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Salil Mehta
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http://statisticalideas.blogspot.com/ http://statisticalideas.blogspot.com/2013/02/additional-resources.html
  • Risk-Unaware

    October 15 reprint: this article was featured as a popular WSJ MW Call of the Day.

    Wasn't it all about 2014 (S&P), by the end of 2014? Or don't markets tend to do great, leading up to a Presidential, second mid-term election? Or how about the recent favorite, still, of central banks' induced liquidity for a long time to come? Now we learn that, over the weekend, a nurse in Dallas contracted the Ebola fever. So shareholders and their ever sheepish and unknowing advisors can just blame that for -once again- nervously being stuck holding devalued chips. At least casinos treat you to free drinks as they siphon away your cash.

    People now are selling stocks. It's too late; the price has already fallen. Just as easily, the same people will buy them back too late, after a rebound in the financial markets. Market strategists, who until recently felt better that their year-end S&P and 10-year yield targets were becoming safe, must now concede they just don't know (but they have myriad data and silly math to handily muddle themselves into thinking otherwise.)

    On a personal level I have mostly stayed out of the markets since very early this year. We wrote a couple times, correctly, that we'd have a 5%-ish drop in the markets before February's end. Once here, and again in a December print of the New York Times. And I have been sleeping great, ever since.

    Market chasers are now "helpfully" telling everyone else to sell, fabricating together any proximate cause, in order for them to make money. But they certainly aren't there to refund anyone for the gross underperformance they silently inflict. And the S&P is essentially where we last saw it, at the end of February. There went Gopro. Castlight Health. Alibaba. They are like ex-post lottery ticket winners. Except for just a percent or so of people who venture into stock and fund picking, confusing dumb luck with excess wisdom is a classic, weak proposition (see here, or here).

    My plan at the end of February was to always pick up a little more risk in the portfolio, at a later time. That time happens to be now as relative fear permeates the streets. There is more comfort now that we are no longer chasing lemmings unaware of where the cliff is, but we now seem to be somewhat beyond that. On a risk-adjusted basis, this will always be a better, winning approach than thinking one knows how to predict future market blips. Appreciating risk is about knowing where it is to begin with, and that soon enough we'll see better times ahead.

    As noted a while back, in a couple weeks we will have a first Featured article on mathematics and risk, coming out in a CFA fourth-quarter publication. The print article, similar to our 2014 Society of Actuaries article published in August and also exciting as it links back to a number of research here, discusses how the inevitable market risk will come. Readers will learn how to consider portfolio risks and hedges accordingly. It is also part of a series of articles that we had formally accepted, many months ago, at the start of summer.

    Oct 21 10:23 PM | Link | 2 Comments
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