From Larry Swedroe's 2012 outlook piece for Seeking Alpha (similar to what I did with them a week or so ago. The following is offered without comment from me (this time), only a question. What do you think of the approach outlined in his answer?Seeking Alpha: So under specific circumstances such as the current situation in the Eurozone, you don’t lighten up on particular problem areas at all in client portfolios?
Larry Swedroe: That would not make sense. The reason is simple. If we know there are problems, the market surely also knows and that means the problems are already incorporated into prices. And why would you buy when things look safe, and thus valuations are high and thus expected returns are low, only to sell when risks show up, and thus valuations are low and expected returns are now high? That doesn’t seem like a rational strategy, yet it is exactly what most investors do, and it explains why they do so poorly, underperforming the very funds in which they invest.
17 comments:
what about "down a lot"
Honestly, I follow his investment approach as closely as possible. Years ago I was humbled in agricultural commodity markets and learned from that mistake to never again confuse investing with speculation. Perhaps it is possible that until you have a major blowup in your investing style, Swedroe's views sound pretty simplistic and naive.
Now here at year end, I have cash to invest. Headlines say to avoide Europe. My portfolio allocation says put new cash into Europe to restore balance.
You're liable to wind up like the poster boy of buying and holding during the risky times - John Paulson.
Roger,
This is the same issue I've tried (unsuccessfully) to discuss with you previously, on several different occasions. I'm surprised you posted this topic, since whenever I bring it up in the comments you seem very bored and give one or two sentence answers.
I think Swedroe is wrong to assume that the bad news is *always* priced in, but your assumption seems to be the opposite, which is that the bad news is *not* priced in and therefore countries/sectors with "bad fundamentals" should be avoided. It also seems to be your assumption that the good news is not already priced into countries/sectors with good fundamentals. I think this is an important limitation in your investment process, and it's worth a discussion longer than a one or two sentence answer.
Here's something for you to think about. Let's consider the worst possible sector right now, which I'd say is the European banking sector. You suggest avoiding it because of its bad fundamentals. Well what if the aggregate price of this sector were cut in half, should it still be avoided? How about if it fell to 1% of its current price, should it still be avoided? Once you come to the realization that a country/sector, while it may be troubled, is unlikely to be worth zero, it raises the issue of *valuation*; if you can buy something for less than its worth, even if it's worth very little, then it's a good investment. This concept seems to be missing from your investment process. Same goes for countries/sectors with "good fundamentals". Once your realize that something with good fundamentals is unlikely to be worth infinity, one realizes that if something is selling for more than it's worth, even if it's worth quite a lot, then it's a bad investment.
Why not write a post that explains why you believe, in general, that countries/sectors with bad fundamentals don't have the bad information already priced in, and likewise why you believe that countries/sectors with good fundamentals don't already have this good information priced in? That's obviously your overall point of view, but you've never justified it.
- aagold
This is pretty simple, I've been through too many market events where the efficient market was not very efficient in my opinion, I am far from alone in this line of thinking. If one's interpretation is that markets are not universally efficient then why would one invest like they believe they are?
I'm not sure if you have brought up Euro financials before but several commenters have. My contention all along, and I think stated quite plainly, has been the news is bad now and I think there will be more shoes to drop. I have been saying that for now many years and this comment has been based on what I know from before and what I think is going on now to make a forward looking assessment. YTD Barclays is down 31% in the UK and Soc Gen is down 58%.
My view of the fundamentals is that looking forward more shoes, I've been saying this for a long time and so far it has been correct which means that the facts of valuation that lead you to your conclusion will change or if we had this debate 12 months ago (maybe we did?) that the facts of valuation ended up changing contributing to those stocks' large decline.
What would John Templeton do? Probably cherry pick Europe or it's Northern neighbors.
Ok, with your last comment at least we're getting to a useful discussion on this topic.
You said,
"I've been through too many market events where the efficient market was not very efficient ... If one's interpretation is that markets are not universally efficient then why would one invest like they believe they are?"
The "father" of the efficient market hypothesis, Eugene Fama, had an interesting comment about this many years ago. Let's assume you're correct that markets are not "perfectly efficient". Well, there are two ways markets can be wrong: (a) they can underreact to incoming information, or (b) they can overreact to incoming information. If you think about it that way, it suggests an interesting way to differentiate value investors, momentum/growth investors, and index investors.
Index investors believe that markets are generally correct (don't overreact or underreact), so they just buy and hold the market. Momentum/Growth investors believe the market has a tendency to *underreact*; so they buy sectors/countries with good fundamentals (because they think the market hasn't figured it out yet), they sell sectors/countries with bad fundamentals (again because they think the market hasn't figured it out yet)and they tend to sell into falling markets and buy into rising markets (as you do with your 200-DMA strategy). Value investors tend to believe just the opposite, which is that the market overreacts; so they buy sectors/countries with low prices in comaprison with long-term fundamentals (because they think the market is overreacting to the bad news), and they sell sector/countires with high prices in comparison with long-term fundamentals.
So my point is this: one can agree with you that the market is inefficient, but disagree with your overall philosophy that the market tends to *underreact* to incoming information. You've never described your investing philosophy in those terms, but as a long-time reader and observer of your investment advice it certainly appears that way to me. This overall philosophy appears in three different ways, in my opinion: (a) you advocate underweighting sectors/countries with "bad fundamentals", (b) you advocate overweighting sectors/countries with "good fundamentals", and (c) you advocate a trendfollowing strategy such as 200-DMA. All three of those philosophies only work, on average, if the market has a tendency to underreact to incoming information.
The reason why I give you such a hard time on this topic is that I'm a value investor, so my tendency is to believe just the opposite, which is that markets have a tendency to *overreact* to both good and bad news.
- aagold
One of the best aspects of Swedroe's approach is that it is simple and it doesn't require the services of a portfolio manager. The savings from management/advisor fees goes a long way toward narrowing the performance differences between active management and passive investing. When your active manager moves on or otherwise no longer is in a position to manage your portfolio, what are you going to do? I don't think Swedroe has ever said his approach is "the best."
Swedroe's approach is not easy however. As I mentioned earlier, my plan says to invest new money into the underweighted asset class which happens to be European equities. Comments from bright writers like Roger make this very difficult. It is very difficult to avoid second guessing.
If you remember, last year at this time there was a steady drum beat of pending muni defaults on a scale like we've never seen before. The experts said that the fundamentals meant munis were to be avoided. One year later, munis as an asset class have done pretty well. I don't know how European shares will fare going forward, but if they do fall, it will be a lot less than if I had invested in them this time last year when equities were out performing fixed income.
aagold, rather than attempting to convince Roger that his approach is flawed, I think your time might be better spent studying the psychological traps involved in investing. It sounds as if you are struggling with your convictions.
Personally, I like checking in here to read posts about living below one's means and the more philosophical topics. Posts about ETFs, sector investing etc don't do much for me, sorry Roger. I do though check in with this blog everyday.
anon 6:39
thank you 6:39, I hope you will continue to stick with the blog
If all the bad news was already discounted by the market, in theory, the market would no longer go down. I don't think I would base my investing on this principle.
1:51,
Your assertion indicates that there will be no further bad news which of course is nonsense. I think what Swedroe says is that future events (positive or negative) are unknowable and therefore cannot be reflected by prices until they occur.
One more thing. I believe that most people are not suited for passive investing as a DIY investor due to the psychological difficulties. I believe there is a strong market for portfolio managers who follow passive investing principles for their clients. The main focus of the job would be calming nerves...as it probably is with any portfolio manager.
Just my opinion of course.
12:33
One might consider what Warren Buffett once said about himself:
"If the market was truly efficient, I may as well make my living selling pencils".
O/T--Doug Kass, in his list of 2012 surprises, also foresees the possibility of a swift move to new highs in the equity markets, not unlike your hypothesis, Roger. Less optimistically, he foresees the possibility of an explosion in the etf business. Interesting but long read, if you have time.
Happy holidays.
i have the Kass post open on another tab but am procrastinating due to the length.
thank you for the heads up about ETFs
6:39/12:33 I agree, passive investing can be a successful strategy, but I think many people underestimate the sustained self-discipline required. It looks easy at first, so they try it for a while, but then give up when the next downturn comes along, often just when the potential reward is greatest.
It may sound a bit odd, being a passive investor myself, but Roger's blog has helped me stick with it. Thanks Roger,
10:59,
Agreed. I frequently tell people that some of the best investment books deal with behavioral aspects. I would even go as far as to say it is the best investment of time one can make in his "investment education."
"Why Smart People Make Big Money Mistakes...and How to Correct Them" by Gary Belsky and Thomas Gilovich is a great place to start.
From there another book, "Behavioral Finance and Wealth Management: How to build optimal portfolios that account for investor biases" by Michael Pompian provides more detail and is not as easy to read as the first book.
I think Jason Zweig has a book on the subject which is highly recommended although I have not read it.
Combined though, the serious reader interested in a bit of introspection will learn a great deal about himself after reading.
My all time favorite investing book would be "The Intelligent Investor" by Benjamin Graham. I think it is timelss.
Maybe it is just me, but for the people who have never read the above mentioned books, I think your time would be better spent on them than some websites like Seeking Alpha etc. There is much to learn from a different perspective.
6:39/12.33
7:59,
I would agree with you that markets are not 100% efficient. The problem lies in the fact that very, very, very few have the talent to exploit those inefficiencies.
Warren Buffett also said that most investors (including professionals) are better off in index funds.
We'll see how his ten year bet hedge funds vs SP500 turns out. I think 2011 will favor SP500.
Post a Comment