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Posted
9/4/2003 |
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The Speculator
Our final advice: Go with the
evidence
The Speculators take their bow by noting that
market wisdom isn't enough. 'Meals for a lifetime' come from
studying and testing all the evidence first.
By Victor
Niederhoffer and Laurel Kenner
To dream the impossible dream
To fight the unbeatable foe
To bear with unbearable sorrow
To run where the brave dare
not go
To right the unrightable wrong
And to love pure and
chaste from afar
To try when your arms are too weary
To
reach the unreachable star
This is my quest
To follow that
star
No matter how hopeless
No matter how far
To fight
for the right
Without question or pause -- “The Impossible
Dream “
from “Man of La Mancha” by Mitch Leigh, Joe Darion and
Dale Wasserman
We started this column with an impossible
dream. We wished to redress the wrongs, rectify the errors and
reform the abuses in the market, to relieve the public from its
position of being eaten by those with superior information and
chips. Tens of billions of dollars are needed each year to pay for
the buildings, brokers, research, market makers, specialists and
equipment that keep the market going, and the public traditionally
provides the money for that upkeep by trading the wrong way, with
the wrong investments, at the wrong time.
To change things,
we attempted to provide our readers with analytical techniques and
principles -- what we would call meals for a lifetime. The main
technique we recommended can succinctly be called counting. A
person who counts meets all assertions about the market, any
theories, any tendencies with the questions, “Have you tested that?”
and, “What does the evidence say?”
Steve Stigler of the
University of Chicago, the foremost expert following in the
tradition of Francis Galton, Karl Pearson and others, describes the
necessary frame of mind:
“If a serious question has been raised, whether it be in
science or society, then it is not enough merely to assert an
answer. Evidence must be provided, and that evidence should be
accompanied by an assessment of its own reliability. If one
position has been advanced with well-considered supporting
evidence, then it is incumbent on a critic to put ‘statistics on
the table.’” The main principles we used to analyze markets
were supply and demand; the law of ever-changing cycles;
cross-fertilizations from science, music, sports and literature; and
knowledge of the psychological biases that result from focusing on
easily remembered events.
Supply and
demand we wrote about last week. It is good to watch at all times
how much stock companies are selling and repurchasing, and how much
the insiders are buying. The flow of money between money market
funds and equity funds is relevant here, as the former provides a
reserve for the latter, especially when optimism is lost. The demand
situation for stocks is always good when earnings yields on equities
are substantially higher than the comparable yields on fixed-income
securities.
Suffice it to say that all these supply-demand
measures have been highly bullish for the last nine months, as we
have repeatedly mentioned throughout the entire period. The measures
remain bullish, but are becoming much less so, because the
interest-rate differential is not as good and the supply of
secondary offerings is increasing. A good working hypothesis is that
our prediction of the beginning of this year will hold true: stocks
will be best at the end of 2003, and fixed-income the
worst.
Our last prediction: Stocks
up, bonds down
In fact, we’ll go out on a limb with a
forecast that has a one-in-a-million shot, but one that captures the
essence of our thinking. We predict that stocks will be at a
one-year high at the end of the year, while bonds will be at a
one-year low. While it is unlikely that our prediction will be
realized, we offer it as an antidote to the constant pessimism,
quavering disbelief and incessant focus on the negatives that the
public must of necessity be exposed to at just the wrong times.
Even in the 1500s, Don Quixote was exposed to a similar
backdrop. The little people longed for the golden days when there
were neither malefactors nor magistrates, a world where damsels were
safe, a world when “all was peace, all amity, all concord,” when “no
other labor was necessary than to raise their hands and take it from
the sturdy oaks, which stood liberally inviting them to taste their
sweet and relishing fruit.” Like the people in our own time, and
like certain chronically bearish columnists today, they saw “fraud,
deceit and malice” everywhere, and believed justice was impossible.
Like the Don, our goal was to defend the public, protect
widows and provide for the college education of orphans by
emphasizing that things were not as bad as the naysayers would have
it. We adopted as armor and sword the immemorial results of the
Triumphal Trio -- Elroy Dimson, Paul Marsh and Mike Staunton -- who
showed in “Triumph of the Optimists: 101 Years of Global Investment
Returns” that almost every stock market in the 20th century gave a
total return from buy-and-hold on the order of 1.5 million %.
Instead of becoming a knight-errant to arrest the wrongs,
Vic chose to join Laurel in writing a stock market column. Our
chances of success seemed high. Vic had traded for four decades,
most of the time at the top of his profession. Having vetted all of
the known trading systems and developed a programming approach that
earned him hundreds of millions and turned some of his ex-employees
into billionaires, he was well equipped to provide the counting.
Laurel had just quit Bloomberg News after five years as chief U.S.
stock markets editor and could contribute knowledge about individual
stocks.
Surviving
humiliation
Like the Don, though our valor was great and
our quest a noble one, we fell on our face often, and suffered
frequent defeat and humiliation. The fate of our book, "Practical
Speculation," which encapsulated many of our MSN Money columns, was
typical in this regard. It was a worst-seller. It was not reviewed
by any major publication. It is almost unavailable in bookstores. On
Amazon, the only place where buyers may purchase our book, a groups
of spoofers and spammers has manipulated the ratings to make it seem
like the public’s main reaction to it is: “This is the worst book
ever” and “This is all there is?” (Editor’s note: We read some of
the reviews and can truthfully say that not all the reviews are as
bad as that. Many are, in fact, quite good.)
But that was
guaranteed to happen. If the public were to get wise, to realize, as
the racetrack betting expert Robert Bacon says, that they have no
right to lose so much, that they shouldn’t switch into the wrong
stocks at just the wrong time, that they ought not to get out of
stocks altogether when they should be putting all of their funds
into them, that they shouldn’t buy only the most risk-free companies
when they should be buying risky things like IPOs that must be
priced to realize returns of 40% or so -- why, that would create a
golden age in the market, and the existing order of things would
have to be dramatically changed.
For the public provides the
energy for the market’s wheels to turn, covering its overhead and
overcoming its friction. And it must continue to play that role or
else the system stops. A million mechanisms have evolved, conscious,
semiconscious and unconscious, to prevent the system from grinding
down.
Again, Bacon put it best in his out-of-print classic,
“Secrets of Professional Turf Betting”:
“The public’s play beats down the prices of horses picked
by any set scheme. Some well-to-do horsemen who send their horses
out to do their best for probable betting prices of 3-to-1 “cool
off” as the prices sink below 5-to-2. Instead of trying their
hardest to win, they send the horses out to win if they can win
easily. But the boys are told not to punish the animals, to pull
them back out of the money in the stretch if they see an easy
winning is not possible. The horsemen know that this pulling back
out of the money will make a bad race show as the last outing in
the past performance charts, thus putting the public off the horse
for next time.” Enough. We are pulling the plug today. Like
Don Quixote, we are retiring. We are thinking of becoming shepherds,
or perhaps technical analysts. More likely, we will simply trade a
little and quietly enjoy our remaining time. We are proud of all 170
columns we wrote together beginning in April 2000.
- We treated readers with respect and dignity as if they were at
least as intelligent and more sensible than us and the countless
college professors whose articles we reviewed.
- We gave meals for a lifetime rather than meals for a day,
never being content to merely describe “5 stocks to buy right
now.”
- We encouraged readers to believe in innovation, enterprise,
freedom and the pursuit of happiness. We glorified the
entrepreneurial spirit of the Founders and showed that great
plenty and thanksgiving followed in the wake of the incentive
unleashed by the market and private property system.
- We passed along hard-won insights on getting over disaster.
- In most of our columns, we looked at the economic or
scientific principles underlying aspects of the market, reviewed
the academic literature on the subject, often interviewed the
leading academic in the field, and updated the data -- invariably
too old not to be subject to the law of ever-changing cycles. And
we extended the work with our own studies.
- We kept our column free of pronouncements by mediocre money
managers with stock to unload. Instead, we passed along insights
from top hedge fund managers and published the thinking of readers
who generously shared their wisdom and expertise in diverse
fields. The fruitfulness of our e-mail exchanges with readers, one
of the principal benefits of the Internet age, provides a lesson
that is key to proper reporting in modern times and violated at
one's peril in markets and politics.
- We showed that the market is a deceptive place, explained why
it must always be so and described where the deceptions currently
are found.
- We explained why testing is superior to received wisdom for
all fixed systems, cautioned against the retrospective biases of
the commonly used databases, and showed how prospective systems
that compare growth to value show growth to be the better choice.
- We showed over and over again that the main regularity adduced
by most technical analysts, i.e., that the trend is your friend,
is not in accord with the actual movement of market prices in the
stock market.
- In a series of articles on how to overcome fraud, we focused
on balance sheet analysis, particularly the importance of
overstated inventories, increasing accounts receivable and
excessive deferred tax payments relative to cash payments as key
signals to watch.
- We showed how the public could make more money than the market
by buying companies that are buying back their shares, and we
provided and will continue to provide on our Web site an ongoing
enumeration of such companies along with updated results.
- We made a first effort to show that there is considerable
profit potential in systems based on buying companies that have
considerable private knowledge when they are beaten down and their
insiders buy them.
- We refrained from making fun of the advice of the Father of
Securities Analysis, Ben Graham, to buy stocks only when the Dow
is below 100, and only at less than half liquidating value. We
were also polite to his acolytes, even Mr. Integrity of Omaha.
- We drew from literature, science, history, music, sports --
especially tennis and baseball -- games, economics, biology,
physics, nature, psychology, and our own painful experiences to
show that survival is key in markets and life.
While we
were by no means perfect in all of our calls, we heard from many
readers who said that taking our advice had paid off. We never make
money ourselves, of course, but at least the bill collectors have
not kicked down the door, and the tuitions for Vic’s six daughters
have been paid. The oldest daughter graduated from Harvard this year
and this week is signing a lease on offices for her own filmmaking
company. Daughter No. 2 is proceeding to a doctorate and a wedding,
and the other four are lovely, intelligent and growing up well.
Please contact Vic at gbuch@bloomberg.net with marriage
offers.
 | We are immeasurably
grateful to Jon Markman, our editor, for seeing value in our
approach and for sharing his mastery of the art of writing. We thank
our copy editors, Charley Blaine and Ron Prichard, for asking sharp
questions, catching countless bloopers and augmenting the finished
column with useful links and headlines. We also thank our bosses,
from Bill Gates to Mark Pawlosky, for allowing us the freedom to
write about what’s closest to our heart: the glorious productive
efforts and resulting happiness that arise when individuals have
incentives to improve their material and personal well-being.
Readers are invited to join us for a farewell party at the
Conservatory Garden in Central Park at 2 p.m. this Sunday, Sept. 7.
We will continue our tradition of holding Stock Talk in the same
garden at 2 p.m. on the final Sunday of each month. All speculators
of good will are invited to attend. We hope you will visit our Web site, where we will
continue to share market insights and provide forums for those with
interests in speculation and natural
philosophy.
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MSN Money's editorial goal is to
provide a forum for personal finance and investment ideas. Our
articles, columns, message board posts and other features should not
be construed as investment advice, nor does their appearance imply
an endorsement by Microsoft of any specific security or trading
strategy. An investor's best course of action must be based on
individual circumstances.
 Fund data provided by Morningstar, Inc. © 2003. All rights
reserved.
 Quotes supplied by Standard & Poor's ComStock, Inc.
and are delayed at least 20 minutes. NYSE, AMEX, and
NASDAQ index data are provided real time.
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