Who, Me? Biased?
It’s probably politically incorrect to admit this, but I can be a little prejudiced. We all have our biases, and some of them are healthy and some not. Keeping these predispositions from getting the best of us and blinding us to reality is a common problem we all deal with from time to time.
We humans tend to invest when we are predisposed to think the market will go up. But when our biases are not born out by market action, it is foolish, and expensive, to stick with them. Yet sadly many folks do stick with losing investments because they believe that if it went up once it will go up again or because so-and-so said it would go up it just has to go up some time. There are so many variables to consider that the financial markets are truly unknowable in their entirety. The weather, crack pots a half a world away, a kid in a garage developing new technology – there is simply too much to figure into the equation. Even full time professional portfolio managers like myself are limited to dealing with probabilities and making educated guesses. We never really know for sure.
In fact, if anyone tells you that they know for sure, keep your hand on your wallet and back slowly away. There are no slam dunks in this business. No guarantees. We can never be certain about anything because investing involves too many unknowns. Biases tend to make us think we know what is going to happen whether the bias is positive or negative. When we are right our biases can keep us out of a lot of trouble and make us a lot of money. That we never really know for sure does not mean that we are never right. Our biases are often right. The trouble comes when the biases are proving to not be right and we refuse to give them up.
In the 1990’s the markets went up with few pauses. Buying and holding was a common bias that investors developed during this period. The evidence was everywhere that you could do very well by just buying an index fund and holding it. Down markets were all short and swift, and then the advancing market continued on. It was a simple, cheap, effective strategy. What is there not to like about that?
The conditions in the 1990’s were clearly right for buy and hold and many investors thought they had the investing game all figured out. They were certain they knew what worked because their experience confirmed it. Their bias became a conviction.
But conditions changed in 2000. Unfortunately many investors and sadly many financial advisors refused to change their biases in light of the new market conditions. They were convinced they would be proven right in the long run. Their experience, bolstered by Wall Street’s exhortations to “stay the course”, reinforced this conviction.
Michael Price, publisher of Investor’s OnTrack and a brilliant hedge fund manager, taught me that the success of most strategies is determined by the long-term trend and when that changes strategies will begin to fail if not changed. Sir John Templeton, founder of the Templeton family of mutual funds often said “All things cycle in and out of favor. Investments and investment styles.”
Because of these ideas, I was prepared to change the investments my clients held as the markets began to change in 2000.
Buyers of S&P 500 index funds are still waiting to recover from the losses incurred since 2000. Six years later, the S&P 500 Index is still 15% below it’s 2000 high. Holders of Nasdaq index funds may never see account values back to the 2000 levels during their lifetimes, their losses were so great. What happened?
Those investors clung to their biases despite the markets shouting, “no, No, NO!” and providing day after day’s worth of data to prove how wrong these investors were. One of the hardest things to do in life is to let go of a bias, but to be a successful investor one must be willing to let go when a bias stops working on your behalf.
When the markets or the world in general gives us information that conflicts with our preconceived notion of things it often means that there is something bigger going on that we cannot yet see or understand. But not seeing it does not mean it is not there. Remember, the market reflects all information that is knowable. When market action is in conflict with our preconceived notions of what ought to be happening, the part that we don’t know about is in our face.
When the market numbers tell us that things don’t fit our ideas of what should be happening, we can recognize reality and back away from our biases, or we can choose to continue to beat our heads against the brick wall of the financial markets.
Here at the firm, we deal with this common investment problem with a systematic approach to investing. One technique built into our systems is called “stops”. When we buy an investment we pick a point at which, if the investment moves against us, we are willing to admit we might be wrong and there is more going on than meets the eye. When we hit a stop we sell.
Managing investments often involves a larger than normal ego. Even the geeks, quants and gearheads I rub shoulders with at conferences for investment managers all have good sized egos. Few rocket scientists (and some of my colleagues are literally former rocket scientists) get that far without realizing they are pretty bright. And they wouldn’t be managing millions or billions without being right more than they are wrong.
But even these brainiacs have to be willing to recognize the message in the numbers that they might be wrong this time, and back away from an investment.
Brokers, those who just sell investments, but don’t really manage them on a daily basis have a particularly tough time with this issue. Investments with big commissions are often justified as being intended “for the long haul” to minimize the commission expense by spreading it out over many years. So, the ego involvement on the broker’s part to not change an earlier recommendation can be particularly strong. Fee based managers don’t have this commission trap to overcome. And, if they are true money managers, watching each investment they deal with every day, they also have a better chance of seeing a change in the market when it is happening.
Being successful at managing investments demands discipline. The need to overcome one’s biases when they are no longer being useful is part of the human condition. Whether you use stops or other methods of discipline is immaterial, but a method must be found or the price can be significant as index buy and hold investors have found out.
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Of Concern 00
There is never a shortage of gloom and doomers eager to point out how our country is going down the tubes and how our way of life will never be the same. Not wanting to be lumped in with this crowd, it is with some trepidation that I write this article. Although it may not seem so as you read this, please remember that I am an optimist.
The resiliency of free markets is our greatest strength, and I have faith that we will overcome these latest challenges as long as the powers that be don’t fiddle too much with those free markets. It may be tempting to kill the goose that lays the golden eggs to get to the supply of eggs, but as every child learns that is a very foolish thing to do.
One of my concerns was raised when President Bush recently vetoed legislation that would have furthered stem cell research in this country. If you haven’t followed this debate, stem cells come from our earliest stage of development, embryos, and can become virtually any part of your body. Need a new liver? It can be grown from a stem cell. Medically this has huge potential for us all. Pitted against the medical community are groups who are ethically opposed to the use of embryonic cells for anything other than growing babies. Both sides make many good points, and President Bush, in a move calculated to appeal to his conservative base, sided with the ethicists and against the medical researchers in his veto.
Regardless of which side you are on, the reality is that stem cell research will go on no matter what laws we pass. If it can’t happen here, it will be done somewhere else. This is a truly global economy, remember. There are free market forces at work all over the world and this is simply too big of an issue to be ignored. Vast amounts of money will be made and the race is on. To think we can legislate this away is short sighted.
To underline this point, within days of the President’s veto of stem cell legislation, Great Britain announced multi-billion dollar funding for stem cell research. What this means to you and me is in 10 or 20 years when we need a new body part, instead if buying it from a US biotech company we will be buying it from a British company, and our standard of living slips one more notch in the process as more of our money goes overseas.
Another golden goose we are killing is in the area of renewable energy.
China now has rules that any new factory must be fueled by renewable energy resources; solar, wind, fuel cells, etc. Not surprisingly, these devices must also be manufactured in China. China has decided to become the leader in renewable energy, and their own industrial base will become their launch pad.
China has a command economy, and these autocratic systems can be very efficient. There is no wasting time on pesky political debates or environmental impact statements. Just get the job done now! Eventually a command economy will succumb to market forces as we saw in the struggles of Japan in the 1990’s after 40 years of incredible economic growth. But one can lose a lot of ground to a rival in 40 years, and that is what I foresee happening in alternative energy.
Because the US has done next to nothing to promote research into alternative energy, and the Chinese are being forced into it, what this means to you and me is that in 10-20 years when you want to install solar because the cost of oil is so high, you may be buying it from a Chinese company who perfected the technology while we were fiddling away the time. And our standard of living slips yet another notch as more money goes overseas.
Another golden goose is our preeminence in the financial arena. Wall Street has long been the financial capitol (pun intended) of the world. But recent legislation threatens to end this, also.
It is a thin line that separates insufficient regulation and over regulation. The Sarbanes-Oxley Act (SOX) was put into law in the wake of the Enron and Worldcom accounting scandals, supposedly to force big business to clean up their act. However, the Enron and Worldcom executives that have been sent to jail were convicted under existing laws. SOX would have accomplished nothing that the existing laws could not. The existing laws worked just fine. Slowly, perhaps, but they worked.
Incidentally the only real prosecution under the SOX statute so far was against Richard Scrushy of Health-South, and it failed in securing any convictions.
So, do you feel safer? You should, feel safer considering the many billions US companies are being forced to spend to comply with SOX.
What really concerns me is the huge drain on the resources of US companies due to the inefficient and ineffective Sarbanes Oxley Act. These SOX billions could be used to provide more American jobs, but, Nooooooo. We have to throw it away to comply with useless regulation.
Perhaps I’m being too harsh. After all, there are jobs being created for regulators and accountants. Not exactly the productive jobs than can raise our collective standard of living, but at least they are going to Americans.
Mike Glasior in a recent column, reports: “The exodus of foreign companies being listed on U.S. securities markets has already begun in a robust way because any company listed on these markets will be required to comply with the onerous SOX requirements. The legislation has already made non-U.S. markets more attractive to foreign companies and unfortunately it goes deeper than that.
Unless Congress acts to stop this unfortunate exportation of a lousy law, it is reasonable to assume that the U.S. will only become a less and less desirable destination for large companies to do business. Jog your own memory here, and consider every large merger in recent history that involved a U.S. and a non-U.S. company. Ask yourself why it almost never comes to pass that the combined entity ends up being an American company (read Chrysler/Daimler Benz, Bankers Trust/Deutsche Bank, et al) and you’ll quickly realize that nobody wants to operate within the U.S. regulatory climate if they can avoid it. The list of merged companies grows pretty darn fast the longer you think about it, too.
And our standard of living takes one more hit. Thank you, Congress, for this gem.
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Doing Good
Here’s a way to help people and animals around the world in only a few seconds a day. If you click on the link for “The Hunger Site” a donation of grain will be made by ad sponsors on the site.
You can then flip back and forth to support the Breast Cancer Site, the Child Health Site, the Literacy Site, the Rainforest Site and the Animal Rescue Site and ad sponsors will make a donation for each click. One click per person per day per site will be processed.
The whole business only takes about a minute, unless you stop to read the ads, which are also pretty entertaining. Philanthropy has never been so affordable. Try it. www.thehungersite.com/
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A Glimpse Into the Future
The website listed below will give you a fascinating glimpse into the future of automotive transportation. Check it out it’s fun. My only question is why can’t we get them now?
