Hyman Minsky is celebrated posthumously for observing that very extreme events occur as a result of long periods relative tranquility which creates complacency. The complacency then gets shattered by something like Bear Stearns or Lehman Brothers blowing up.
Are we now in Extremistan? When will complacency return so we can all go back to making money again? Candidly I do not frame it this way. I think Minsky's idea holds plenty of water and I don't think disagree with Taleb, I just don't think in terms of tails in the manner that Taleb (and Hui) writes about them.
Where extreme events are concerned I think about avoidance more than anything else. For my money S&P 500 sector weights give ample warning of trouble (but not magnitude). This worked with energy almost 30 years ago, tech ten years ago and financials three years ago. For people who have been reading this site for a while, are you going to overweight the next sector that comprises 20%, or more, of the S&P 500? In the last decade I think choosing the correct sector to avoid has been the most important decision possible regarding domestic stocks.
WRT to foreign stocks figuring out what countries to avoid (Japan and big Western Europe) may not have been as important as picking Brazil or a couple of others but avoiding those countries did make things much easier.Obviously some folks would argue that just as it is impossible to pick stocks it is probably impossible to correctly avoid stocks as well. One such person could be Jack Bogle. He was profiled in the LA Times. He is widely known as a proponent of indexing but as the LA Times article notes (I have mentioned this once or twice as well) he is pretty good at making macro market calls. I find it fascinating that one of the foremost indexers is a pretty good timer.
Bogle isolates a key point about the pitfalls of emotion. Paraphrasing him from the LA Times article people look at their statements, see something they don't like and end up selling low only to be followed later by buying high. I agree that emotions are one of the biggest threats to investment success, maybe the biggest.
Where I disagree (actually there are a couple of things I view differently than Bogle does) is that indexing worked over the last decade. I don't think it did. The Vanguard Total Stock Market Fund (VTSMX) was up 4.1% last decade including dividends and the S&P 500 Total Return Index was down 4.5% (both numbers per Morningstar). Recently I cited an article written by a fund manager who believes people realistically only have 20 years to accumulate for retirement. While I think people have more than 20 years it makes the point that no growth for ten years can be a big problem and while a repeat of that this decade is a low probability I would not want to bet/rely on indexing working in this decade.
To the extent Extremistan exists, to the extent we will have future Minsky Moments and to the extent our emotions are our worst enemy the focus here will continue to be avoiding certain sectors, countries and themes. The behavioral finance nugget about the emotion of losses dwarfing the emotion of gains rings very true and I think reducing the chances of huge losses is the most effective way to navigate through. New readers can search for my name with the term 200 DMA for more details.
Mercifully Fox has not renewed the show 24 so when the current season ends in May that will be it. I used to love the show and have stuck with it last season and this despite how bad it has been all the while hoping they would pull plug.
12 comments:
I do not disagree with Minsky, but Talebs fat tail is to simplistic to the current issues. These were all very predictable based on housing and excess leverage in general. This was a very predictable out come (look at Japan).
24 has been rather mediocre this season.
Even a mediocre season of 24 is way better than 90% of the competing crap on TV. I'll miss Jack Bauer, the last true American hero.
The concerning aspect of Minsky is once the Minsky moment happens the problem doesn't go away until the underlying malinvestment or inefficiency is rectified.
The financial world certainly is calmer, but we haven't addressed the underlying debt issue or finance reform. All we have done is flooded the world with stimulus, which was actually the large cause of the problem. So we may have more work ahead of us.
the panic is gone but I don't think we are anywhere near being complacent.
"Bauer, the last true American hero."
Do not despair there are plenty of American heroes. The press would simply rather promote comrade Obama for now, but you will see plenty of heroes in the future.
I think your comparison of "fat tails" thinking versus Minsky's thinking is very appropriate. Statistical distributions over one independent variable are bad over-simplifications for capital markets. In the "fat tail" world-view things can be going fine bouncing around the mean return, and the WHAP black swan due to nothing besides a bad roll of the dice.
In Minsky's view though there is another dimension: the market has to spend too long at a certain benign return distribution before a "black swan" type event can happen. There isn't any probability of a market crash until soceity has gone through the effort of setting up for a crash.
As a reader of this blog almost since the beginning it pains me greatly to see a certain poster constantly bringing up politics.
I like this blog for a variety of reasons - one of which is not constant political hack crap, which seems to be almost everywhere else.
So, please find an everywhere else to spew.
The best longitudinal curve fits to market data I've seen were either fat tail (Mandelbrot, Taleb et al) or some form of punctuated equilibrium (Minsky et al) neither of which necessarily imply the other although both were better long-term fits than a normal distribution for most markets; e.g., most commodity markets behave in a manner more consistent with fat tail than any other model.
Since the vast majority of economic and market models rely upon a normal distribution the implications of this need to be taken into account.
Fat tail means a stable power law is involved and risk must always be higher than expected no matter how normal the circumstances may appear. Not only can extreme price movements come more frequently and/or be larger than expected but statistics such as standard deviation and correlation are treacherous guides; e.g., both standard deviation and correlation are defined in terms of variance and variance can be infinite in stable power distributions.
Punctuated equilibrium has periods of relative stability that can be measured and evaluated under normal assumptions but the system is not inherently stable so measures of central tendency (mean, median, etc) can move to very different values in a relatively short period of time taking the entire curve with them to establish a new 'stable' regime; somewhat like ecological succession or a chaotic system with more than one attractor.
The practical implication of this is that an investing discipline that primarily follows price movements is not likely to serve long-term, strategic investors well; fundamental value, business cycle and/or quantitative weighting regimes such as Bob Arnott's RAFI offer a stronger foundation upon which to build. JMO
"He is widely known as a proponent of indexing"
In addition, he is widely known as the inventor of indexing.
I would say that indexing (or passive investing) worked if you had a sensible overall allocation that also included exposure to bonds and foreign stocks along with rebalancing. I am not sure why everyone always compares what they do to a portfolio of 100% SP500.
Funny, my word verification spells "a dead deal." Hmmmm.
i was not comparing it to 100% equities but equities going down for a decade is a big problem for people who bought and held on throughout.
"As a reader of this blog almost since the beginning it pains me greatly to see a certain poster constantly bringing up politics."
Sorry to be smart aleck, but do you mean the poster named "Anonymous?"
Show your aversion to it by registering.
I am not sure why everyone always compares what they do to a portfolio of 100% SP500.
Because it is widely considered as THE PROXY for U.S. equity exposure.
OK. You are going to add some foreign developed, some emerging, some small-cap, etc. Even if you stick with index funds, you are still making a somewhat ACTIVE decision in your percentages and when you rebalance.
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