WSJ is out with a post calling stock picking a “dying business” and declaring passive investing the winner. And the facts about money flows are on the Journal’s side, but as usual, they are greatly exaggerating things by posting data out of context.
Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds
As Howard Lindzon would say “there’s no such thing as pure passive investing, just fifty shades of active investing”. What’s more interesting to me are the potential consequences of this rising passive investing tsunami:
1.The more money flows to passive investing, the faster markets are likely to become. This will lead higher correlations among stocks and more volatility, which means bigger and quicker corrections; it also means bigger and quicker recoveries. Take a look at the bear market of 2000-2002. As harsh as it was, there were plenty of stocks the kept making new all-time highs during that period and delivered some real alpha. Then, compare it to the correction in 2008, 2011, even early 2016. We saw a lot higher correlations during the most recent corrections. Most stocks went down together; then, they recovered together. Is it a big surprise then if leveraged ETFs are becoming the weapon of choice of more and more active traders?
2. More opportunities for savvy stock pickers. A rising wave (bull market) will lift all boats, including the crappy ones, creating multiple great short targets. A swift correction will bring down strong businesses to super-attractive valuations.
3. A decrease in hedge funds’ fees. 1 & 10 might become the new 2 & 20. If you find a great money manager, 2 & 20 is a small price to pay, but the majority of investors are likely to demand and try to negotiate lower fees. Finding a great money manager is like finding the next Amazon before it happened. The trouble is that in most cases, people won’t stick long enough to see a big difference.
It is funny how the best traders of all times basically repeat the same things with different words.
Gerald Loeb is the author of ‘The Battle for Investment Survival’ and is one of the most quotable men on Wall Street. Here are five of the smartest things he has ever said about the stock market:
Financial markets are often forward-looking.
The market is better at predicting the news than the news is at predicting the market.
To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.
Patiently wait for your pitch
Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed.
Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.
The single most important factor in shaping security markets is public psychology.
In addition to many other contributing factors of inflation or deflation, a very great factor is the psychological. The fact that people think prices are going to advance or decline very much contributes to their movement and the very momentum of the trend itself tends to perpetuate itself.
How to recognize future leaders
One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages.
It is not important how often you are right or wrong, but how much money you make when you are right and how much you lose when you are wrong.
The difference between the investor who year in and year out procures for himself a final net profit and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.
The fastest way to become a legend in financial markets is to make a lot of money when almost everyone else is losing a lot of money. It doesn’t matter what you do afterward. Jesse Livermore made 100 million dollars during the market crash in 1929. Five years later, in March 1934, Livermore filed for bankruptcy. No one really knows how he managed to lose so much money in such short period of time. Nowadays, he is still one of the most quoted men in the trading circles. His book “How to Make Money in Stocks” is cited as one of the favorite trading books by just about everyone who is anyone in finance.
Here are a few of Livermore’s most interesting thoughts about markets and speculation:
1. The only leading indicator that matters
Watch the market leaders, the stocks that have led the charge upward in a bull market. That is where the action is and where the money is to be made. As the leaders go, so goes the entire market. If you cannot make money in the leaders, you are not going to make money in the stock market. Watching the leaders keeps your universe of stocks limited, focused, and more easily controlled.
2. Patterns repeat because human nature hasn’t changed for thousand of years
There is nothing new on Wall Street or in stock speculation. What has happened in the past will happen again, and again, and again. This is because human nature does not change, and it is human emotion, solidly build into human nature, that always gets in the way of human intelligence. Of this I am sure.
All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis.
I absolutely believe that price movement patterns are being repeated. They are recurring patterns that appear over and over, with slight variations. This is because markets are driven by humans — and human nature never changes.
3. Your first loss is your best loss.
When the market goes against you, you hope that every day will be the last day – and you lose more than you should had you not listened to hope. And when the market goes your way, you become fearful that the next day will take away your profit and you get out – too soon. The successful trader has to fight these two deep-seated instincts.
When you make a trade, “you should have a clear target where to sell if the market moves against you. And you must obey your rules! Never sustain a loss of more than 10% of your capital. Losses are twice as expensive to make up. I always established a stop before making a trade.
4. On the importance of sitting tight and being patient with your winners
They say you never go broke taking profits. No, you don’t. But neither do you grow rich taking a four-point profit in a bull market.
I did precisely the wrong thing. The cotton showed me a loss and I kept it. The wheat showed me a profit and I sold it out. Of all the speculative blunders there are few greater than trying to average a losing game. Always sell what shows you a loss and keep what shows you a profit.
The market does not beat them. They beat themselves, because though they have brains they cannot sit tight. Old Turkey was dead right in doing and saying what he did. He had not only the courage of his convictions but also the intelligence and patience to sit tight.
After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting.
5. You don’t have to be active every day.
First, do not be invested in the market all the time. There are many times when I have been completely in cash, especially when I was unsure of the direction of the market and waiting for a confirmation of the next move….Second, it is the change in the major trend that hurts most speculators.
Always remember; you can win a horse race, but you can’t beat the races. You can win on a stock, but you cannot beat Wall Street all the time. Nobody can.
There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily– or sufficient knowledge to make his play an intelligent play.
Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes.