I thought you might be interested in some ideas about the investment climate around the time of this”great recession”. You might find them disturbing, or enlightening, depending on where you think we are today.
Without too much of a stretch, it could be documented that the stock market”Crash of’87” was caused by investor focus on company fundamentals, as the best companies in the world led the market on a reckless course to a sudden and painful reversal of fortune for most investors.
It would be a”piece of cake” to prove that the”irrational exuberance” of the”.com bubble”, ten years or so later, was due to blind faith worship of technical evaluation, as the”no worth at all industry” flourished while profitable, higher quality, dividend payers significantly underperformed NASDAQ’s much more speculative issues.
More recently, blame for”The Great Recession” could well have been laid at the feet of big government, misguided authorities, and Modern Portfolio Theory zealots instead of heaped upon Wall Street banking associations, complicit as they were in forming the disaster. There was plenty of guilt to pass around.
In an April, 2010 article in Jotwell: Trusts and Estates:”Time to Rethink Prudent Investor Laws?”
Sterk, in my opinion, supports the assertion that Modern Portfolio Theory (MPT) and its computer production”The Efficient Capital Market Hypothesis” were straight, without reasonable doubt, the origin of the recent global financial crisis.
By removing the”prudence” from the Prudent Man Rule, the federal government had allowed hypothesis and theory to substitute profits and regular recurring interest payments. Effectively, probabilities, standard deviations, and correlation coefficients replaced fundamental value analytics, real profit numbers, and income generation capabilities, as determinants of investment acceptability in trusteed portfolios.
No category or type of investment is inherently imprudent. Therefore, junior lien loans, limited partnerships, derivatives, futures, options, commodities, and similar investment vehicles, were acceptable.
At exactly the exact same time, Congress was: encouraging lenders to make mortgages available to absolutely everyone; allowing national mortgage providers to package products for Wall Street; preventing the SEC from regulating a burgeoning derivatives sector; and making all regulators remain clear of any involvement with a growing interest in”credit default swap” gambling.
It’s not difficult to surmise just how involved Wall Street lobbyists were in making the formerly”sacred ground” of trusteed investment and retirement plans a trillion dollar market place for every conceivable manner of”Masters of the Universe” creation/speculation. My assessment is that we remain in an”artificial portfolio” bubble as this is being written.
Not even Dodd Frank contained a solution to the issues that fostered the recession/ correction (at least not efficiently ). Both pension and defined contribution plan (401k) trustees are still expected to concentrate on portfolio market value growth instead of growing the earnings that plan participants will need in retirement… conservative, income based, portfolios would be fined mercilessly by feckless regulators for”poor performance”.
The very popular”retirement income fund” in the world (Vanguard’s VTINX) generates less than 2% in spending money, check it out… while countless different securities, safely yielding much more, are unacceptable to the regulators.
With no meaningful correction for more than ten years, it appears likely that millions of investors are about to become victims of a”How Can This Be Happening, Again” debacle.
Blinded By The Math
MPT does not just ignore all basic analytics while enjoying Frankenstein with the technical variety, additionally, it pays no attention to the fact of market, interest rate, and economic cycles. It’s produced an investment environment that has taken diversification to new heights of lunacy by including every possible speculation from the formulation, while ignoring fundamental quality and income generation.
The only significant”risk”, it postulates, is”market risk”… in fact only the always clear and present danger of securities and markets. The MPT mixologists’ mix:
Combine all market price numbers of all securities irrespective of quality rankings, income, as well as sustainability amounts
determine how these amounts varied against one another during various past market scenarios… no matter cyclical cause
quantify the dispersion of the outcomes as they relate to the average and newest iterations of the real numbers (what!)
Measure the probability of every possible result, assign a”standard deviation” market value change risk measurement to every possible result, and conclude by correlating the various risk assessments.
Add a shot of single malt, and a pinch of Old Bay, bring to a boil, shake a stick over it and SHAZAAM… we understand the combined market, liquidity, concentration, credit, inflation, fiscal, and economic risk of every marketable security.
MPT portfolio construction assures that everything possessed is negative directionally correlated to nearly everything else, without ever owning a single stock or bond, or considering the amount of income produced by the portfolio. Thus creating, eh, making, a passively managed… well, I haven’t quite decided what such a portfolio would be.
The”oxymoronic” passive management (let the formulas and standard deviations steer your retirement jumped ship) of”Modern Portfolio Theory” may initially have a sexy ring to it… until you try to figure out exactly what it does to the data it fuels itself on.
Are not we bringing way too much science to a relatively simple method of measuring dollars for ownership interests in business enterprises… an age old means for taking quantified financial risk in the quest for improved personal wealth.
MPT has spewed forth thousands of derivative products that have shifted the equity playing field…
Should an uptick in a”triple-short-the-S & P 500″ ETF be considered a positive or a negative?
Should individual issue numbers be adjusted for the amount of derivative entities that hold them, short or long?
Does share price have anything whatsoever to do with fundamental price or is it just the impact of derivative parlor game action?
S & S p/e ratios are roughly 50% higher than they were five decades ago; a sampling of high-dividend-paying ETFs sports an ordinary p/e more than double that of the S & P.. . And none of your advisers (myself excluded) seems concerned with the anemic level of income being produced by your retirement-bound portfolios.
Déjà Vu all over again?
Modern Portfolio Theory would have us believe that the future is, indeed, predictable within a reasonable degree of error. Theorists, research economists, other academics, and Wall Street marketing departments have always gone there — and they have always been wrong.
Any claim to precision; any attempt to time the market; any hope of being in the right place at the ideal time, most of the time, is simply not a fact of investing. And there is the rub for both forms of analysis, and for”the emperor’s new clothes” risk assessment methods and”active asset allocation” procedures so well known in MPT.
So long as we live in a world where there are tsunamis and Madoffs; politicians and terrorists; big corporate egos and far more dangerous big government; and imperfect intelligence (both human and artificial) there will be no expectation of certainty.
Get over it, reality is pretty cool as soon as you’ve learned to deal with it.
All the disciplines, concepts, and procedures explained there work together to produce (in my experience) a safer, more income productive, investment experience. No implementation should be undertaken without a complete understanding of all facets of the procedure.