Hi Guys,
I just returned from one of my escape completely sea cruises. During these cruises I completely isolate myself from any worldly event distractions. Given the markets ascendancy during my absence, I suppose I ought to do this more often.
I was very pleased to learn that Gene Fama has been honored with a Nobel economics award. He has earned it across many decades of fine, productive work
When Fama and Ken French initially published their 3-factor equity market model, I directly challenged it with a post to him suggesting some possible data mining contamination. Fama graciously responded by advising me that he addressed that same issue by successfully exposing his model to 17 sets of foreign market data. He sent me the actual data sets so I could confirm his analyses. I did not pursue the matter any further.
Fama and French have had to defend the efficient market hypothesis for a long time now. Communications enhancements have vindicated their commitment to that controversial model assumption. If it was somewhat true 50 years ago, it is more so today given the growing tsunami of financial information sources. It is not perfect yet, and will never be so, but the investment marketplace is functionally efficient.
Famous stock operator Jesse Livermore observed that “Markets are never wrong – opinions often are”. This during a period when Bucket Shops corrupted the honest market pricing mechanism with misinformation. We are now more free to choose our own poison.
I am genuinely surprised that Ken French did not share in the Nobel award. The sharing would have been proper in the tradition of the Tversky-Kahneman team effort, and, the options pricing model of Black, Scholes, and Merton.
Fama is still the recipient of a ton of enemy hostile flak; respect has been a hard fought and elusive battle. Even with a Nobel prize under his belt, the critics still fire away. In an October 19 posting on the excellent 25iq website, its chief continued the barrage with an unfriendly article that identified “Ten Investors Who Prove Fama is Suffering from Confirmation Bias”. Indeed, Fama gets too little respect. Here is the Link to the supposedly anti-Fama cohort:
http://25iq.com/The list of 10 contributors is a notable honor roll of superior active investors. All of the men on it are remarkable, exceptional, talented investors. They are surely not the average investor. I find it equally remarkable that at least half of the gentlemen who populate the listing are rather strong advocates of a passive investment strategy for the prosaic “average” investor. Wizards like Soros, Buffett, Templeton, Lynch, and Munger recognize the shortcomings of the common market investor and endorse a passive Index strategy for these folks.
I was also pleased to learn that Robert Shiller was awarded a Nobel prize in economics. Unlike Fama, Shiller is a very humble scientist who recognizes the limitations of his Cyclically Adjusted Price to Earnings Ratio (CAPE) model and his Housing Market Index model.
The 10-year Earnings data smoothing that is incorporated into the CAPE formulation only modestly improves its forecasting accuracy. Even over the decade-long timeframe, CAPE only explains about 40 % of future market movements with considerable data scatter about the predicted trend-line. Here is a Link to a recent Vanguard study that explored the usefulness of 16 common market predictive tools including CAPE:
https://personal.vanguard.com/pdf/s338.pdfThe Vanguard research team concluded that none of the frequently deployed predictive tools did yeomen work in forecasting future equity rewards. Many had zero correlation coefficients with future returns; they failed in both the short and long-term time horizons. Even the much admired Fed Model suffers from a near zero predictive capability. It always pays to test these models against fresh, out-of-sample data.
The Shiller CAPE model proved to be the most effective market forecasting tool over extended periods. It too failed on an annual basis. Shiller does not trust any short term predictor. A deliberate detachment from the crowd herding influences are “the best way to avoid getting swept up in the next bubble" according to an earlier Shiller interview reported by Jason Zweig in last Saturday’s Wall Street Journal.
Even a dedicated trader like Jesse Livermore understood that “Few people ever make money on tips”. As part of his 21 investment rules he observed that “If there was easy money lying around, no one would be forcing it into your pockets”.
Bad advice is pervasive within the investment universe. Livermore learned that truism at an early age, but his constant speculative investment decisions made him millions and lost him millions several times over his lifetime. He lived Big, but sadly, he died a defeated man.
Enjoy the references. Although I enjoyed my holiday away from the marketplace, I’m happy to be home again.
Best Regards.
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