This article does a great job at educating mainstream investors and the underlying aspects of our 21st century market. Written by the Chief Economic Advisor, Allianz and Chair of the President’s Global Development Council
- Because today’s markets are heavily influenced by the direct and indirect involvement of central banks, correlations among asset classes are less reliable, weakening the effectiveness of risk mitigation through traditional portfolio diversification.
- …opportunities for higher monthly/quarterly returns <shift> away from conventional strategic long-term portfolio positioning and toward more short-term trading and volatility trades.
Take 2 minutes – and read the entire article here:
SmartStops Commentary: This was why we created our service as the 21st century markets are much more volatile then in the past. One must recognize that the old theory of Buy & Hold and strictly relying on diversification is insufficent to protect one’s invesments. Active risk management is a MUST in our markets today.
Complete article can be found here:
Global markets are facing a crisis and investors need to be very cautious, billionaire George Soros told an economic forum in Sri Lanka on Thursday.
China is struggling to find a new growth model and its currency devaluation is transferring problems to the rest of the world, Soros said in Colombo. A return to positive interest rates is a challenge for the developing world, he said, adding that the current environment has similarities to 2008.
Global currency, stock and commodity markets are under fire in the first week of the new year, with a sinking yuan adding to concern about the strength of China’s economy as it shifts away from investment and manufacturing toward consumption and services. Almost $2.5 trillion was wiped from the value of global equities this year through Wednesday, and losses deepened in Asia on Thursday as a plunge in Chinese equities halted trade for the rest of the day.
Read more Bloomberg article – George Soros
One of the reasons SmartStops came into existence was to help investors worldwide understand the risk they were taking when owning a stock or ETF. As the article points out: “..Understanding risk is critical to a person’s financial well-being.” The concept of Risk in the stock market originally focused on modern portfolio theory’s of diversification. But in today’s computerized/internet age, even that has shown to be insufficient. We, at SmartStops, hope to help investors move into a more profitable Buy & Protect vs. Buy & Hold mindset by proving the efficacy of such an approach.
From article here:
Risk diversification. The concept that most people didn’t understand was risk diversification, or the idea that you need to diversify assets to minimize potential losses.
Lusardi, who teaches an elective course on personal finance to graduate business students at George Washington University, says she’s not surprised.
“I’ve seen the same thing in my class,” she said. “It’s just a harder concept because you’re talking about probabilities. And with diversification, you have to think about correlation. It’s just more complex.”
But understanding risk is critical to a person’s financial well-being. As Lusardi noted, most financial decisions involve some type of risk, from buying a home to deciding how much money to save for retirement.
And worldwide, it is becoming increasingly important to teach about risk and other financial basics.
SmartStops Comment: This is why you always need a smart objective third party managing the risk of your investments.
as reported by the AP:
Those record profits that companies are reporting may not be all they’re cracked up to be.
As the stock market climbs ever higher, professional investors are warning that companies are presenting misleading versions of their results that ignore a wide variety of normal costs of running a business to make it seem like they’re doing better than they really are.
What’s worse, the financial analysts who are supposed to fight corporate spin are often playing along. Instead of challenging the companies, they’re largely passing along the rosy numbers in reports recommending stocks to investors.
“Companies are tilting the results,” says fund manager Tom Brown of Second Curve Capital, “and the analysts are buying it.”
SmartStops comment: an excellent article that every investor should read as MPT continues to be deeply entrenched in our systems. Its shortcomings are proven. The article concludes with:
The advice that most investment advisors give their clients – At its core, the message is usually something similar to this: “The markets are random and unpredictable, so the best way to invest is to properly diversify and wait for the averages to play out.”
However, what most investors seem to be unaware of is that this whole theory of random movement of market prices was proven false over 50 years ago by one of the most influential mathematicians of the 20th century, Benoit Mandelbrot. The random motion of market prices was a very nice theory, but it just doesn’t match what actually happens in the real world.
Some excerpts from JJ Abodeely, CFA’s article : Modern Portfolio Theory Is Harming Your Portfolio
1. MPT and the quantification of investing has further (mis)informed the debate by seeking a easy way to label and quantify “risk.” In 1952, Harry Markowitz chose variance or volatility of prices or returns to define risk. He did so because it was mathematically elegant and computationally simple. However, this idea has serious limitations (most of which Markowitz has since acknowledged).
On the individual stock level, Vincent notes
Risk is often in the eye of the beholder. While “quants” (who rely heavily on MPT) might view a stock that has fallen in value by 50 percent over a short period of time as quite risky (i.e. it has a high beta), others might view the investment as extremely safe, offering an almost guaranteed return. Perhaps the stock trades well below the cash on its books and the company is likely to generate cash going forward. This latter group of investors might even view volatility as a positive; not something that they need to be paid more to accept. On the other hand, a stock that has climbed slowly and steadily for years and accordingly has a relatively low beta might sell at an astronomical multiple to revenue or earnings. A risk-averse, beta-focused investor is happy to add the stock to his diversified portfolio, while demanding relatively small expected upside, because of the stock’s consistent track record and low volatility. But a fundamentally-inclined investor might consider the stock a high risk investment, even in a diversified portfolio, due to its valuation. There’s a tradeoff between risk and return, but volatility and return shouldn’t necessarily have this same relationship.
2. After all, if you buy and hold the market you can earn the long-term returns right? Unfortunately, the answer to that is no. The long-term “average” returns are rarely available. In fact, depending on where you are standing, the returns are either much higher, or much lower. Consider this chart from Crestmont Research which shows that even for periods as long as 10 years, average rarely occurs:
3. Consider this chart which you’ve probably seen in one form or another. It shows expected risk and return of various mixes of asset classes and the typical approach to asset allocation which Modern Portfolio Theory has spawned:
So what’s wrong with this picture? Lots of things.
The first is the inputs– namely expected returns and volatilities of various asset classes– most investment programs are built on logic like this:
- Bonds will return 5% on average over the long-term but be between 0-10% in any given year
- Stocks will return 10% on average over the long-term but be between -10% and +20% in any given year
- Some might include other nuance regarding different types of bonds like High Yield or different types of stocks like Emerging Markets
- Some might include different types of assets like real estate, commodities, or “alternatives”
The problem of course is this is an incomplete description of investment returns:
- The math contends that returns are randomly and unpredictably distributed around the average
- This “normal distribution” of returns contends that larger market movements outside of the ranges above will be relatively rare
- “Average” returns ignore the role of valuation and the importance of when you start investing (buy) and when you finish (sell) even over multi-decade time horizons
The traditional approach to asset allocation is built on false axioms. The phenomenal secular bull market in stocks and bonds from 1982-1999 created the perfect conditions for the nearly religious acceptance of MPT. In a recent post, Expensive Markets Mean Low (or Negative) Prospective Returns, I made the case that valuation matters greatly and currently portend disappointing returns for both stocks and bonds. Traditional asset allocation has no way of dealing with this in a way that successfully protects portfolios from experiencing meaningful and unnecessary drawdowns.
Read JJ Abodeely, CFA’s article : Modern Portfolio Theory Is Harming Your Portfolio in its entirety.
SmartStops Comment: Modern Portfolio Theory – continues to have holes poked in it. Here’s a post by Hedgeable reiterating the importance of missing the worst times in the market.
From their post: If you merely miss out on 75% of market losses during the two largest crashes of the past 25 years- the dot-com crash and the financial crisis crash- you will have $1 MILLION MORE IN THE AVERAGE IRA ACCOUNT!!!
BaseBall fans will like the rest of the post too. Read Entire Post
SmartStops comment: Interesting perspective posted on by Doug Kass (TheStreet.coM) as to signals he’s watching.
SmartStops Mantra: ALWAYS STAY PROTECTED !
From the article: Since early August I have highlighted numerous technical divergences (in the weakness of the Russell Index (IWM) , new highs, the cumulative advance/decline lines, etc.), the schmeissing of the high-yield market (often seen as a precursor to stock vulnerability) coupled with growing evidence of weakening global economic growth (posing a threat to consensus corporate profit forecasts) and other factors (including valuation, sentiment and geopolitics) suggesting that a downward trend and (potential) bear market might be in the early state of developing.
History also shows that rising volatility in foreign exchange markets may be consistent with bear markets. (A good analysis by Nautilus Research can be found here.)
Economic weakness in Europe has been a worrisome factor that I have steadily highlighted.
Read entire article at: