China at 45 Times Earnings = Bubble

Yes China's economy is growing. Its' financial markets may go on up higher for some time. But no, it cannot grow fast enough to justify such valuations. Period. Simple enough? For you and for me, um-hum. For all the speculators out there praying for greater fools to keep coming in, and for investing newbies, 'fraid not. We are living in interesting times.


Bloomberg.com: Exclusive

The Correction has been Corrected!

So, if the market has made back the ground lost due to the "correction" -- I despise that word -- does that mean that the correction was incorrect? Mark Hulbert discusses it.



February-March correction now completely overcome - MarketWatch

What do You Think of the Dow Theory? What do the Researchers Think?

For those who are into the Dow Theory version of technical analysis, Mark Hulbert at MarketWatch has a bit of a review, which I've linked to below, including the interesting note that the three Dow Theory newsletters do not agree on what it says about the present state of the market and the outlook. two are bullish, and the third is bearish. Now stop and think on that for a moment.

Hmmm. Academic researchers pretty much "busted" the Dow Theory decades and decades ago. Mark does refer to one Journal of Finance article all the way back in 1998 which argues for its validity. I don't know if anyone other than the authors was convinced! The Dow theory, like technical analysis generally, has pretty much been in the academic dumper for a generation now. When you test it, it consistently fails to succeed any more often than dart-throwing at the Wall Street Journal.

So, why do people cling to ideas after they are tried in the crucible of research and found to fail? Is it a matter of human nature? Of needing something on which to base decisions? Two things are definitely true. First, the folks who sell newsletters have a conflict of interest. They make a lot of money selling those newsletters. Second, Wall Street's brokerages like clients who trade a lot, be they big hedge funds or little guys investing on their own with newsletter in hand. They have a conflict also. Trading is money, commissions and/or spreads (discounts or premiums, technically,) on crossing transactions to them. Applying a technical analysis-based approach requires a lot of trading, generally. Being as gentle about this as possible, they are self-interested, and the consequences of conceding the failure of technical analysis would be somewhat difficult, particularly for the newsletter writers.

Also, what do you base investment decisions on, if this old, once-popular approach is not really any good? I have advocated in this blog a globally-diversified, multiple asset class approach, using indexed vehicles at least as the default choice. This approach has excellent research support. Well, you may ask, it this idea is so good, why isn't everybody doing it?

Mr. Roger Gibson wrote one of the most remarkable books on investing, primarily for financial advisors, Asset Allocation - Balancing Financial Risk. (3rd. ed., Mcgraw-Hill, 2000.) He writes of what he calls a "quadrant 4 worldview of investing", where the investor, after reviewing what is known about the realities of investing, concludes that neither market timing nor active security selection (stock-picking, for us,) will succeed over time in beating the market. The quadrant 4 worldview is in good accord with the consensus of a mountain of objective financial research. So he writes on the implications of a quadrant 4 view:

"First, a quadrant 4 worldview undercuts to a large degree the reason for the existence of the money management profession." It means that the billions and billions of dollars in fees and expenses investors pay to keep up the lifestyles of the cast of thousands employed in attempts to beat the market are largely wasted. Worse than wasted actually, as what you get for trying to beat the market these ways is that usually you do worse than the market, when all the costs are counted. So, who at your local wirehouse brokerage or online broker is going to tell you that!

They don't even typically talk about that to each other. What newsletter writer is going to want to face that, much less tell you?

The beauty of the "quadrant 4 worldview" is that it lets you, knowing the score, knowing the reality of risk, use market forces rather than fight them. it lets you invest in hope based on what is real! Market returns over time have been good enough to be really worth going after. And wouldn't you, when you think about it expect it to be that way when all is said and done?





What the Dow Theory has to say about current stock market - MarketWatch

Does Mutual Fund Upgrading Work? Part One

I'll be posting on a few of the commonly-encountered mutual fund upgrading approaches. Tip-off: there is essentially no objective research support for this idea. It is one approach to trend-following as an investment approach. We'll start with an overview of how these things try to work.

Fund upgrading approaches are often, but not exclusively based on someone's proprietary, undisclosed quantitative method for determining what kind of securities are moving upward, for which information you pay them. You would generally describe this as what is known as a technical approach. You buy the recommended funds, holding on to them as the trend continues to work, then selling and either going to cash if nothing is working or buying into a new trend when it shows up. It sounds powerful.

Is there a fly in the ointment?

Usually. Mutual funds generally do not like this behavior, as it screws up management of the fund. Cash moving in and out based on "market timing" systems forces them to buy and sell securities at times when they do not see doing so as beneficial to their investors, as short term gains are generated, portfolio trading costs are incurred, and their "steady" investors are left holding the bag. So they retaliate by imposing short-term trading fees and penalties, which can be as much as one or two percent of the amount invested. Get hit by charges like this two or three times in a year and you will be left wondering why you have fallen behind. The upgraders have evolved toward using exchange-traded funds and some funds which are more open to people trading in and out of them. Those funds typically nick you with hefty expense ratios though. So what you see is the upgraders having fewer choices with regard to actively-managed funds, and part of the appeal of that idea was the hope of finding the funds with managers on a hot streak, and getting in on the action while that fund's hot streak lasted. It's harder and harder to do that now. Index funds don't like people moving in and out like this either, for most of the same reasons.

But wait, there's more! Academic research mostly supports the idea that there is such a thing as a trend, sometimes. And, the research supports the idea that a trend can continue, for a time, sometimes. But trends end, randomly, unpredictably. Whenever it ends, it ends. Unless it doesn't! Sometimes they stutter. There is no research to tell you how to figure out when a trend will end. Market valuations can and do go to extremes, both high and low, sometimes. Sometimes trends end with a really bad reversal. Think dot-coms in the year 2000.

And that's not all! If you are out of the market when an investment style or asset class begins to move up, you miss participating in it. By the time you get in, you may have missed a good bit of it. Think of it as Investing 101: market timers just fall behind more and more over time. Steady investors (if they are well invested!) capture the full upward movement of the markets, including dividends, and their gains when they sell are long term and tax-favored, presuming we're talking about a taxable account of course. Patience wins big for you over the more impatient approaches. There is some justice in the world!

In the next week or so, I'll put up a few posts looking at returns of several trend-following approaches which have created mutual funds you can buy to get the convenience of their picks in one fund.