The Blumenthal Viewpoint: Behavior Gap

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August 23, 2013
By Steve Blumenthal

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An advisor client called the other day and wanted to talk about investor behavior.  Broadly diversified portfolios will always underperform the top performing asset classes at any given time.  He wanted to know how I might advise a client who is comparing his total investment portfolio performance to a single index like the S&P 500 Index.  I’m sure you face similar calls.

Our industry’s canned response is to say that “We’re in it for the long haul”.  Though I think you’ll agree this answer is not enough for most clients, let’s see if we can break this down and give your clients some real data.  What follows is my attempt at answering this question and I hope it proves useful to you as you sit with your clients.

Absent from memory are the two 50% market corrections in the last 13 years.  Big corrections happen from time to time and will happen again.  A new cyclical bear?  Yes.  When?  Soon (I think) but exactly when I do not know.

Ask your client if he is an investor or a speculator.  Investing is about broad risk diversification; speculating is about taking targeted bets.  Both approaches are ok.  Which one is he?

While keeping your client educated is important; keeping him on plan is vital.  Here is some data to share:

  • The S&P 500 Index is up 20% year-to-date; however, no broadly diversified portfolio is up 20%,
  • a Global 60/40 portfolio is up approximately 7%,
  • a U.S. 60/40 portfolio is up approximately 10% and
  • while U.S. equities are the world’s best asset class, the U.S. bond market is down close to 5% (take 60% of +20% and 40% of -5% and you get approximately 10%).

From May 22 to June 24, 2013, the S&P 500 lost 5.6%, MSCI EAFE lost 10.1%, MSCI Emerging Markets fell 15.3%, the Dow Jones/UBS Commodity index fell 4.5%, the U.S. 10-year T-Note fell 4.4%, and the Barclays U.S. TIPS index fell 7.1%. For good measure, the J.P. Morgan Emerging Debt Global index fell 10.8%, the German 10- year Bund fell 5.2%, the UK 10-year Gilt fell 3.4%, and the Australian 10-year bond fell 6.5%.  Equity markets have made a fairly sharp recovery since then, with the S&P 500 actually hitting new highs, but lots of other asset classes are still licking their wounds.  Source: Ben Inker

Emerging markets are down over 10%, Biotech is up more than 40%.  The Market Vectors Gold Miners ETF is down over 35%, the SPDR Gold Shares is down 18%, the SPDR Regional Banking ETF is up over 32%, the Vanguard REIT ETF is flat, Health Care is up over 25% and the Vanguard Total World Stock Market ETF is up 11%.  Forget the comparison to the S&P; give me Biotech at +40%. (Data through July 2013)  Investor or speculator?

I reflect back on one of the best investment books I have ever read titled Reminiscences of a Stock Operator.  I was a young institutional broker at Merrill Lynch and my mentor, John Ray, was a star portfolio manager at Delaware Funds.

The book details the career of Jesse Livermore, who, just out of grammar school, goes to work as a quotation-board boy in a stock-brokerage office.   Livermore develops a feel for the stock market and, in time, begins to speculate.

He’s not an investor — he’s a speculator.  He gambles in stocks.  He does a good job of it building a million dollar fortune during his twenties.  Then he loses everything.  In fact, Livingston makes and loses several million dollar fortunes between 1901 and 1921.

This book is one of the most helpful books I have ever read on investing.   Following are a few quotes:

  • After spending many years in Wall Street and after making and losing millions of dollars, I want to tell you this:  It was never my thinking that made the big money for me. It was always my sitting.  Got that?  My sitting tight!
  • Nowhere does history indulge in repetitions so often or so uniformly as in Wall Street. When you read contemporary accounts of booms or panics, the one thing that strikes you most forcibly is how little either stock speculation or stock speculators today differ from yesterday.  The game does not change and neither does human nature.
  • Tips!  How people want tips!  They crave not only to get them but to give them.  There is greed involved and vanity…  It has always seemed to me the height of damfoolishness to trade on tips… The belief in miracles that all men cherish is born of immoderate indulgence in hope.
  • There is profit in studying the human factors — the ease with which human beings believe what it pleases them to believe; and how they allow themselves — indeed urge themselves — to be influenced by their cupidity or by the dollar-cost of the average man’s carelessness.   Fear and hope remain the same; therefore, the study of the psychology of speculators is as valuable as it ever was.
  • The sucker has always tried to get something for nothing and the appeal in all booms is, frankly, to the gambling instinct aroused by cupidity and spurred by a pervasive prosperity.  People who look for easy money invariably find that it cannot be found on this sordid earth.

“My sitting tight!”  I don’t know anyone who can pick winners trade after trade.  It doesn’t exist.  John Paulson got rich shorting sub-prime.  He had to sit tight as the trade continued to move away from him until it came his way.  There was no evident bubble in the housing market according to Greenspan.  Remember that?  How many clients called Paulson to tell him he was nuts?  Some couldn’t stay the course.  Paulson and his clients that stayed the course got super rich.

I’ll add that today, Paulson is again taking heat as his fund is down a great deal over the last few years.  He and his brilliant team are not looking so smart today.  Is he right on his bets?  Don’t know.  Go all in on one manager?  Not for me.

Kyle Bass excelled in 2008.  He too shorted sub-prime.  I don’t believe his fund is up 20% year-to-date.  His favorite trade is long gold, short yen.  Is he right or wrong?  He’s “sitting tight”.  I like that trade.  It is underperforming the S&P year-to-date.  Switch from him to the S&P?

Buffett is good great.  Buffett is perhaps the best modern day performer yet he too has had years when his investors said he lost his touch.  Perhaps it was simply that his value approach was out of favor.

Most stock mutual funds fail to outperform their benchmarks.  There are smart managers running those funds.  The individual investor is up against the greatest pros in the business and those pros work 70 hours a week.  They can’t pick the top winners all the time.

As you answer your client’s questions about returns, ask him if he is a speculator or an investor.  Speculation might be his path.  That’s ok but he should know that very few, even the greats, might make millions yet might lose the same on their next targeted bet.  If he is an investor, coach him back to plan.  If he is a speculator, there is a good chance he will not be your client for long.

This is a game of probabilities and while you might be 100% correct on a particular risk, you might just not have the time and inner belly to patiently live through the painful decline you’ll experience along the way to being right.

I loved the following quote from GMO’s Ben Inker in his piece titled, What the *&%! Just Happened?  “I’d like to put our current positioning in terms of a summer camp metaphor. We’re in a canoe race to the other side of the lake. We know all of the canoes are old and a bit leaky in the best of times and there’s a storm coming. If we knew the storm was going to break now, we’d just stay in the cabin and laugh at everyone else as they were forced to turn around and trudge back to the cabin, sopping wet and half drowned. But we don’t know when the storm will break or even if it might miss us altogether, so we’ve stuck an extra guy in the middle of our boat with a bucket instead of a paddle. We know it will slow us down, but it will go a long way to help ensure we don’t sink along the way, even if we’re resigned to the likelihood of a long slow paddle in the rain, sitting in water up to our ankles.”

Below are links to a few other pieces I have found helpful in supporting the need to diversify and also to help address investor’s tendency to consistency buy and sell at the wrong time:

  • Blackrock, the world’s largest money manager, hired my good friend, Dr. Christopher Geczy, and put together this highly educational piece.  The next time your client calls and says the guy across the street can give him better returns, please feel free to share this piece, and others like it, and I hope it helps him re-center back to plan.
  • Adaptive Markets Hypothesis
  • Thinking, Fast and Slow by Daniel Kahneman
  • Morningstar Investor Behavior Chart – 20 years of poor behavior
  • Vanguard’s John Bogle – “The moment the temptation gets to its highest level [is] when people start to think, ‘I’ve got to change now,’ and that’s the worst time to do it.”1

 1Bogle quote source:

You are advisor, coach and psychologist.  This is not an easy task but it is deeply rewarding.  Dealing with investor behavior is critical along the path to financial success.  It takes discipline and a strong ability to help re-center your client at important inflection points.  Dear Investor, stick to the game plan!

I finish today with a quick aside about Reminiscence of a Stock Operator.  In 1984 and for years that followed, I would walk a few blocks from 15th and Market in downtown Philadelphia to John Ray’s office.  I was always nervous.  I knew very little about the business but was hungry to learn.  “John, what should I read?”  He handed me his copy and said “I want it back”.

What I learned more than 30 years ago applies today.  There is a psychology to investing and human behavior plays the most critical role.  Human emotions don’t change and are predictable.  It took years before I could understand what John was teaching me.  Every so often Linda lets me know that John Ray is on the phone.  She then blocks out my schedule for the next 45 minutes.  I want to know what John has to share.  He is super smart and his market instincts are shaper than ever.  It is a real treat for me.  Thankfully, I’m no longer nervous.

My two cents on investor behavior:

Speculator or investor?  You can’t switch back and forth tied to emotions and yesterday’s strong move.  If you are a speculator, maybe short the Yen and short the U.S. Government bond market.  Perhaps go big on your company’s stock.  Exxon has worked well and made long-term holders rich (assuming they stayed the course post the last two major market declines). Going “all in” on Enron didn’t work.  I can promise that the emotional roller coaster will not be easy along the way.

If you are an investor, actively hedge long-term focused equity exposure, shorten up and tactically manage your fixed income exposure and muscle up on other non-correlating risk streams like Tactical Equity, Long or Short Strategies, Managed Futures and Managed Currency.  Think three diverse buckets: Equities, Fixed Income and Tactical-Alternative-Other.  There are a number of solid solutions available in a managed account or mutual fund structure.

We are living in an unprecedented and highly manipulated period.  I believe that the biggest bubble of all time now exists in the bond market. I know no one who can get the bets right all the time.  Wish I could.  Educate, share this piece and other important research on investor behavior with your clients.  Most importantly, have a plan in place and let your client know you are going to work hard over the years to coach him to execute his game plan.

I am going to call my good buddy, John Ray.  China and others are buying less of our bonds while the Fed is buying 100% of newly issued Treasurys – one of the concerns John foresaw last fall.  It’s time for me to see what is on his radar – I know that I am way overdue.  I’m sure there is a mentor in your life too.  Give him or her a call.  Life is moving just too quickly.

Wishing you an outstanding weekend.


Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
610-989-9090 Phone
610-989-9092 Fax


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