market correlation

Make Believe

© Can Stock Photo / nameinfame

It’s good fun to watch small children at play, using their imagination – they might be pirates or princesses, or serving imaginary meals, or having conversations with stuffed animals.

What is not good fun are financial types who pretend that so-called “market-linked” products actually provide exposure to real investment market returns. Often, a formula used to determine returns pays only a fraction of percentage gains, puts a maximum limit on returns, and ignores the effect of dividends. That’s investing only in the same sense that talking to a teddy bear is actual conversation*.

There is another common form of make-believe in the investment world. Some pretend that one might sharply limit the ups-and-downs in an account, yet still reap stock market returns, through some special strategy or tactic. Our view is that this is pandering. Long term investing is about willingness to accept a certain amount of risk in pursuit of getting paid.

Both of these fantasies play on the natural human desire for stability. But lower volatility may come at a cost of lower returns or higher costs. By the time the investor figures out there is either less stability than expected, or lower returns, a lot of freight may have been paid. Skip the make-believe, keep it real.

Clients, not everyone agrees with us – we hold contrarian views. If you would like to talk about this or anything else, please email us or call.

*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

A Better Topic Than “The Market”

© Can Stock Photo / Pedxer

Everybody talks about it; it raises a lot of questions. Is the market too high? Where will it go next? Is it due for a fall? How will the economy affect it? (Or politics, or world affairs, or astrology?)

Many people seem to be referring to a major market average or index when they talk about the market. But the investment universe is far broader than those. The individual pieces may have little to do with what is happening with the major averages.

  • For example, even when the averages are near all time highs, stocks in some industries or companies may be half or less of their own highs from years ago.
  • The United States is not the only advanced economy in the world with a stock market. Some overseas markets have done very little for a decade, and are not close to high points.
  • Certain holdings have shown a tendency to go the opposite direction from the major averages.
  • Even with in the US stock market, some holdings appear to be bargains even when highflyers have gone off the charts.

Instead of asking those questions about “the market,” we think it makes more sense to always be asking these questions:

  • Where are the best bargains in the investment universe? We should be looking at them.
  • Where are the stampedes? We should avoid them.
  • Is there a way to secure reliable income in today’s environment?

This is a way to bring the focus to something useful, in our opinion. Clients, if you would like to talk about this or anything else, please email us or call.

The Trouble with Zig and Zag Theory

© Can Stock Photo / chokniti

The idea behind massive diversification, owing a bit of everything, is that some things zig when others zag, keeping the whole bucket steadier. Great theory.

The problem is that things do not zig and zag ALL the time. When the big downturn comes, they all go down together. Oh, some things do not go down – but those things also tend to never go up, either.

The mathematical basis for massive diversification is Modern Portfolio Theory. It depends on different types of assets behaving more or less independently of one another – zigging and zagging. The lack of correlation is what drives the hypothetical usefulness of the theory.

In the big downturns, however, the correlations may converge. In plain language, in times of market stress, even independent investments may act as though they are related. The theory may not work due to systematic risks.

This is a real problem, because it is a theory that sometimes has the potential to drive investors to diversify into sectors and asset classes which may hold unknown risks, in the interest of avoiding market volatility.

This only makes sense if one defines volatility as risk, something to always be minimized and avoided. We think it makes more sense to understand volatility as an integral and necessary part of long term investing, a feature to be tolerated (or embraced) as the price of pursuing market returns over the long haul.

Investing in fluctuating markets with confidence requires us to know where our needed cash will come from – only long term money should be invested for the long term.

Clients, if you would like to talk about this or anything else, please email us or call.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.