are prominent examples, but they will be cited elsewhere).


    • The Commentariate: Lots of people comment a lot on the markets and our industry. In my view, three stand out above the crowd: Barry Ritholtz’s The Big Picture, Josh Brown’s The Reformed Broker and Cullen Roche’s Pragmatic Capitalism.  Each is prolific as well as insightful and each has a powerful and unique voice.  If you don’t read them every day already, what are you waiting for?


    • The SpecialistsDoug Short‘s market analysis and charts are invaluable.  For eclectic, data-based takes on politics and finance, Political Calculations is a must-read. Michael Kitces is the best financial planner I know and his blog is great. Tom Brakke is the best investment analyst I know and his blog (in three parts) is wonderful. David Merkel is really, really good, too. For retirement planning, Wade Pfau’s Retirement Researcher Blog is unbeatable. Rick Ferri is my go-to on indexing.  Mark Buchanan’s The Physics of Finance is a brilliant look at economics and finance through the lens of physics.  James Osborne is a newer voice I really appreciate. Ed Yardeni’s Dr. Ed’s Blog is fabulous for investment strategy. Shane Parrish’s Farnam Street is always fantastic and regularly speaks to some of my particular interests, including behavioral and cognitive finance. I really like The Psy-Fi Blog too, for similar reasons. The Enterprising Investor, from the CFA Institute’s Lauren Foster, is consistently helpful. And I try to read everything Morgan Houselwrites.


    • The Conscience. For my money, Jason Zweig of The Wall Street Journal is the conscience of our industry. If you don’t read everything he puts out, including his weekly column, The Intelligent Investor, you’re missing something really important.


  • The Platform.  I should particularly note StockTwits, which is my “home base” for dealing with the markets and seeing who’s who and what’s what.



Exhibit A

By Robert Seawright, Proprietor, Above the Market

I have often warned against making investment decisions based upon political commitments, and I am hardly alone. A wonderful/dreadful example is provided by Stephen Moore, who announced this week that he is leaving The Wall Street Journal to become Chief Economist for the Heritage Foundation. Quite obviously, Moore opposes the policies of President Obama vociferously (“Everything he’s done has been such a massive failure…”).

That is his right, of course, and I take pains to keep Above the Market away from politics as much as possible. My point is that Moore’s political commitments foolishly override more objective analysis and thus impact his economic and investment outlooks negatively.

Back in 2010, Moore called for a truly dismal set of investment and economic outcomes because — of course — Barack Obama was in charge. These included higher interest rates (which didn’t arrive until 2013), higher inflation (still not happening) and gold at $2,000 an ounce (currently in the range of $1,250). He even called for a further rise in the unemployment rate from the then-current 9.6 percent on account of the repeal of the Bush tax rates (the current unemployment rate is 6.7 percent). Especially in retrospect, it appears obvious that Moore’s forecast was based more upon his political hopes and dreams than upon economic and market realities.

To be clear, this problem isn’t limited to Moore and those who agree with him. We’re all prone to seeing things through an ideological lens. But if you want to be a successful investor, you’d be wise to avoid it — to the extent you can. Politics and investing simply don’t mix.

What will trigger the next correction?

By Robert Seawright, Proprietor, Above the Market

As I was thinking about my 2014 Investment Outlook (watch this space, it will be out shortly), I considered what obvious catalysts might stem the tide of higher equities and saw none. While it was already clear to me that market obstacles need not be foreseeable in advance (think Donald Rumsfeld’s famous “unknown unknowns”), that lack was still a significant factor in my preliminary thinking. Other than the unforeseeable — which seemed limited to me somehow — it looked like clear sailing ahead, despite high market valuations and the need for some correction to clean things out. That is, it looked like clear sailing until I remembered Black Monday: October 19, 1987. Coverage by The Wall Street Journal of that day began simply and powerfully. ”The stock market crashed yesterday.”

On that fateful day, after five days of intensifying stock market declines, the Dow Jones Industrial Average lost an astonishing 22.6 percent of its value (for its part, the S&P 500 dropped 20.4 percent), plummeting 508.32 points after a 5-year run from 776 in August of 1982 to a high of 2,722.42 in August, 1987. Black Monday’s losses far exceeded the 12.8 percent decline of October 28, 1929, the start of the Great Depression.

It was “the worst market I’ve ever seen,” said John J. Phelan, Chairman of the New York Stock Exchange, and “as close to financial meltdown as I’d ever want to see.”

But a closer look at the coverage and its aftermath is revealing, especially for what is missing. There is no “smoking gun.” According to the Big Board’s Chairman, at least five factors contributed to the record decline: the market’s having gone five years without a major correction; general inflation fears; rising interest rates; conflict with Iran; and the volatility caused by “derivative instruments” such as stock-index options and futures. Although it became a major part of the later narrative, Phelan specifically declined to blame the crash on program trading alone.

In other words, the market collapse had no definitive (or even clear) trigger. The market dropped by almost a quarter for no obvious reason. And while it’s counterintuitive, that observation is wholly consistent with catastrophes of various sorts in the natural world and in society. Wildfires, fragile power grids, mismanaged telecommunication systems, global terrorist movements, migrating viruses, volatile markets and the weather are all complex systems that evolve to a state of criticality. Upon reaching the critical state, these systems then become subject to cascades, rapid down-turns in complexity from which they may recover but which will be experienced again repeatedly.

This phenomenon was discovered largely on account of the analysis of sandpiles. Scientists began examining sandpiles and discovered that each tiny grain of sand added to the pile increased the overall risk of avalanche, but which grain of sand would make the difference and when the big avalanches would occur remained unknown and unknowable.

Notice that often a single grain of sand added to the pile makes very little difference. Sometimes there is a good bit of shifting around. But once in a while the addition of just a single grain of sand can result in the collapse of an entire side of the pile. This finding is consistent with the “butterfly effect” in chaos theory, which refers to idea that a small change at one place can result in large differences in a later state somewhere else. Thus a hurricane’s formation might be contingent upon whether or not a distant butterfly had flapped its wings several weeks earlier. It’s eery — really odd even – but nonetheless true.

For the markets, that means that we should not expect ever to be able to identify the trigger of any correction or crash in advance or to be able to predict such an event with any degree of specificity. This understanding doesn’t change my outlook (which remains cautiously constructive), but it does emphasize the need to manage one’s risks aggressively and to hedge appropriately. Tomorrow could be the day that the market tanks…and you shouldn’t expect to see it coming.