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The optimal portfolio of risky assets is exactly the same for everyone :

1. Investors should control the risk of their portfolio not by reallocating among risky assets, but through the split between risky and risk-free assets.

2. The portfolio of risky assets should contain a large number of assets – it should be a well diversified portfolio.

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( Source : https://theirrelevantinvestor.wordpress.com/2016/01/12/probably-everything-you-need-to-know-about-bear-markets/ )

10%= correction, 20%= bear market.

I know these arbitrary numbers sometimes seem silly, but when looking at the data, you have to draw the line somewhere. Get over it, let’s move on.

The S&P 500 has been in a drawdown for the last eight months. Stocks are currently 9.2% below the highs made in May 2015, just a hair away from official correction territory. Everyone knows this is totally normal, but you might be surprised to know that since 1928, stocks have been in a 10% drawdown 55% of the time. The problem of course is that they never feel normal because we don’t know in real time if this is just a correction or the start of a bear market. And the deeper stocks go, the harder it is to resist fear’s temptation.

In times like this, historical facts don’t provide much comfort and even less of a roadmap, however, hopefully they can provide a little context.

Since 1928, there have been fifteen separate drawdowns of 10%. Before I continue, you might be thinking, “only fifteen corrections, that doesn’t sound right.” Here’s how I look at drawdowns; in my mind, a drawdown is not over until new highs are made. Of these fifteen corrections, ten have turned into a bear market.

Let’s take a closer examination of these 20% declines because not all bear markets are created equal. There are secular bear markets, which by their nature can only be defined after the fact. These are long periods of time in which stocks make little progress. Then there are cyclical bears, which can come in the middle of a long secular bear or even a secular bull. The chart below shows the three secular bears over the last ninety years.

As you can see, the defining characteristic for secular bears is that stocks make no progress for long periods of time. Even worse, they experience severe declines which can scar an entire generation of investors. The chart below shows the painful drawdowns investors witness during these secular bear markets.

The frustrating thing about each and every bear is it’s impossible to know how long they will last. Think about the most recent secular bear, which lasted from March 2000 through March 2013 (I think it’s over, though reasonable people can disagree on this). Stocks briefly poked their heads above their 2000 highs in October 2007 before being slammed right back into their decade long range. Investors had a similar experience in 1980; break above the long range for a minute only to be delivered one final gut punch.

Looking at bear markets over long periods of time might not be as helpful as breaking them down further. Within the three secular bears have been distinct cyclical bears (think the tech bubble of 2000 and credit bubble of 2007). Here is how I’ve compiled the data below; any time there is a 20% rally, the bear market is over. What this does is break up 1929-1954 period into 11 separate bear markets.

The average of these 20 distinct bear markets saw a 36% peak-to-trough decline, lasting just over 52 weeks. The fifth column shows how long each bear was and the the sixth column shows how quickly stocks gained 20% from their lows, resetting the bear market. For instance, the October ’07 peak to the March ’09 lows was 74 weeks. Stocks then rallied 20% in 4 weeks, making 78 weeks the total length of that particular bear market.

Whether the S&P 500 sees a correction, and whether or not that turns into a bear market, and how deep it might go and how long it might last is anybody’s guess. The only thing in your control is what you choose to do or not do. Making decisions in the heat of the moment is almost never a good idea, which is why having a plan in place is so important. Knowing that you have an answer, whether stocks go up, down or sideways a is really liberating feeling.

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(Source :  http://jimoshaughnessy.tumblr.com/post/137235375474/short-term-luck-versus-long-term-skill )

Daniel Kahneman, one of the fathers of behavior economics, said one of his favorite papers was “On the Psychology of Prediction (1973).” He claims in the paper that intuitive predictions are often unreliable because people base their predictions on how well an event fits a story. In behavioral economics, this phenomena is called a judgmental heuristic—representativeness, or how familiar you are personally with the story. This is one of the worst ways to make a forecast, because it uses a highly limited data set and allows the law of small numbers to mislead you and your forecast. For example, one study showed that when a doctor is told that a procedure works 50 percent of the time (essentially a coin toss probability or base rate) he or she could get the majority of patients to undergo the procedure if he or she simply added “The last patient who did this is doing great!” The story of success eliminates consideration of the base rate.

I recommend that to successfully make predictions about the long-term results of something such as an investment strategy or the overall direction of a market, you must consider three things:

1.      The long-term base rate of the success or failure of the strategy you are evaluating;

2.      The tendency of systems where both luck and skill are involved to revert to the mean and;

3.      What happened historically after certain extreme observations.

So, for example, when I wrote the commentary entitled “A Generational Buying Opportunity” in March of 2009, I was not relying on any particular insight that I might have had at the time, but rather on the data available to me about what happens in markets after they reach an extreme infection point.  It’s important to remember that the stock market is a complex, adaptive system with feedback loops that has elements of both luck and skill. Luck, in the stock market, essentially holds sway over the short-term and is a specific chance occurrence that affects the overall market or individual stock or portfolio can be either good or bad. Luck is a residual—it’s what is left over after you subtract skill from the outcome.

How much luck is involved determines the range of outcomes—where little luck is involved, a good process will almost always lead to a good outcome. Where a measure of luck is involved, a good process will usually have a good outcome, but only over longer periods of time. The luck/skill continuum in investing is almost entirely a function of time. Over shorter periods, your results are highly contingent on luck and chance. This is vital to understand because you might see a bad process provide excellent results due entirely to chance and a good process provide poor results for the same reason.

Consider a simple intuitive strategy of buying the 50 stocks with the best annual sales gains. But consider this not in the abstract but in the context of what had happened in the previous five years:

Year                            Annual Return            S&P 500 return

Year one                      7.90%                          16.48%

Year two                     32.20%                        12.45%

Year three                   -5.95%                         -10.06%

Year four                     107.37%                      23.98%

Year five                     20.37%                        11.06%

Five-year

Average Annual

Return                         27.34%                        10.16%

$10,000 invested in the strategy grew to $33,482 dwarfing the same investment in the S&P 500, which grew to $16,220. The three-year return (which is the metric that almost all investors look at when deciding if they want to invest or not) was even more compelling, with the strategy returning an average annual return of 32.90% compared to just 7.39% for the S&P 5000. Also consider that these returns would not appear in a vacuum—if it was a fund it would probably have a five start Morningstar rating; it would probably be featured in business news stories quite favorably and the “long-term” proof would say that this intuitive strategy made a great deal of sense and would attract a lot of investors.

Here’s the catch—the returns shown are from “What Works on Wall Street” and are for the period from 1964 through 1968, when, much like the late 1990s, speculative stocks soared. Investors without access to the very long-term results to this investment strategy would not have the perspective that the longer term brings, and without these tools, might have jumped into this strategy right before it went on to crash and burn. As the data from What Works on Wall Street makes plain, over the very long term, this is a horrible strategy that returns less then U.S. T-bills over the long-term. Had this investor had access to long-term returns, he or she would have seen that buying stocks based just on their annual growth of sales was a horrible way to invest—the strategy returned just 3.88 percent per year between 1964 and 2009! $10,000 invested in the 50 stocks from All Stocks with the best annual sales growth grew to just $57,631 at the end of 2009, whereas the same $10,000 invested in U.S. T-Bills compounded at 5.57 percent per year, turning $10,0000 into $120,778. In contrast, if the investor had simply put the money in an index like the S&P 500, the $10,000 would have earned 9.46 percent per year, with the $10,000 growing to $639,144! An investment in All Stocks would have done significantly better, earning 11.22 percent per year and turning the $10,000 into $1.33 million! What the investor would have missed during the phase of exciting performance for this strategy is that, in the end, valuation matters, a lot.

This is a good example of why Kahneman’s paper is so important—people make forecasts not on the data, but how well the prediction fits their perspective and the story behind it. Extrapolating from a small data set can be disastrous to long-term results. The “Most Dangerous Equation” was derived by Abraham de Moivre and states that the variation of the mean is inversely proportional to the size of the sample. A small sample tells you nothing about the true direction of results. Using a small sample—as we see above—can lead to costly errors over the long term.

What this tells us

1.      Investors are well advised to look at short-term performance as a worthless indicator for what will happen over the long-term. Indeed, short-term performance can be among the most misleading to investors and should be heavily discounted. The stock market combines both luck and skill, with luck more pronounced over short time periods, and skill more telling over long periods of time.

2.      Investors should make decisions using the long-term base rates a strategy exhibits—in other words, they should concentrate on what is probable rather than what is possible. If you organized your life around things that might possibly happen to you, you’d probably never leave your house, and when you did, it would only be to buy a lottery ticket. Consider, on a drive to the supermarket, it is highly probable that you will get there, buy your groceries and get back home to unpack them without incident. But what’s possible? Almost anything—it’s possible a plane flying overhead could lose an engine falling directly on your car and instantly killing you. It’s possible another car runs a red light and kills you on impact. It’s possible that you get carjacked and your assailant kills you in the process. You get the point—anything is possible but highly improbable. It’s only when you think in terms of probability that you will get in your car and go, yet few investors do so when making investment decisions. Our brains create cause and effect narratives after something has occurred that seem to make sense, however improbable the event. Witness anyone who invested in the stocks with the highest sales gains after a great short-term run.

3.      In the stock market, short term trends are mostly random and heavily influenced by luck. To succeed, you must ignore them and invest in strategies that have the highest probability (base rate) of succeeding in the future.

4.      You will not win the lottery. Avoid buying tickets and avoid what my son, Patrick O’Shaughnessy, calls lottery stocks.

5.      Over short periods of time, a good investment strategy can lead to poor results just as a poor investment strategy can lead to good results. Do your homework; understand how a strategy performs over long periods of time and stick with it. If you can do just this one thing, you will be ahead of the vast majority of investors over the long-term.

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Examining the HSBC Hedge Weekly voluntary performance update, it appears certain hedge funds, after some of the most volatile markets in years, have not been quick to post their performance, while others, such as Roy Niederhoffer, have enjoyed the recent market volatility.

Hedge funds: Greenlight and Glenview hedge funds slow to report, while JPMorgan and Odey report mid-August update

Greenlight Capital’s David Einhorn, running $4 billion, for instance, has not been very quick to update his fund’s performance.  As of July 31 Greenlight was negative by -6.3 percent on the month and is off -9.32 percent on the year. Larry Robbins of Glenview Capital Partners has likewise not updated his $4.7 billion fund’s performance. It was off -2.04 as of July but was nonetheless up 4.87 on the year.

Funds with a European focus have been quicker to update their performance. JPMorgan’s Europe Dynamic Long / Short Fund, run by Jonathan Ingram, John Baker and Anis Lahlou-Abid, was up 1.83 percent on the month as of August 21, and is up 9.23 percent on the year. Crispen Odey 2.7 billion (euro) European Fund was up 1.9 percent on the month as of August 14, but was still down -11.84 percent on the year.

Hedge funds: Neuberger Merman, Lansdowne, Trian, Pershing Square and Marcato all report August performance

Neuberger Berman’s US Long Short Equity fund was quick to report and as of August 26 it was down -3.33 percent on the month and -2.88 percent on the year. The $9.7 billion Lansdowne Market fund as of August 21 was up 0.51 percent on the month and 10.71 percent on the year. The equity diversified US focused Marcato International, operated by Richard McGuire with $3.3 billion under management, was down -4 percent as of Aug 14 and is down -3.08 percent on the year.

Another fund to update performance on a relatively recent basis was Nelson Peltz $2.9 billion Trian Partners, which was down -2.75 month and -1.35 on the year as of August 21. The $6 billion Pershing Square Capital Management reported they were down 2 percent as of August 18, and was up 6.95 percent on the year. ValueWalk this morning reported more up-to-date performance for NAV, noting Pershing Square was down 13 percent in August.

Brevan Howard Asia Fund, with $2.6 billion under management, reported as of July 31 they were positive by 3.25 percent on the year, while the flagship Brevan Howard Fund, in the diversified global category with $21 billion under management, was up 1.96 percent on year as of July.

Paul Tudor Jones, Man AHL and Roy Niederhoffer like August

Paul Tudor Jones $8.4 billion Tudor BVI Global fund reported performance as of Aug 21 up 2.35 percent on the year, 0.36 percent positive on the month. Man AHL Alpha and its $3 billion under management were reported up 2.44 percent on the month and positive 3.99 percent on the year August 21, while Roy Niederhoffer enjoyed the recent volatility, he was up 6.4 percent on the month as of August 26.

In explaining the recent market behavior, Niederhoffer told ValueWalk:

While it is easy – and a constant of history — to place the blame on “speculators” for any market move that goes against the preferred direction, it’s almost always the case that the presence of speculators in a market adds, rather than removes, liquidity in a market. In fact, it may be the unnaturally low volatility in the equity market, which went nearly four years without a correction, was the positive result of a great deal of “speculation” that the market would rally. The current burst of volatility is merely a return to normal levels of volatility. Corrections of 5-10% in the stock market are quite common in history. Going four years without one is actually quite rare. Even current levels of volatility are nothing compared to truly turbulent markets like 2000 and 2008.

That having been said, I do expect volatility to be higher going forward, in keeping with the Fed’s decision to end QE (for now). QE certainly had a dampening effect on equity volatility, and I would expect a lack of QE, and a potential tightening in the future, to cause more volatility in the future. So yes – fasten your seatbelts!

source : http://www.valuewalk.com/2015/08/hedge-fund-august-returns/

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ECB’s QE programme launched this month is targeting wrong policy and likely to fuel an already massive bubble in stocks and bonds. It is also unlikely to help generate real economic growth, as it simply transfers more wealth to the financial markets.

Look at the facts: 

• The Eurozone is suffering from structural stagnation that is driven by the lack of investment, anaemic domestic demand and policies, including taxation and enterprise regulation, that reduce entrepreneurship and make jobs creation and productivity growth (especially Total Factor Productivity) excessively costly.
• Overall household and corporate indebtedness in the Euro area remain high despite several years of deleveraging.
• Bank lending markets fragmentation contrasted by booming equity and bond markets shows that the problem is not in the lack of liquidity, but in over-leveraging present in the economy.

Experience in other countries that recently deployed QE shows that current measures by the ECB are unlikely to provide sufficient stimulus to drive growth to the new (and higher) ‘normal’:

• Japan, the US, and the UK experiences with QE show that monetary policies are useful to the real economy only when they are combined with either expansionary fiscal policies or real investment increases or both.
• Even in such cases where QE has been successful, sustainability of QE-triggered growth has been weak in the presence of structural debt overhangs (Japan) and had to rely on structural drivers for growth present prior to the deployment of QE (the UK and the US).
• In the Euro area, the idea is to combine QE with austerity policies and in the presence of dysfunctional financial markets. Such a program could increase misallocation of resources via bidding up financial assets prices over and above their long term fundamentals-justified levels.
• Bank of England created £375bn over the course of its QE programme. By the Bank of England’s own estimates, QE in the UK pushed up share and bond prices by around 20%. But because around 40% of stock market wealth is held by the wealthiest 5% of households, QE has made that wealthiest 5% better off by around £128,000 per household.
• You might want to check this post on the potential effects of QE on the real economy:http://www.zerohedge.com/news/2015-03-28/finally-very-serious-people-get-it-qe-will-permanently-impair-living-standards-gener

In short: the QE, as currently being carried out by the ECB, benefits the less-productive holders of financial assets, not the poor, nor the entrepreneurs, nor the real enterprise.

There is an alternative policy, a policy of “Quantitative Easing for the People”, an idea of distributing QE money directly to the citizens of the Euro area.

This is a more efficient approach for stimulating the real economy precisely because it puts liquidity directly at the point where it is needed most and can be used most efficiently, absent intermediaries, to address real structural problems present in the economy.

The plan is identical to the ECB current plan in terms of funds allocated: €60 billion will be created each month for 19 months. The amount each national central bank will create can also depend on its share of capital in the ECB, just as the current ECB QE programme envisages.

Each Eurozone citizen can receive ca €175 on average each month for 19 months.

• The funds are taxable income, so there is a benefit to the Exchequers, allowing the governments to engage in expanded investment programmes or more efficiently close some of the budgetary gaps, while buying more time to implement structural reforms.
• The funds (net of tax) can be used by households to accelerate debt deleveraging and/or repair their pensions funds and/or fund consumption.
• As the result, “QE for the People” will stimulate domestic demand (consumption, investment and Government investment), while increasing the rate of debt deleveraging.
• In addition, “QE for the People” can help improve banks’ balancesheets by increasing loans recovery (as households repay loans). In contrast, ECB QE will not have such an effect as it will be taking off banks balancesheets zero risk-weighted Government bonds.  Thus, “QE for the People” can be seen as a more efficient mechanism for repairing financial system transmission mechanism than ECB own QE policy.
• The quantum of stimulus implied by the “QE for the People” proposal is significant. Take Ireland, for example. “QE for the People” means annual benefit of around EUR8 billion in direct stimulus (depending on how Ireland’s share is estimated). In 2014, Irish Final Domestic Demand grew by EUR6.15 billion. So the direct effect of this measure for just one year would be equivalent to more than full year worth of real economic growth.

19 economists from across Europe and outside signed last week’s FT letter proposing this plan (with some variations) to stimulate the real economy in the euro area. The original letter is available here:http://www.basicincome.org/news/2015/03/europe-quantitative-easing-for-people/.

Source : http://trueeconomics.blogspot.se/2015/03/31315-qe-for-people.html

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