With the formidable entry into our capital market by public sector interventionist-directed algorithms that have been designed to position prices where “they” want them to be, the game has changed. The simple application of common sense and learned decision rules to grow capital no longer applies.
Bloggers and promoters can tell you all they want that their so-called “proven strategies and tactics” are market beaters; but, unless and until you see proof in the form of a successfully managed portfolio, I wouldn’t believe it. In fact, I’d bet against it, knowing the odds would be strongly in my favor.
To repeat: the game has changed. Unless you can beat a machine, you’ll lose.
Consider the fact that chess grand masters now seldom beat machines that play the game at the highest level. Also consider the fact that central banks – those organizations with unlimited funds – have the best machines at work every day in all stocks, in all markets. They do not lose. Why? It’s because they can set interest rates at low or high levels never seen in history and they can also set price-earnings multiples at low or high levels never seen in history. They are programmed to create history, to overcome common sense and learned decision rules, and to rip the heart out of anybody who acts with the least bit of emotion.
How are the industry’s portfolio managers standing up to this machine competition? For five years through 2014, 89% of managers failed to beat the S&P 500 industry benchmark, and many of these active managers even had the support of computer algorithms. Over 10 years, 82% were losers.
http://money.cnn.com/2015/03/12/investing/investing-active-versus-passive-funds/index.html
In any case, that’s not to state that active management lost money for their investor clients. A good many did make money; they just didn’t beat the S&P 500 index.
The sad news for investors in the passive index funds — i.e., the ones being touted as being superior — when that S&P 500 benchmark drops, 100% of investors are losing money. Moreover, the investor in the passive fund typically sells out at the worst time, i.e., at or near the cycle low. The promoters don’t like to tell you that.
The main point though is that machines are beating humans.
Am I saying that machines are destroying the capital market? Not at all. At least, in my view, independent investors can win if (i) they recognize that machines are the competition and can learn how to effectively trade against those machines, and (ii) they can adapt to the new reality that central banks, public pension funds and sovereign wealth funds are the main player in our capital markets, trading largely by computer algorithms.
Are central banks and other public organizations truly the biggest player today? This articles points to the facts: http://www.usatoday.com/story/money/markets/2014/06/15/david-marsh-new-force-in-world-markets-global-public-investors/10548183/
…a large-scale survey compiled by Official Monetary and Financial Institutions Forum (OMFIF), a global research and advisory group… launched June 17 [2014] the first comprehensive survey of $29.1 trillion worth of investments held by 400 public sector institutions in 162 countries. The report focuses on investments by 157 central banks, 156 public pension funds and 87 sovereign funds, underlines growing similarities among different categories of public entities owning assets equivalent to 40% of world output. The assets of these 400 Global Public Investors comprise $13.2 trillion (including gold) at central banks, $9.4 trillion at public pension funds and $6.5 trillion at sovereign wealth funds.
We know that in the past two years, these figures have grown to be substantially larger.
BlackRock, which is by far the largest private manager of capital market portfolios, this month reported a total of $4.89 trillion Assets Under Management. That is substantially smaller AUM than the public sector investors. Moreover, no other private sector enterprise is even close in size to BlackRock. I suspect no public sector investor is close in size to the Fed.
All the big investment houses as well as the public organizations now use computer algorithms to trade. These algorithms are all designed to trick humans. The technology, unfortunately, is also just part of the trickery system, which all together is lethal.
As a percentage of trading volume on the NYSE, computer algorithms accounted for 85% in 2012, which had been rising annually for ten straight years. So, today, “real” traders account for probably less than ten percent of trading.
https://en.wikipedia.org/wiki/Algorithmic_trading#/media/File:Algorithmic_Trading._Percentage_of_Market_Volume.png
How can a “real” trader win?
First, we need to learn how to invest. Swing trading using momentum indicators is not investing. Given that humans cannot separate their gut instincts from their squiggly line interpretations, swing trading is not even effective. Given that the majority of people who call themselves pro traders who rely on momentum indicators are losing, it’s a terrible system.
Investing requires an holistic understanding and rigorous analysis of industry and corporate fundamentals and risks; macro-economic value drivers; and trends and cycles. It’s not easy; but it can be learned. Trying to comprehend why the majority of capital market participants are going to be wrong is the first step down that road.
Because computer algorithms have made capital markets today more unstable day-to-day and week-to-week than ever before, a successful investor must also be a successful trader. By trading, I mean the ability to take profits off the table, which requires an understanding of social psychology and human nature. The rally cry of the pro trader is: Book Profit. Book Profit. Book Profit. This road requires the focus and cold-blooded decision-making equivalent of the machines you are in competition with.
I’ll write more about this in the weeks and months ahead.
Enjoy the rest of the weekend. In Canada, it’s Thanksgiving (markets closed on Monday). In the U.S., Columbus Day (markets open).
/Bill
