Posts tagged ‘European Crisis’
Time Arbitrage: Investing vs. Speculation
The clock is ticking, and for many investors that makes the allure of short-term speculation more appealing than long-term investing. Of course the definition of “long-term” is open for interpretation. For some traders, long-term can mean a week, a day, or an hour. Fortunately, for those that understand the benefits of time arbitrage, the existence of short-term speculators creates volatility, and with volatility comes opportunity for long-term investors.
What is time arbitrage? The concept is not new and has been addressed by the likes of Louis Lowenstein, Ralph Wanger, Bill Miller, and Christopher Mayer. Essentially, time arbitrage is exploiting the benefits of moving against the herd and buying assets that are temporarily out of favor because of short-term fears, despite healthy long-term fundamentals. The reverse holds true as well. Short-term euphoria never lasts forever, and experienced investors understand that continually following the herd will eventually lead you to the slaughterhouse. Thinking independently, and going against the grain is ultimately what leads to long-term profits.
Successfully executing time arbitrage is easier said than done, but if you have a systematic, disciplined process in place that assists you in identifying panic and euphoria points, then you are well on your way to a lucrative investment career.
Winning via Long-Term Investing
Legg Mason has a relevant graphical representation of time arbitrage:
Source: Legg Mason Funds Management
The first key point to realize from the chart is that in the short-run, it is very difficult to distinguish between gambling/speculating and true investing. In the short-run (left side of graph), speculators can make nearly as much profits as long-term investors. As famed long-term investor Benjamin Graham astutely states:
“In the short-run, the market is a voting machine. In the long-run, it’s a weighing machine.”
Or in other words, speculative strategies can periodically outperform in the short run (above the horizontal mean return line), while thoughtful long-term investing can underperform. Like a gambler/speculator dumping money into a slot machine in Las Vegas, the gambler may win in the short-run, but over the long-run, the “house” always wins.
Financial Institutions are notorious for throwing up strategies on the wall like strands of spaghetti. If some short-term outperforming products randomly stick, then financial institutions often market the bejesus out of the funds to unsuspecting investors, until the strategies eventually fall off the wall.
Beware o’ Short-Termism
I believe Jack Gray of Grantham, Mayo, Van Otterloo got it right when he said, “Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth.” What’s led to the excessive short-termism in the financial markets (see Short-Termism article)? For starters, technology and information are spreading faster than ever with the proliferation of the internet, creating a sense of urgency (often a false sense) to react or trade on that information. With 3 billion people online and 5 billion people operating mobile phones globally, no wonder investors are getting overwhelmed with a massive amount of short-term data.
Next, trading costs have also declined dramatically in recent decades to the point where brokerage firms are offering free trades on various products. Lower trading costs mean less friction, which often leads to excessive and pointless, profit-reducing trading in reaction to meaningless news (i.e., “noise”). Lastly, the genesis of ETFs (exchange traded funds) has induced a speculative fervor, among those investors dreaming to participate in the latest hot trend. Usually, by the time an ETF has been created, any exploitable trend has already been exploited. In other words, the low-hanging profit fruits have already been picked, making long-term excess returns tougher to achieve.
There is rarely a scarcity of short-term fears. Currently, concerns vary between Federal Reserve monetary policy, political legislation, Middle East terrorism, foreign exchange rates, inflation, and other fear-induced issues du jour. Markets may be overbought in the short-run, and/or an unforeseen issue may derail the current bull market advance. However, for investors who can put on their long-term thinking caps and understand the concept of time arbitrage, opportunistically buying oversold ideas and selling over-hyped ones should lead to significant profits.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Sitting on the Sidelines: Fear & Selective Memory
Fear is a motivating (or demotivating) emotion that can force individuals into suboptimal actions. The two main crashes of the 2000s (technology & housing bubbles) coupled with the mini-crises (e.g., flash crash, European crisis, debt ceiling, sequestration, fiscal cliff, etc.) have scared millions of investors and trillions of dollars to sit on the sidelines. Financial paralysis may be great in the short-run for bruised psyches and egos, but for the passive onlookers, the damage to retirement accounts can be crippling.
Selective memory is a great coping mechanism for those investors sitting on the sidelines as well. Purposely forgetting your wallet at a group dinner may be beneficial in the near-term, but repeated incidents will result in lost friends over the long-run. Similarly, most gamblers frequenting casinos tend to pound their chests when bragging about their wins, however they tend to conveniently forget about all the losses. These same reality avoidance principles apply to investing.
A recent piece written by CEO Bill Koehler at Tower Wealth Managers, entitled The Fear Bubble highlights a survey conducted by Franklin Templeton. In the study, investors were asked how the stock market performed in 2009-2012. As you can see from the chart below, perception is the polar opposite of reality (actual gains far exceeded perceived losses):
Source: Franklin Templeton via Tower Wealth Managers
With so many investors sitting on the sidelines in cash or concentrated in low-yielding bonds and gold, I suppose the results shouldn’t be too surprising. Once again, selective memory serves as a wonderful tool to bury the regrets of missing out on a financial market recovery of a lifetime.
Humans also have a predisposition to seek out people who share similar views, even though accumulating different viewpoints ultimately leads to better decisions. Morgan Housel at The Motley Fool just wrote an article, Putting a Gap Between You and Stupid, explaining how individuals should seek out others who can help protect them from harmful biases. A scientific study referenced in the article showed how the functioning of biased brains literally shuts down:
“During the 2004 presidential election, psychologist Drew Westen of Emory University and his colleagues studied the brains of 15 “committed” Democrats and 15 “committed” Republicans with an MRI scanner. Each group was shown a collection of contradictory statements made by George W. Bush and John Kerry. Not surprisingly, the partisans were quick to call out contradictions made by the opposing party, and made up all kinds of justifications to rationalize quotes made by their own side’s candidate. But here’s what’s scary: The participants weren’t just being stubborn. Westen found that areas of their brains that control reasoning and logic virtually shut down when confronted with a conflicting view of their preferred candidate.”
Rather than letting emotions rule the day, the proper approach is to stick to unbiased numbers like valuations, yields, fees, and volatility. If you continually make mistakes; you aren’t disciplined enough; or you don’t like investing; then find a trusted advisor who uses an objective financial approach. Opportunistically taking advantage of volatility, instead of knee-jerk reactions is the preferred approach. For those people sitting on the sidelines and using selective memory, you may feel better now, but you will eventually have to get in the game, if you don’t want to lose the retirement account game.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is the information to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Time Arbitrage: Investing vs. Speculation
The clock is ticking, and for many investors that makes the allure of short-term speculation more appealing than long-term investing. Of course the definition of “long-term” is open for interpretation. For some traders, long-term can mean a week, a day, or an hour. Fortunately, for those that understand the benefits of time arbitrage, the existence of short-term speculators creates volatility, and with volatility comes opportunity for long-term investors.
What is time arbitrage? The concept is not new and has been addressed by the likes of Louis Lowenstein, Ralph Wanger, Bill Miller, and Christopher Mayer. Essentially, time arbitrage is exploiting the benefits of moving against the herd and buying assets that are temporarily out of favor because of short-term fears, despite healthy long-term fundamentals. The reverse holds true as well. Short-term euphoria never lasts forever, and experienced investors understand that continually following the herd will eventually lead you to the slaughterhouse. Thinking independently, and going against the grain is ultimately what leads to long-term profits.
Successfully executing time arbitrage is easier said than done, but if you have a systematic, disciplined process in place that assists you in identifying panic and euphoria points, then you are well on your way to a lucrative investment career.
Winning via Long-Term Investing
Legg Mason has a great graphical representation of time arbitrage:
Source: Legg Mason Funds Management
The first key point to realize from the chart is that in the short-run it is very difficult to distinguish between gambling/speculating and true investing. In the short-run, speculators can make money just as well as anybody, and in some cases, even make more profits than long-term investors. As famed long-term investor Benjamin Graham so astutely states, “In the short run the market is a voting machine. In the long run it’s a weighing machine.” Or in other words, speculative strategies can periodically outperform in the short run (above the horizontal mean return line), while thoughtful long-term investing can underperform.
Financial Institutions are notorious for throwing up strategies on the wall like strands of spaghetti. If some short-term outperforming products spontaneously stick, then the financial institutions often market the bejesus out of them to unsuspecting investors, until the strategies eventually fall off the wall.
Beware o’ Short-Termism
I believe Jack Gray of Grantham, Mayo, Van Otterloo got it right when he said, “Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth.” What’s led to the excessive short-termism in the financial markets (see Short-Termism article)? For starters, technology and information are spreading faster than ever with the proliferation of the internet, creating a sense of urgency (often a false sense) to react or trade on that information. With more than 2 billion people online and 5 billion people operating mobile phones, no wonder investors are getting overwhelmed with a massive amount of short-term data. Next, trading costs have declined dramatically in recent decades, to the point that brokerage firms are offering free trades on various products. Lower trading costs mean less friction, which often leads to excessive and pointless, profit-reducing trading in reaction to meaningless news (i.e., “noise”). Lastly, the genesis of ETFs (exchange traded funds) has induced a speculative fervor, among those investors dreaming to participate in the latest hot trend. Usually, by the time an ETF has been created, the cat is already out of the bag, and the low hanging profit fruits have already been picked, making long-term excess returns tougher to achieve.
There is never a shortage of short-term fears, and today the 2008-09 financial crisis; “Flash Crash”; debt downgrade; European calamity; upcoming presidential elections; expiring tax cuts; and structural debts/deficits are but a few of the fear issues du jour in investors’ minds. Markets may be overbought in the short-run, and a current or unforeseen issue may derail the massive bounce from early 2009. For investors who can put on their long-term thinking caps and understand the concept of time arbitrage, buying oversold ideas and selling over-hyped ones will lead to profitable usage of investment time.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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