Sunday Morning Coffee

Yesterday during the Olympics I spent a little time reading about Karl Popper, seriously, and while no one will confuse me for a Popper scholar I am in a slightly more critical (thinking) frame of mind than whatever is normal for me. With that in mind I stumbled across a couple of things that could be worth thinking about, critically or otherwise.

First up was this comment left on the Seeking Alpha version of yesterday's post (sorry if that link doesn't work correctly) about the agriculture theme. A reader asked rhetorically "Why by an ETF, instead by a basket of AG stocks, you will control portfolio, and generally get a better return. I have often looked at various ETFs, but they seem to underperform their parallel markets."

Oh boy.

His comment is a cornucopia of fallacies and other behavioral issues in just a few short words. There are always stocks related to the specialty of an ETF that will outperform the ETF but of course there are always stocks related to the specialty of an ETF that will lag the ETF. Within a fund some portion add to the return of the fund and some are a drag; this should be obvious. Perhaps the reader in question can "generally get a better return" but the implication of how easy it can be is very optimistic.

Similar to the holdings in a fund, in a diversified portfolio whether it uses ETFs, stocks or both there will be holdings that do better than the market and some that lag. I would hope this too would be obvious. The proper expectation whether you pick stocks or use ETFs is that whatever method you choose it cannot always be the best. A good example came up earlier in the week. I disclosed owning Vale (VALE) for most clients and how in 2009 it lagged iShares Brazil (EWZ) but that in most other years since I've owned it it outperformed that ETF. I'm quite pleased with it as a way into Brazil but it will not always be the best way in. Going forward it would be reasonable to expect some years of beating EWZ and some lagging and it would not necessarily be easy to figure ahead of time when that would be.

Embedded in that last sentence is the notion that the market is random and the magnitude of randomness is random and the reader's comment ignores this completely. I believe part of the equation for success in the market (I should probably talk about this more) is a healthy respect for the vagaries that can cause the market to move big in one direction or the other for no reason at all. Taleb has talked about the need that people have to explain why the market or a stock did something or another when often the truth is there is no explanation. "Just because" is often the correct answer.

In a similar vein lately I have been reading posts by Graham Summers as published on Seeking Alpha. Of late, and maybe longer than that I'm not sure, he has seemed to aligned with the deflationists. He has written posts about troubles in the US bond market that I have found insightful. He draws more negative conclusions than I do which is why I read him. It is useful to understand the most bearish of arguments in order to understand what might go wrong and then decide for yourself on the probability of the argument panning out.

His latest post is actually a two-parter titled Is Deflation About To Rear It's Head? He is reasonably down on the extent to which the extreme measures taken created the fuel for the rally that started last March and has quite a few negative things to say about Wall Street as the rally has unfolded, he thinks there are big problems to come and that we are starting to see signs of that trouble now. His past commentaries about recent bond auctions are good reads and are part of his thesis. Then he notes the following;

There are many forces at work in a market, but ultimately the sentiment of its participants is what decides where stocks go in the near-term. With the market being dominated by those expressing the sentiment of desperately wanting to believe that the worst has passed (how many times have we heard this proclamation in the last 18 months?) it is not surprising that the market was dominated by the “inflation trade” with stocks and commodities generally rallying higher and higher, becoming more and more divorced from reality or Market Forces in the process.

This fact is most evident when you compare the performance of a company that believes and lives (literally) based on Government Intervention - Goldman Sachs (GS) - to that of a company with little if any exposure to Government Intervention - Coca-Cola (KO) - and the general market itself - S&P 500 (SPX).

He inserts a chart showing that Goldman Sachs outperforming Coke (KO) over the last year by a mile and the S&P 500 by a little less than a mile. He then concludes;

As you can see, companies influenced by Government Intervention clearly TROUNCED those that did not, as well as the market itself (more on this in a minute).

This is something of a generalization and proves nothing. I left a comment noting that Apple (AAPL) is not "influenced by government intervention" and it blew the doors off of GS in the last year. His example proves nothing and neither does mine. Here is where maybe some Popper applies. I believe Popper was most known for the following (paraphrased); all the positive results in the world can only support a conclusion but it only takes one negative to refute it.

More specifically a high beta stock like GS is a very good bet, but not a guarantee, to outperform a low beta staples stock like KO during a monster rally like we've had. That the firms "influenced by government intervention" benefited unfairly and are a part of the problem (however you care to define the problem) is far from an unreasonable conclusion but GS besting KO means nothing.

Many of the most bearish of bloggers use unquantified phrases like utter collapse or total failure which I think are unnecessary. Peter Schiff, among others, is big on this of thing and I do not know why. A clear, concise and correct analysis arguing for inflation, deflation or any other flation can be written without undefined parameters and hyperbole.

The picture is from Yosemite.