Invest Like a Fox Not Like a Hedgehog Bob Carlson AAII-DC Editor, - - PowerPoint PPT Presentation

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Invest Like a Fox Not Like a Hedgehog Bob Carlson AAII-DC Editor, - - PowerPoint PPT Presentation

Dec 04, 2023 221 likes •472 views

Invest Like a Fox Not Like a Hedgehog Bob Carlson AAII-DC Editor, Retirement Watch January 2008 800-552-1152 www.RetirementWatch.com 1 Foxes vs. Hedgehogs The fox knows many things, but the hedgehog knows one big thing.

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Invest Like a Fox… Not Like a Hedgehog

Bob Carlson Editor, Retirement Watch AAII-DC January 2008 800-552-1152 www.RetirementWatch.com

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“The fox knows many things, but the hedgehog knows one big thing.”

Foxes vs. Hedgehogs

Archilochus, 7th century BCE

From Isaiah Berlin

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Foxes Are…

  • Skeptical of big, central principles
  • Wary of simple historical

analogies

  • Less likely to be swept away in

their own rhetoric

  • Worried about judging the past

too harshly

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Foxes…

  • See more value in keeping

passions under wraps

  • Make efforts to integrate

conflicting beliefs, theories, and

  • bservations
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Hedgehogs Always Believe in:

The Pursuit of the ONE BIG THING

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Hedgehogs Always Believe:

The most dangerous words in the English language are: “It’s different this time.”

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Hopeful Optimistic Excited Thrilled Euphoric Worried Anxious Denial Scared Desperate Panicked Depressed Relieved Hopeful Optimistic

Point of Maximum Risk Point of Maximum Opportunity

I'm so smart.

It's just a correction.

How did this happen?

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20 40 60 80 100 120 140 160 180

1/3/2000 5/3/2000 9/3/2000 1/3/2001 5/3/2001 9/3/2001 1/3/2002 5/3/2002 9/3/2002 1/3/2003 5/3/2003 9/3/2003 1/3/2004 5/3/2004 9/3/2004 1/3/2005 5/3/2005 9/3/2005 1/3/2006 5/3/2006 9/3/2006 1/3/2007 5/3/2007 9/3/2007 1/3/2008

SPDR ETF

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Questions Hedgehogs Cannot Answer  Why are prices of investments more volatile than fundamentals?

  • Why do stock prices change

without a change in fundamentals?  Why does the equity risk premium exist?

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Reasons Questions Are Not Answered

 Returns in shorter periods differ

from long-term average returns  Correlations and volatility change  Volatility is not risk to most investors  Long-term bull and bear markets are not explained

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Risk Return

The Efficient Frontier

Portfolios on the Efficient Frontier Areas of Non- Efficient Portfolios

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Correlations Change

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Modern Portfolio Theory  Risk is as important as return  Risk of a portfolio is more important than risk of assets  True diversification reduces risk  Forecasting is essential to risk reduction and efficiency

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What Foxes Believe

 Markets are not always efficient and

  • rational. They are dynamic.

 Investors make mistakes.  Endogenous risk is significant.  Markets can reach extreme valuations.  Investors must act on forecasts.

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  • MPT says risk as important as

returns  Make forecasts  Consider probability of error  Reduce or eliminate unwanted risks  Contingency plans  Monitor and adjust

Investing as Risk Management

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Relative Returns vs. Absolute Returns  Traditional strategy measures against index  Should measure against probability of achieving goals  Return pattern different from indexes, not dependent on them

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What To Do Now Investors should seek:

  • Absolute returns, more

predictable returns

  • Reduced risk, volatility
  • Low correlation with major

market indexes—True Diversification

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Ways to Manage Risk

  • Add asset classes
  • Rebalance more frequently
  • Use value managers
  • Manage asset allocation
  • Use unconventional strategies
  • All-Weather Strategy
  • Hedge or use hedge funds
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Indicators That Have Failed

  • Dividend yield

 Price to book value  Price-earnings ratio  q ratio  Technical analysis  Extra-market factors

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What Not to Do—Why Indicators Fail

 Random events ≠ cause and effect  Too many variables  Fat tails: The unexpected happens  End points affect results  Correlation never is 100%  Markets are dynamic  Turning points obvious only in hindsight

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Where Are We Now?  Unique Financial Markets:  Interest rates already low  Credit and borrowing crisis  Global growth supporting U.S.  Housing problems isolated?  Inflation still not contained

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2001 or 2002?

20 40 60 80 100 120 140 160

1/3/2000 3/3/2000 5/3/2000 7/3/2000 9/3/2000 11/3/2000 1/3/2001 3/3/2001 5/3/2001 7/3/2001 9/3/2001 11/3/2001 1/3/2002 3/3/2002 5/3/2002 7/3/2002 9/3/2002 11/3/2002 1/3/2003 3/3/2003

SPDR ETF

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  • Weakening labor market
  • Soft mortgage applications
  • Record profit margins
  • 21 of 27 measures turned negative
  • Export growth is slowing
  • Signs of weakness in Europe
  • Gradual deterioration of economy

Time to Bottom Fish?

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Why Disasters Don’t Happen

  • Diverse, service-oriented economy
  • Regulators, investors aware of

problem

  • Globalization, with weak linkages
  • Sectors not as correlated
  • Wealth effects are lagged