Is This Time Really Different?
01/15/2013 10:30 am EST
Many are worried that the markets have changed permanently to the detriment of investors. Mark Hulbert explains what he sees as well as the potential investment implications.
Mark, I wanted to talk to you about the changes over your 30-year history in following several hundred investment advisory newsletter editors and the discussions that you have on a daily basis with these leading advisors. Many of whom participate in our conferences and media, and it comes down to what's happened just in recent years to the tried and true indicators. What are you hearing out there?
It's a great question, and I am afraid it's a pretty sobering message I am hearing: a lot of the tried and true indicators aren't working anymore, and it really challenges us. Do we think that this is just a temporary blip in a long history, or has the world permanently changed? We get "Oh no; the dangerous words on Wall Street are 'this time it's different,'" but sometimes things change.
For example, high-frequency trading, I think, has permanently changed the investment landscape. I mean, you have more than half the volume on Wall Street-more than half on some days-being accounted for by high-frequency trading. So you can't look at any volume statistics. Volume indicators are going to be, I think, highly suspect at least if you try to make them comparable to prior decades when you didn't have the phenomenon.
Another example: insider trading. Insider trading has historically been a very reliable indicator both for the market as a whole as well as individual stocks, and it make sense that it will still continue. But a lot of the indicators have been skewed because of option issuance and option exercise on the part of executives and larger shareholders.
I think it was in the early 90s there was a rule change that allowed an insider to sell or exercise his or her options much more quickly. Prior to that, I think, you had to hold the options for a much longer period of time. So you now can have a greater percentage of an insider's compensation coming from options that will immediately be reflected in the insider data. That's just another example. But if you start looking at the data in the last ten years for insiders and try to make it comparable to the data in the 1980s or 1970s, you're going to be led to improper conclusions.
I don't mean to be so despairing as to say the world has changed and we can throw out all of our past history. On the other hand, I think we are constantly challenged to see how the recent past relates to the distant past, and that's where wisdom and insight comes and it's not purely a statistical matter.
What are the investment implications? I remember 30 years ago or more, when we started, we were in the midst of a big boom in precious metals. At the time, it was then alternative investing. Today, alternative investing has become a very popular theme, specifically anything that isn't long stocks and bonds all the time. What's your view of how that's working for the average investor?
I am very suspicious, as you know from our contrarian nature, of any conventional wisdom. So back in the 70s when we started, conventional wisdom was to buy bonds, right? Probably more wealth has been destroyed from that conventional wisdom than any other thing in recorded history.
So you worry that conventional wisdom is now going to lead people just as horribly down that primrose path. I don't know, but I am suspicious about it. I think the idea of alternative investing was that it was off the beaten path, that it was alternative. By definition, it can't become the conventional wisdom.
It's not alternative anymore, and I think you've seen a lot of what happened. I mean, and this is all for the best of reasons, but Yale's endowment went into alternative investments. Incredibly successful throughout the late 90s and the first decade of the current century. Now all of a sudden every endowment, every pension fund in the world is trying to get into the same alternatives. You can't all pile onto the same thing. By definition it's not alternative, but even worse it can't continue to make money at the rate that it was.
This is then perhaps back to a broader theoretical point. The markets are incredibly efficient, much as we would like to...I mean, we should celebrate how efficient they are, because it means that it's quite a good engine for economic growth and capital raising and so forth. But what it means it's going to be difficult for individuals to beat it, because anything that truly works will soon be discounted away as the market discovers it.
So it's then back to this point: We never can rest on all the rules, much as we would like to say, "OK, we've come up with a set of indicators that will work and we can just follow that reliably through thick and thin." I am afraid we're always going to have to be going back to the drawing board and really challenging. Are these really the best indicators and has the world changed and so forth.
What I tell my clients is not only to do that, but to do that exercise when their indicators are working. Typically, what we do is we only look at them when they're not working, and then you have your emotions as a big additional factor to deal with and our emotions almost always trump our intellect. So we can be looking at an indicator thinking that we're looking at it objectively, but if we're losing money by following that indicator, we have an enormous impulse internally to try to get rid of it, even though it might be working.
So we constantly should be looking at our indicators, but especially when they're working, and say, "What can we learn from the recent past?" Then, use that insight to decide how we'll go forward.
Should investors be trading out of any investment if it falls by a certain amount, or should they be holding for the long term?
I don't take a position on things like that. I do think that a disciplined approach regardless of how you come out on that question is a good one. The reason I say that is, there are investment newsletters that I track that say you should never use a stop-loss. Some of them have done very well. Some of them have done very poorly.
There have been others who say you should always have a trading rule of the kind that you just mentioned and some have done well and some have done poorly, which is to suggest that in the right hands almost any strategy...I am not going to go as far as to say any strategy, but a lot of different strategies, varied strategies, can work well in the right hands and work poorly in another person's hands, which is to suggest that there's some additional ingredient.
Call it ingredient X. Add it to the mix above. Beyond the methods per se that account for why some advisors do well and some don't, I think that ingredient has a lot to do with the discipline and the patience and the objectivity that an advisor can bring to bear so that they don't fall to their emotions when they're trying to reanalyze their indicators.