I thought you might be interested in some thoughts 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.
It would be a”piece of cake” to prove 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 worth at all sector” flourished while rewarding, higher quality, dividend payers significantly underperformed NASDAQ’s more speculative issues.
More lately, blame for”The Great Recession” could well have been laid at the feet of big government, misguided authorities, and Modern Portfolio Theory zealots rather than heaped upon Wall Street banking institutions, complicit as they were in forming the disaster. There was plenty of guilt to pass around. , Jeffrey Cooper paraphrases a similarly titled article by Stewart Sterk.
Sterk, in my opinion, supports the assertion that Modern Portfolio Theory (MPT) and its computer creation”The Efficient Capital Market Hypothesis” were directly, without reasonable doubt, the cause of the current global financial crisis.
By removing the”prudence” from the Prudent Man Rule, the federal government had permitted hypothesis and theory to replace gains and periodic recurring interest payments. Effectively, probabilities, standard deviations, and correlation coefficients replaced basic value analytics, real gain numbers, and income generation capacities, as determinants of investment acceptability in trusteed portfolios.
No class 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 federal mortgage providers to bundle products for Wall Street; preventing the SEC from regulating a burgeoning derivatives industry; and making all regulators remain clear of any involvement with an increasing interest in”credit default swap” gambling.
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 problems that fostered the recession/ correction (at least not efficiently ). Both pension and defined contribution plan (401k) trustees continue to be expected to concentrate on portfolio market value increase instead of growing the earnings that plan participants will need in retirement… conservative, income based, portfolios will 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 hundreds of different securities, safely yielding much more, are unacceptable to the authorities.
With no meaningful correction for over ten decades, it seems likely that countless investors are going to become victims of a”How Could This Be Happening, Again” debacle.
Blinded By The Math
MPT doesn’t just ignore all basic analytics while enjoying Frankenstein with the technical variety, it also pays no attention to the fact of market, rate of interest, and economic cycles. It’s generated an investment environment that has taken diversification to new heights of lunacy by including every possible speculation from the formulation, while disregarding fundamental quality and income creation.
The only significant”risk”, it postulates, is”market risk”… in reality only the always clear and present danger of all securities and markets. The MPT mixologists’ concoction:
Combine all market price numbers of securities irrespective of quality positions, income, as well as profitability numbers
determine how these numbers varied against one another during various past market scenarios… regardless of cyclical cause
measure the dispersion of the results as they relate to the typical and newest iterations of the actual numbers (what!)
Measure the probability of every possible result, assign a”standard deviation” market value change risk measurement to each possible outcome, and finish by correlating the various risk assessments.
MPT portfolio construction ensures that everything owned is negative directionally correlated to nearly 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 have not quite determined what such a portfolio is.
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.
Aren’t we bringing too much science into a relatively simple method of measuring dollars for ownership interests in business enterprises… an age old means for carrying measured financial risk in the quest for improved personal wealth.
MPT has spewed forth thousands of derivative products that have changed the equity playing area…
Should an uptick at a”triple-short-the-S & P 500″ ETF be regarded as a positive or a negative?
Should individual issue numbers be corrected 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 the impact of derivative parlor game action?
S & P p/e ratios are approximately 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 earnings being generated by your retirement-bound portfolios.
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 right time, most of the time, is just not a fact of investing. And there’s the rub for both kinds of analysis, and for”the emperor’s new clothes” risk assessment techniques and”active asset allocation” processes so well known in MPT.
So long as we live in a world where there are tsunamis and Madoffs; politicians and terrorists; large corporate egos and a lot more dangerous major government; and imperfect intelligence (both artificial and human ) there will be no hope of certainty.
Get over it, reality is really cool once 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 productive, investment experience. No implementation should be undertaken without a complete understanding of all aspects of the process.