Monday, November 29, 2010

On Conventional Wisdom

“… it is the long-term investor … who will in practice come in for most criticism wherever investment funds are managed by committees or boards or banks. For it is the essence of his behavior that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Source: John Maynard Keynes via Investment Postcards

Saturday, November 13, 2010

Behavioral Investment Tips

Top tips for better decision making

This applies to me, you and everyone else.

You know less than you think you do.

Be less certain in your views, aim for timid forecast and bold choices.

Don’t get hung up on one technique tool, approach or view – flexibility and pragmatism are the order of the day.

Listen to those who don’t agree with you.

Top tips for better decisions

You didn’t know it all along, you just think you did. Forget relative valuation, forget market prices, work out what the stock is worth (use reverse DCFs).

Don’t take information at face value, think carefully about how it was presented to you.

Don’t confuse good firms with good investments, or good earnings growth with good returns.

Vivid, easy to recall events are less likely than you think they are, subtle causes are underestimated.

Try to focus on facts, not stories.

Sell your losers and ride your winners.

Beating the biases

Being aware of the biases is not enough. It is just an important first step.

Need to create a framework that incorporates mental best practice. Easier said than done. Mental bad habits are persistent.

The good news, we continue to create new brain cells throughout our lives.

Wednesday, November 10, 2010

Market Wizard Quote of the Day

Michael Marcus taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.

Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I'm getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. I never think about other people who may be using the same stop, because the market shouldn't go there if I am right.

Place your stops at a point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you are willing to lose.

If you personalize losses, you can't trade.”


Bruce Kovner

Sunday, November 07, 2010

Market Wizard Quote of the Day

"Taking advantage of potential major winning trades is not only important to the mental health of the trader but is also critical to winning. Letting winners ride is every bit as important as cutting losses short. If you don't stay with your winners, you are not going to be able to pay for the losers.

In addition to not overtrading, it is important to commit to an exit point on every trade. Protective stops are very important because they force this commitment on the trader."

Michael Marcus

Wednesday, November 03, 2010

The Night of the living Fed

Today is the important FED announcement day when "Big Ben" is expected to give details of the QE2. Jeremy Grantham, the chief investment strategist of Boston-based GMO has just published the October edition of his quarterly newsletter entitled “Night of the living Fed”. In this report, Grantham’s outlines what he believes to be the disastrous effects that the policies of the Fed, under the direction of both Alan Greenspan and Ben Bernanke, have had on the U.S. and global economies.

Bellow we have Prieur du Plessis summary of Grantham’s attack:

1) Long-term data suggests that higher debt levels are not correlated with higher GDP growth rates.

2) Therefore, lowering rates to encourage more debt is useless at the second derivative level.

3) Lower rates, however, certainly do encourage speculation in markets and produce higher-priced and therefore less rewarding investments, which tilt markets toward the speculative end. Sustained higher prices mislead consumers and budgets alike.

4) Our new Presidential Cycle data also shows no measurable economic benefits in Year 3, yet point to a striking market and speculative stock effect. This effect goes back to FDR, and is felt all around the world.

5) It seems certain that the Fed is aware that low rates and moral hazard encourage higher asset prices and increased speculation, and that higher asset prices have a beneficial short-term impact on the economy, mainly through the wealth effect. It is also probable that the Fed knows that the other direct effects of monetary policy on the economy are negligible.

6) It seems certain that the Fed uses this type of stimulus to help the recovery from even mild recessions, which might be healthier in the long-term for the economy to accept.

7) The Fed, both now and under Greenspan, expressed no concern with the later stages of investment bubbles. This sets up a much-increased probability of bubbles forming and breaking, always dangerous events. Even as much of the rest of the world expresses concern with asset bubbles, Bernanke expresses none. (Yellen to the rescue?)

8) The economic stimulus of higher asset prices, mild in the case of stocks and intense in the case of houses, is in any case all given back with interest as bubbles break and even overcorrect, causing intense financial and economic pain.

9) Persistently over-stimulated asset prices seduce states, municipalities, endowments, and pension funds into assuming unrealistic return assumptions, which can and have caused financial crises as asset prices revert back to replacement cost or below.

10) Artificially high asset prices also encourage misallocation of resources, as epitomized in the dotcom and fiber optic cable booms of 1999, and the overbuilding of houses from 2005 through 2007.

11) Housing is much more dangerous to mess with than stocks, as houses are more broadly owned, more easily borrowed against, and seen as a more stable asset. Consequently, the wealth effect is greater.

12) More importantly, house prices, unlike equities, have a direct effect on the economy by stimulating overbuilding. By 2007, overbuilding employed about 1 million additional, mostly lightly skilled, people, not counting the associated stimulus from housing-related purchases.

13) This increment of employment probably masked a structural increase in unemployment between 2002 and 2007, which was likely caused by global trade developments. With the housing bust, construction fell below normal and revealed this large increment in structural unemployment. Since these particular jobs may not come back, even in 10 years, this problem may call for retraining or special incentives.

14) Housing busts also help to partly freeze the movement of labor; people are reluctant to move if they have negative house equity. The lesson here is: Do not mess with housing!

15) Lower rates always transfer wealth from retirees (debt owners) to corporations (debt for expansion, theoretically) and the financial industry. This time, there are more retirees and the pain is greater, and corporations are notably avoiding capital spending and, therefore, the benefits are reduced. It is likely that there is no net benefit to artificially low rates.

16) Quantitative easing is likely to turn out to be an even more desperate maneuver than the typical low rate policy. Importantly, by increasing inflation fears, this easing has sent the dollar down and commodity prices up.

17) Weakening the dollar and being seen as certain to do that increases the chances of currency friction, which could spiral out of control.

18) In almost every respect, adhering to a policy of low rates, employing quantitative easing, deliberately stimulating asset prices, ignoring the consequences of bubbles breaking, and displaying a complete refusal to learn from experience has left Fed policy as a large net negative to the production of a healthy, stable economy with strong employment.