I thought you might be interested in some ideas about the investment climate around the time of the”great recession”. You might find them disturbing, or enlightening, based on where you believe we are today. But two things are fairly certain… not a whole lot has changed, and a look to the past often provides insight about the present.
It would be a”piece of cake” to demonstrate that the”irrational exuberance” of the”.com bubble”, ten years or so later, was caused by blind faith worship of technical analysis, as the”no value at all sector” flourished while profitable, higher quality, dividend payers significantly underperformed NASDAQ’s much more speculative issues.
More lately, blame for”The Great Recession” could well have been laid at the feet of big government, misguided regulators, and Modern Portfolio Theory zealots rather than heaped upon Wall Street banking institutions, complicit as they were in forming the tragedy. There was plenty of guilt to maneuver around.
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 current global financial crisis.
By removing the”prudence” in the Prudent Man Rule, the national government had allowed hypothesis and theory to replace profits and regular recurring interest payments. Effectively, probabilities, standard deviations, and correlation coefficients replaced basic value analytics, real profit numbers, and income generation capacities, as determinants of investment acceptability in trusteed portfolios.
The Uniform Prudent Investor Act (UPIA), which reflects an MPT and”total return” approach to the exercise of fiduciary investment discretion, was adopted by most states by May 2004.
No category or type of investment is inherently imprudent. Therefore, junior lien loans, limited partnerships, derivatives, futures, options, commodities, and similar investment vehicles, were okay.
At exactly the exact same time, Congress was: encouraging lenders to make mortgages available to absolutely everyone; allowing national mortgage providers to bundle 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 pension plans a trillion dollar market place for every conceivable manner of”Masters of the Universe” creation/speculation. My evaluation is that we stay in an”artificial portfolio” bubble as this is being written.
Not even Dodd Frank contained a solution to the problems that fostered the downturn / correction (at least not efficiently ). Both pension and defined contribution plan (401k) trustees continue to be expected to focus on portfolio market value increase rather than growing the earnings that plan participants will need at retirement… conservative, income based, portfolios will be fined mercilessly by feckless regulators for”poor performance”.
The most popular”retirement income fund” in the world (Vanguard’s VTINX) generates less than 2% in spending cash, check it out… while hundreds of different securities, safely yielding much more, are unacceptable to the authorities.
Without a meaningful correction for more than ten decades, it appears likely that countless investors are going to become victims of a”How Can This Be Happening, Again” debacle.
Blinded By The Math
MPT does not just ignore all fundamental analytics while enjoying Frankenstein with the technical selection, it also pays no attention to the reality 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 in the formula, while disregarding fundamental quality and income generation.
The only significant”risk”, it postulates, is”market risk”… in reality just the always clear and present threat of all securities and markets. The MPT mixologists’ concoction:
Combine all market price numbers of securities irrespective of quality rankings, income, or even sustainability amounts
determine how these amounts varied against one another during various past market scenarios… regardless of cyclical cause
measure the dispersion of the results as they relate to the average and latest iterations of the real numbers (what!)
Measure the probability of each possible outcome, assign a”standard deviation” market value change risk measurement to every possible outcome, and finish 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 on it and SHAZAAM… we know the joint 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 almost everything else, without ever owning a single stock or bond, or contemplating the amount of income created by the portfolio. Thus creating, eh, producing, a passively managed… well, I haven’t quite determined what such a portfolio would be.
The”oxymoronic” passive management (allow 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 information it fuels itself on.
Are not we bringing too much science to a relatively simple system of exchanging dollars for ownership interests in business enterprises… an age old means for taking measured 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 at 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 which hold them, long or short?
Does share price have anything whatsoever to do with fundamental value or is it the impact of derivative parlor game activity?
S & S p/e ratios are roughly 50% higher than they were five years ago; a sampling of high-dividend-paying ETFs sports an average p/e more than double that of the S & P.. . And not one of your advisers (myself excluded) appears concerned with the anemic level of earnings being generated by your retirement-bound portfolios.
Déjà Vu all over again?
Modern Portfolio Theory would have us believe that the future is, indeed, predictable in a reasonable degree of error. Theorists, research economists, other professors, and Wall Street marketing departments have always gone — and they’ve always been wrong.
Any claim to precision; any attempt to time the market; any expectation of being in the right place at the ideal time, the majority of the time, is just not a reality of investing. And there’s the rub for the two forms of analysis, and for”the emperor’s new clothes” risk assessment methods and”active asset allocation” processes so popular in MPT.
As long as we live in a world where there are tsunamis and Madoffs; politicians and terrorists; big corporate egos and a lot more dangerous big government; and imperfect intelligence (both human and artificial) there will be no hope of certainty.
Get over it, reality is pretty cool as soon as you’ve learned to deal with it.
All of the disciplines, concepts, and procedures described therein work together to produce (in my experience) a safer, more income effective, investment experience. No implementation should be undertaken without a complete understanding of all facets of the process.