Hamsters Spinning Wheels

Early critics of the efficient market hypothesis claimed incorrectly that market efficiency meant that a monkey throwing darts at a list of stocks was just as good an investment strategy as any other. Now we have hamsters spinning wheels. Mr Goxx, a hamster, makes cryptocurrency investments by spinning a wheel. Two men in Germany have created a cage in which Mr. Goxx spins a hamster wheel. Where the wheel stops selects the cryptocurrency for investment. Then, Mr. Goxx enters one of two tunnels for a buy or sell order. Switches on the wheel and tunnels automatically execute the order. Since Mr. Goxx has begun investing in September 2020, his return is above all major stock market indices. Are you ready for a hamster investment advisor? We hope not!

Fidelity Goes Behavioral

Fidelity Investments recently hired Gilbert Haddad to head the company's decision science area. The data gathered from the new initiative is "..really like applying behavioral finance and behavioral science to understand” what the portfolio managers and analysts are good at or not. The data will also be used to "help them understand their own biases" in the investments made by the manager to help them avoid bad behavioral decisions. 

The Market Beats Robots!

A recent article highlights a retirement issue, "lost" 401k accounts. It is estimated that 24 million accounts containing $1.35 trillion in assets have been left in 401k accounts when someone leaves an employer. And while these can be claimed easily, we want to make sure that you don't forget about a retirement account. You can often leave a 401k account with an old employer if you like the options and costs available, but you can also roll over the account tax-free into an IRA. We did want to point out one sentence in the article:

Those robo accounts have returned almost 9% annually over the past three years, while popular S&P 500 ETFs have seen annualized returns of nearly 14% over the past 10 years.

Over the past three years, it is even worse for robo advisors as the S&P 500 has returned about 18 percent over that period. One important caveat is that robo advisors likely have a more diversified portfolio, including bonds and money market accounts. This would reduce the risk of robo advisor accounts, but, as you see, can also reduce the return.

 

Morningstar Stock Valuation

So how do analysts value a stock? A recent video from Morningstar, one of the most trusted independent sources for stock values, discusses the methodology it uses. If you watch the video, you will hear a lot of methodology similar to what we discussed in the textbook, especially discounted cash flow analysis. Similar to what we discussed, the value of the stock increases by the capital gains yield and will change as new information is received. Notice an important point: Morningstar only recommends a stock if it believes that is fair value is significantly above the current market value, which implies Morningstar does not believe the market is semistrong form efficient.

Mutual Funds Underpform...Again

In our discussion of market efficiency, one trait of an efficient market is that it is difficult for investors to outperform the market. The results for mutual funds for 2020 are in and it appears that the market won again. For large-cap equity funds, 57.1 percent underperformed the S&P 500, the 11th straight year less than half of large-cap funds outperformed the S&P 500. Over a 20-year horizon, only 4 percent of large-cap funds outperformed the index, while 10 percent of mid-cap funds and 6 percent of small-cap funds could make that claim. It appears that the market is tough to beat.

Women Outperform Men

Who are better investors, women or men? A recent interview with proprietary trader Kathy Donnelly discusses reasons why the evidence suggests that women tend to outperform men as investors.

A Short Squeeze

A short sale occurs when an investor sells a stock they don’t own to hopefully buy it back later at a reduced price. Recently, Gamestop and AMC have seen a short squeeze. When you short a stock, if the stock price increases, you must make a margin deposit, that is, make an additional deposit of cash into your account, or repurchase the stock and take the loss. In a short squeeze, a group of investors buy the stock, forcing short sellers to make more deposits or take a loss. In the past two weeks, Gamestop has gained about 1,800 percent, which in our opinion, means the stock is in a bubble.

McRib Investing

Although many people love the McRib, an even more important discovery has been made: You can make money investing in the stock market by investing in the McRib! Surely we jest, and we do. A recent article highlights the McRib effect, that is, the stock market as a whole has a higher return when the McRib is avialable. While this is a fact, as the article points out, there is an important distinction between causality and correlation. And while the McRib anomaly may tickle your ribs, it does highlight that many market analysts will tell you why the stock market rose or fell on a particular day. Most, if not all, are inferring causality when only correlation is present.

COVID-19 Stock Trading

In a positive announcement in the fight against COVID-19, on Monday, Pfizer announced a vaccine that is more than 90 percent effective. That day, Pfizer's stock rose about 10 percent. But a strange thing happened: Albert Bourla, the CEO of Pfizer, sold $5.6 million of the company's stock. The stock sale was part of a 10b5-1 plan. A 10b5-1 plan allows company executives to prearrange stock sales with a broker to avoid the appearance of insider trading. In Bourla's case, the 10b5-1 plan was put in place on August 19. However, some have scrutinized Bourla's plan as on August 20th, the company had a press release announcing new Phase 1 testing date. 

An Interview With Eugene Fama

Recently, an interview with Nobel laureate Eugene Fama, who laid the foundation for the efficient markets hypothesis, was published by The Market/NZZ. The wide-ranging interview covers topics from the problems with growing government debt, stock market bubbles, the efficient markets hypothesis versus behavioral investing, the reason for negative oil prices, and negative interest rates. Professor Fama also discusses his belief that the power of central banks is much more limited than many believe. The interview is definitely worth a read.

Universities And Pensions Underperform

We recently discussed the underperformance of Harvard's endowment fund, but it appears that Harvard is not alone. A recent article shows that the endowment funds of major universities have underperformed the market by abut 1.6 percent per year. What is so interesting about that 1.6 percent? That is the average management fee paid by the endowment funds! In other words, the overall investment performance is the same as the market, but once fees are accounted for, performance lags the market. Of course, public pension funds have performed slightly better, only underperforming the market by about 1 percent.

Market Trounces Harvard

So how hard is it to beat the market? From 1993 to 2008, the portfolio managers of Harvard’s endowment fund beat the S&P 500 by almost five percent per year. A major contributor to that performance was a hugely successful investment in timber. Since then, things have not been so rosy (or even Crimson). Using the analysis in the article, the Harvard endowment fund has underperformed a blended portfolio of stocks and bonds by one percent per year over the past 20 years. Based on the current endowment value of $42 billion, this means the endowment potentially lost out on $420 million in growth per year, or roughly $8.4 billion dollars of growth over this period. It is tough for the best and brightest to beat the market.

A Flight To Cash

We have discussed risk and return in the textbook, so by now you should have a grasp on the concept of financial risk. A recent article notes that ultra-wealthy individuals have been moving assets into cash or cash alternatives. In the first quarter of 2019, high-net worth individuals held nearly 28 percent of investable assets in cash. And while cash itself is desirable for liquidity and diversification, this number appears high. There is one sentence in particular we would like to point out:

“Yet perception of risk is an emotional thing.”

We can measure an asset’s total risk by standard deviation, or an asset’s market risk by beta. However we measure risk, it is unemotional. But there can be behavioral factors, such as the fear of risk, that can affect an individual’s decisions.  

As a final point, the article discusses a family that moved money into gold bars and buried them and implies this is moving assets into cash. While gold is a physical asset and often performs well in a bad economy, the volatility of gold prices can often be quite high.

Illusory Superiority

Illusory superiority is a behavioral concept in which people believe they are above average in traits such as intelligence, relationship status, professional achievement, and driving. Obviously, everyone cannot be above average. But one area that many people do not believe they are above average is investing skills. As a result, investors tend to either hire a money manager, or invest on their own. Advice from money managers can be expensive and eat into your return. Additionally, if you go this route, you must be cautious as there are unscrupulous advisors and outright scam artists. We should note that there are also reputable money managers who can help you. By investing on their own, investors often find themselves chasing stock returns. Small investors often suffer from overconfidence, which typically involves a lot of buying and selling, racking up trading costs and taxes. We hope your education and this textbook has prepared you on your journey to becoming and educated investor.

A Blockchain Bubble?

Many would argue that the rapid rise of internet stocks in the late 1990s was a bubble and blockchain company stocks may be following a similar path as internet stocks. Long Island Ice Tea Corp., which sells nonalcoholic beverages and lost $11.9 million on sales of $3.9 million in the first 9 months of 2017, saw its stock price jump as much as 289 percent when it rebranded itself as Long Blockchain. The company stated that it would seek out partners that develop blockchains. Long Blockchain has no agreements with any other company to partner on blockchain technology nor is there any assurance that one will be found. While Long Blockchain may eventually find a partner, we would advise you to be careful of FOMO (fear of missing out) investing.

The Stock Market Is A Home Run

Many people are familiar with the Super Bowl indicator: If an old AFL team wins the Super Bowl, the stock market will be down for the year and if an old NFL team wins the Super Bowl, the stock market will increase during the year. A new sports-related stock market indicator is the home run/strikeout total for Major League Baseball. As total home runs and strikeouts increase, the stock market increases and as the total home run runs and strikeouts decrease, the stock market decreases. Unfortunately, the researcher who discovered this relationship argues the connection is reversed, so the change in the stock market predicts the home run/strikeout total. Guess we won’t be able to use this as a predictor of stock returns.

Indexes Win Again

One method that has been used to examine if the stock market is semistrong form efficient is the performance of actively managed mutual funds. A recent study by S&P indicates that most actively managed mutual funds still lag the appropriate market index. From 2011 to 2015, over 88 percent of mutual funds failed to beat the S&P Composite 1500. And 84 percent of large cap funds failed to outperform the S&P 500. In fact, over the past five years, the fund category with the best performance for retail investors relative to its index was the mid-cap value category, with only about 30 percent of mutual funds in that category outperforming the S&P Midcap Value 400. Small cap growth funds were the worst, with only about 8 percent of funds beating the S&P SmallCap 600 Growth index. So, even if you don't believe the stock market is efficient, as this shows, it is very difficult to outperform the stock market.

The Stock Market Wins Again

The first quarter of 2016 was the worst on record for large cap mutual funds as fewer than 1 in 5 beat the stock market. Growth funds performed particularly poorly, as only 6 percent beat the S&P 500. About 20 percent of value funds and 29 percent of core funds beat the S&P 500. Small cap fund managers performed better, with 80 percent beating their benchmark.

It's Market Efficiency By A Length - Or Several Lengths Now

Back in 2013, we posted about Warren Buffett's bet with the founders of the Protégé Partners hedge fund that the S&P 500 would outperform a hedge fund index chosen by Protégé Partners over a 10-year period. At that time, the S&P had cumulatively outperformed the hedge fund index by about 8.5 percent. Even though the hedge funds outperformed the S&P 500 in 2015, the Vanguard Admiral index fund is up a  cumulative 65.7 percent in the last eight years, while the hedge fund index is up only 21.9 percent. One scenario for a possible comeback for the hedge funds, which is outlined by Ted Seides, the man who engineered the bet for Protégé, is a severe market downturn. Of course, he added about such a circumstance: "No one wins when that occurs."

Golf And Investing

A recent article discusses how golf and investing may be related, but also talks about several behavioral biases that can affect investors. For example, loss aversion shows up in golf as golfers are more likely to make a putt of the same difficulty for par than they are to make the putt for birdie (one under par). Another behavioral bias discussed is probability neglect, that is, people tend to worry about bad outcomes that have a very low probability, such as a plane crash or losing 40 percent of their investment. By overweighting events with a low probability, investors can incur large opportunity costs. Finally, an informational cascade occurs when investors believe the signals from other investors, even if they do not agree. For example, if a stock you view positively begins to drop, you may sell based off what other investors are doing, rather than what your research has revealed to you. As the article notes, smart investors aren't loss averse, they don't neglect probability, and believe in their own analysis.