Sunday, October 16, 2016

Being Long is Worth the Bet -
Despite Consensus


Consensus turns out to be correct occasionally. As  alluded to in last week's post, published bookmakers’ odds are simply the ratio of the amount of money bet on a particular horse, issue, or perhaps someone running for election. There is often a big difference in the confidence expressed by aggregate money and the probabilities of success. Even to themselves (let alone to any third party) voters rarely say why they voted the way they did. After many political elections the people who claim that they voted for the eventual winner is significantly higher than the recorded reality. It is not my professional function to guess which way an election will turn out and history suggests it may not matter as events that take place after the election will determine the enacted policies.

As a professional investor and portfolio manager for institutional and high net worth clients, the essence of my job is to make reasonable judgments about the future course of markets; first to reduce the chances of meaningful capital losses and second to increase the opportunities to grow capital. Notice I phrase my tasks in terms of chances. In other words, I focus on the odds. Thus, one can see why I believe my early exposure to going to the racetracks was instructive. At the time the New York tracks offered the most in prize money and therefore probably had not only the best horses running but also the savviest bettors.  (This was good training for future competition in picking stocks and funds.) At the track the amount of money bet on a particular horse identified the favorite of the betting crowd's dollars. In other words the favorite was the consensus bet. There were two problems with betting on the favorite. Roughly they win only about a third of the time. More importantly the winning payoff from favorites rarely covers more than one losing bet and often not enough to bring the losing bettor to break even. As we all are driven by our own experiences and hopefully those of accepted others, I do not favor consensus bets for investments.

Reading the Consensus is Useful

One of the important investment lessons is that to be successful is to be dependent on someone else to buy your merchandise at a high price. Thus, it is critical to understand the motivation of other investors. By definition many investors are guided by the consensus. 

If one reads what most of the pundits are saying they are more concerned about the present risks than opportunities. This is understandable in view of slow growing or contracting economies with declining productivity, political uncertainties globally, and low nominal manipulated interest rates. A number of market analysts are flashing danger or at least caution signs and reminding us as to the current length of the bull markets.

Consumers are worried about their own economic future. With the mix of population growing older some people may be worried that their retirement capital is insufficient. (Long-term this could be a positive for the investment segment of the market.)

Missing Opportunities from the Past

Going back to the horse racing analysis, longer races allow for temporary recoveries and tend to favor higher quality horses. The same is generally true with investments. In his recent blog,  Bill Smead of Smead Capital published the following chart:
S&P 500: 1926- 2015

Time Frame
% Positive
% Negative
1 Year
5 Years
10 Years
20 Years

Two worthwhile items to note. The first is that the table is just expressed in gains and losses and their size. The second is that historical experience supports our concept of the TIMESPAN L Portfolios ® . We assume that the shorter term portfolios will produce more cyclical performance and the longer term portfolios will show more secular growth.

One attempt size the positives and negatives is this week's Barron's Big Money Poll. Among other questions, one asked what were the chances that the S&P500 would reproduce its long-term performance of approximately 9% per year?  Of the responses, 80% felt that it would not produce this return over the next five years, but 44% of the participants felt that over ten years the index would also underperform. The implication is that the aggregate group is looking for an acceleration in growth in the second five year period.

My Guess

With so many people being worried about the outlook, particularly the near term, I believe there is not a great deal of risk in terms of the permanent loss of capital by remaining long this equity market. I am somewhat comfortable accepting that there can be intermediate price declines of up to 25%. Over the next five to twenty year periods mentioned, there are upside potentials of multiple doubles. Thus it is worth the bet.


For those that attempt to use any particular day to trade rather than a long series, be careful about intraday trading. Currently on many days the pattern of trading is similar to those that my grandfather knew. This view is reinforced when one looks at the number of floor traders working orders at trading posts on the floor of the New York Stock Exchange as shown on cable television. They are busy on the opening and closing. For periods in between, I suspect they are active in off-floor trading with institutions. The opening benefits from orders from Europe which often means more buying than selling as long as the US dollar is rising in value. (I do not expect that the trend to continue.) I have noticed that unless the market is strong at the end of the day, often the gains of the session are reduced as traders want to lessen their exposure overnight.  Investors should be conscious as to the timing and methods of placing orders as it is an important skill in this period of low returns. One of the advantages of using mutual funds as the medium of investment is that orders for fund shares are executed on a forward basis meaning that execution price will be the price of the net asset value on the close.

In Conclusion

Use consensus not as a guide but as a recipient of your investments. Relax through periodic declines. The odds favor the long-term investors.

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A. Michael Lipper, C.F.A.,
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