Big Data: Part C


Some people sense that the conventional investment wisdom of the past couple of decades is not working. With the S&P 500 and Nasdaq* market indexes close to levels they were in 1999 (as of May 2013), it’s no wonder so many are questioning conventional wisdom.  After all, in 26 out of the last 46 years, the US equity markets have done nothing but tread water.  And no one knows what the next decade holds.   (Source: Dow Jones)

In the book Money Ball, Billy Beane got his edge by looking at data in a different way than general managers of other teams.  With the smallest budget in Major League Baseball, he was able to create a highly profitable and winning team.  He wasn’t popular and his method upset the baseball establishment.  He wiped the slate clean and simply let the data tell the story.  In a similar way, we used computers to look at data in a different way, to analyze it and to figure out what really matters.

It’s been said that most businesses don’t count what really matters.  I sought to discover what does matter in the financial markets, so I started with a clean slate.  I used massive amounts of data and used technology like a diagnostic tool, an MRI of sorts, for investments.  I wanted to filter out the noise and discover what clues markets leave, and then develop a series of dispassionate triggers.  In the process, I discovered three principles.  (Of course, no strategy guarantees a gain or is immune to losses).

Principle #2:  Focus on New Money Time.

Research conducted by Ned Davis, and since duplicated by Callan & Associates and UBS Global Asset Management, shows that equity markets go through three phases: 1) Making New Money, 2) Declining and 3) Recovering.

Looking back to the turn of the previous century from 1901 through 2011, they showed that equity markets have:

1)   Made new money about 23% of the time. (The time spent going from an old peak to a new peak.)

2)   Spent 37% of their time falling (from peak to trough).

3)   Spent about 40% of their time recovering from a loss.  Markets spend more time recovering than falling because they tend to fall faster than they rise.

Put another way, equity markets tend to make new money about 1/5th of the time, fall about 2/5ths  of the time and recover from the fall about 2/5ths  of the time.

However, another way to look at the same information is to discover that markets tend to rise about 64% of the time.  From that perspective, most of the rising time is simply making up for previous losses.

So, instead of trying to beat the market on the way up, what if we focused on risk management—on eliminating some of the losses?  If we could miss some of the biggest down days, we would make the ride much smoother and easier to live through emotionally.  But that’s not the main reason to do it.  When we miss the biggest down days, a very powerful thing happens mathematically. It’s what I call the Math of Preservation.

If we can cut out a portion of the fall (reduce the drawdown), then a portion of the recovery phase actually gets added to the making new money phase.  In other words, removing some of the fall time converts some of the recovery time to “new money” time.

Another way to look at this same issue is that losses and gains don’t add up the same.  For example, a 10% loss requires a 12% gain to break even.  A 25% loss takes more than a 33% gain to break even.  A 33% loss takes a 50% gain to break even and a 50% loss requires a 100% gain to break even.  (For more discussion on this, see my book Retire With Confidence, Your Toolbox For Financial Independence.)

Putting a method like this into practice makes for allocations that are very “non-traditional.”  Stepping out from the herd and using a different allocation requires courage.  If you’ve read this far and you’re still with me, you might be the type of person willing to consider something different.

You may want to consider a portfolio review to evaluate whether a non-conventional approach would be beneficial to you.  After all, the same strategy that got you here may not get you to where you want to go.

If you’d like a copy of my white paper Why Conventional Investment Wisdom Hasn’t Been Working – And What You Can Do About It, give us a call.


Show Us Your Logo Wear

 Dead Sea 1

Bob Knestrick, Group Vice President—Maryland Farms Family YMCA, recently traveled to Israel and took some logo wear with him to the Dead Sea.  He took time from his busy travel and swimming schedule to shoot these pictures and remind us about the Luken Kids’ Race that happens on the 4th of July at the Maryland Farms YMCA in Brentwood.  It’s time to let all the young people in your lives know about the event and its new, improved course.  It’s a great way to start a day of celebration.

Dead Sea 3

Thank you, Bob, for the pictures and more importantly, for what you do and the sacrifices you make for our community.