05-20-2020: Opinion versus Facts

A good friend of mine sent me an email today with the following subject line: "Eat your heart out". My friend is a famous financial pundit, newsletter writer and economics professor. You would recognize his name, immediately, but that's not my point...


He proceeded to tell me how well some of his students did in this most recent semester and how, after much research and financial justification picked one stock per student for the semester, along with the professor. He gave me the results of each of the picks and some of them were reasonably good, but most lost money.


Knowing exactly how to goad my friend, with whom I often debate publicly, I told him that stock picking is nothing more than guessing. Educated guessing... but, at the end of the day, it's just a WAG.


As expected, he took umbrage at my outlandish statement; I think more from the following comment I also made than the one about stock guessing.


You see, my friend is extremely well educated and teaches finance and economics at a well-known university, so when I told him that "regardless of how smart you are and regardless of how much research you do and regardless of how you apply that vast knowledge to investing in the stock market, you simply do not have a crystal ball, and you cannot consistently foretell the future." In other words, if you think you are smarter than the market, days like February 24 rise up and turn the most ardent self-ascribed stock-picking genius into a fool.


I went on to explain... On February 19, I had my clients fully invested in a wildly bullish market that was booming higher. On February 20, we went to cash. On February 24, the market began the COVID-19 crash. It mattered little what the fundamentals were. It mattered not at all what the financial economics were a the time. It mattered not that you have a PhD in economics. It mattered not a whit that the market was 'potentially' overreacting to an unknown viral pandemic. What mattered was what the market did and it did crash 30% over the following month. My clients avoided that crash; not because I am smart; not because I knew the crash was coming; not because I was lucky. We went to cash 4 days before the start of the crash because my quant-based algorithms indicated that the market was overbought and the risk of a pull-back was extremely high. As such, our stops (something most asset managers do not use) were all raised to 0.25% of one standard deviation of normal volatility below the prior day’s closing price on each holding. When the market pulled back slightly on February 20, all of our stops fired and we went from 100% invested to 100% in cash; less than 1/4th of 1% below the high for the year.


That doesn't mean a quant-based system will always be right on every trade every time. But, it does mean that quantitative analysis does play a major role in getting in at the right time and getting out at the right time.


This week, so far, our quantitative algorithms have served us pretty well. Tactical Growth is now up almost 6% for the year, compared to the S&P 500 that is still down more than 8%. Beating the market by 14% half-way through the year is nothing to sneeze at and, hopefully, we can build on that performance as the year unfolds (knowing that past performance does not guarantee a similar future return). But, I will tell you this... I will not be guessing. When I bought on Monday of this week, I know a few of you winced and said to yourself, "Why is he buying into a rip-your-face-off rally?" I bought again yesterday when the market tumbled lower. I'll just bet there was one or two of you who said, "Why is he buying when the market is tanking... doesn't he know the bottom is going to fall out of this market at any moment?"


I bought this week because the data, from a quantitative analysis, was indicating this was a good time to be buying, and we did.


So far this week, the trades have been mostly good to very good. That is not bragging... that's just stating a fact. Could the market tank tomorrow and start the next 30% sell-off? Sure... it 'could' happen. It would be an unexpected reversal from what the data indicate should be happening, but it could happen. If the market does tank tomorrow, does that mean the trades we put on this week were all bad decisions? No. The trades we made were the right trades for what the market was telling us it was doing at the time. I pay attention to where the market is and how it got there, far more than attempting to assign logic or knowledge or even common sense to the trading bias. Logic, knowledge and common sense are extremely important, but they are not a crystal ball. The market has a wonderful propensity... It always tells you exactly where it is. This is a mathematical fact. And, it is another fact that the current trend in the market will continue exactly until it doesn't; at which time, we change our investment bias to match up with the change in market direction. Is this process easy? No. It takes a lot of analytical algorithms and rules and discipline to know when the market has changed enough to warrant a change in investment bias. But, that's why you hired us, wasn't it? That's what we are supposed to be doing all the time... and we are.

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