5 Things To Ponder: Margin Of Safety

Tyler Durden's picture

Submitted by Lance Roberts via STA Wealth Management,

In yesterday's missive, I very briefly discussed "recency bias" as it related to sentiment based economic surveys. I spent much of last evening pondering the issue of "recently bias" as it relates to the overall macro market environment. Carl Richards, back in 2012, commented:

"We rely on habit to help us make things easier because few people want to reinvent their lives every day. But this habit of forming habits also does something else. In academic circles, it's called the recency bias, and it can trick us into making decisions we might not make otherwise."

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"The recency bias is pretty simple. Because it's easier, we're inclined to use our recent experience as the baseline for what will happen in the future. In many situations, this bias works just fine, but when it comes to investing and money it can cause problems.

 

When we're watching a bull market run along, it's understandable that people forget about the cycles where it didn't. As far as recent memory tells us, the market should keep going up, so we keep buying, and then it doesn't. And unless we've prepared for that moment, we're shocked and wondered how we missed the bubble.

 

When the market is down, we become convinced that it will never climb out so we cash out our portfolios and stick the money in a mattress. We know the market isn't going back up because the recency bias tells us so. But then one day it does, and we're left sitting on a really expensive mattress that's earning nothing."

The point Carl makes is important. The longer a bull-market runs, the more inclined we become to believe "it will never end." 

It is during these long, and seemingly unending runs, that we begin to dismiss the most simplistic rules of investing and opt for "buy and hold" strategies that are historically responsible for cataclysmic losses of investment capital.

What is most interesting about "buy and hold" investing is that the group that generally promotes it receive a direct benefit (i.e. fees) for keeping investors invested in the market. Secondly, why is it that every great investor in history from Benjamin Graham to Paul Tudor Jones to Bob Farrell all adhered to basic investment disciplines of buying low and selling high?

(For more on investing rules see this, this and this)

This week's reading list is a view on investing, the markets and potential outcomes to try and limit the potential for "recency bias" by focusing on the potential for outcomes. In other words, what is the "margin of safety" for investors now?


1) When In Doubt, Stay Out by Ivanhoff via Ivanhoff Capital

"When an event repeats frequently, it becomes a pattern. A pattern, in which a lot of people wholeheartedly believe in and act upon. Buying oversold dips in the major indexes has been very lucrative in the past few quarters. Even more so, in the past few months, which have been a poster child of range-bound markets. Will the current dip be any different? No one really knows. There are some good reasons to believe so:

  • seasonality;
  • poor reaction to decent earnings reports;
  • lack of great long setups;

I truly believe that knowing when to be out of the market is the single most valuable trading skill anyone could develop. Why do I think so? Because, when markets are trending most setups work, most breakouts work and have a decent follow-through, it is a lot easier to make money. When markets are choppy, everything turns upside down and it is becomes difficult not to lose money. Be aggressive when it pays to be aggressive. Make sure you don't give back most of your gains when the market environment worsens for your approach. For better of for worse, financial markets are one of those business fields, where working smart always trumps working hard."

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Read Also: 13 Investing Rules From Paul Tudor Jones by Ivanhoff via Ivanhoff Capital

 

2) Yellen Says Stocks Might Be Overvalued by Matt O'Brien via The Washington Post

"Now, stocks have cooled off since the start of the year, but not that much. So does that mean stock prices are "quite high"? Well, that depends on how you look at it. Take Robert Shiller's cyclically-adjusted price-earnings ratio, or CAPE, which looks at the past ten years of earnings to figure out how pricey stocks are today. The idea here is that it smooths out any big ups or downs, and shows us how fairly valued—or not—stocks are. And by this measure, as you can see below, stocks really are getting expensive."

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Read Also: Yellen, A "Bear" Late & A "Dollar" Short by Jeffrey Snider via ZeroHedge

Read Also: Charts That Should Give Traders Pause by Michael Kahn via Barron's

 

3) Stocks Are The Most Expensive, Well Ever by Meb Faber via Meb Faber Research

"I jabber a lot about valuation metrics here, and I mentioned this one on Twitter the other day. Its doesn't need much explanation – the median stock in the S&P 500 is the most expensive it has even been (for as long as we have data). That's never a good sign!

 

If your favorite valuation indicator is not at "the highest ever" , many valuation indicators and now at "the highest ever except 2000?. That's not good company unless you are a short seller.""

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Read Also: US Equity Valuations: To Be Dismissed by BCA Research

 

4) What 118 Fed Rate Increases Since 1948 Show by Simon Kennedy via Bloomberg Business

"Since 1948, the Fed has increased its benchmark on 118 occasions against a quarterly backdrop in which the average growth in nominal GDP was an average 8.6 percent, Deutsche Bank's strategists wrote in a report published Wednesday.

 

Only in the third quarters of 1958 and 1982 did the Fed shift when nominal growth was undershooting 4.5 percent and the latter action was even reversed a month later.

 

So for virtually every rate increase since Harry S. Truman was in the White House, nominal GDP was growing 4.5 percent or faster, with 112 occurring when it was above 5.5 percent."

Read Also: The Mistake Everyone Is Making About Fed Rate Hikes by Lance Roberts

 

5) Little Margin Of Safety Left For Investors by Doug Kass via Doug Kass' Tumblr

"Despite protestations from certain market prognosticators and fast talkers, no one knows this answer for sure (I certainly don't). Neither economic forecasts nor risk ranges, quantitative models nor any other economic or technical signpost guarantees investment success in the hunt for intrinsic value. As I have written, there is no secret market sauce.

 

We can just try be logical, rely somewhat on history, depend on the statistical flow of economic statistics and, from there, make an educated guess, as there are few certain truths in the investing and trading games.

 

"After all, according to The Oracle, 'price is what you pay, value is what you get.'

Read Also: The Trouble With Factors by Cam Hui via Humble Student Of The Markets


BONUS READS

Should Investors Unload Their Mortgage REITS? Probably! by Keith Jurow via Advisor Perspectives

"For the past several years, I have written extensively about the Fed's dangerous efforts to drive interest rates low enough to stimulate a stronger recovery. As a consequence, large and small investors have been compelled to go out on the risk curve in a desperate search for higher yield.

 

Lured by almost irresistible double-digit yields in 2012 and early 2013, investors dived into mortgage REITs with abandon. Having discussed the serious risks of equity REITs in my previous article , now is a good time to examine whether mortgage REITs pose similar risks for the unwary."

Why Record Margin-High Debt Should Make You Cautious by Jesse Felder via The Felder Report

"It's recently become popular to dismiss the record level of margin debt in the market as meaningless. Notable bloggers like Josh Brown, Barry Ritholtz and Chris Kimble have all written some sort of 'it just doesn't matter' commentary recently. Barry went so far as to call it, "statistically bogus." To me, this sounds like just another version of, 'it's different this time.'

 

Here are the real statistics: Over the past 20 years, the level of margin debt relative to the economy has had nearly an 80% negative correlation to future 3-year returns in the stock market. What this means is, the higher the level of margin debt relative to GDP, the lower the returns for the stock market over the coming 3 years and vice versa. 'Statistically bogus?' I think not."

Why I Agree With Jesse Felder by Lance Roberts


Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway." - Warren Buffett

Have a great weekend.

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KnuckleDragger-X's picture

No worries, it's all shiny, so BTFD one and all....

Rainman's picture

Dali Llama say whatever you think is a good idea, do the opposite

Model T's picture

I am a short seller; I like it.

TeamDepends's picture

There is a military drill in Canada which will run concurrently with Jade Helm called Maple Guard. Kid you not. Oh yeah Warren, would you prefer they take one of your choo choo trains?

p00k1e's picture

Most nations on the planet are holding military drills.

Either an Alien Invasion is imminent…. Or something internal.

Either way, did you catch the latest Miley Cyrus pic?

Miley Cyrus (PG rated)

https://i.imgur.com/2uTQfvN.jpg

Kirk2NCC1701's picture

Most governments have acted weird for some time now -- in the sense that they have all these side shows, to keep the Sheeple distracted, because they are busy and STALLING FOR TIME.

I too have wondered... Are Space Aliens or an Asteroid headed our way?  Reminds me of the government BS and theater we saw in the movies Deep Impact and 2012.  And Miley --l ike so many others in DC, NY and Hollywood -- is acting as though "Nothing Really Matters Any More".

"REMAIN CALM"

Uber Vandal's picture

The Canadian operation is actually called Maple Resolve.

And the Canadians closed all of its Target stores...... Not sure if it was for plumbing issues.

Just some odd coincidences is all......

 

TeamDepends's picture

You're right, we were thinking of the deoderant. And it's no coincidence that the Mexican military has announced Operation Pungent Enchilado which is to occur at the same time. Prepare accordingly for the End Times.

Crocodile's picture

It is Maple Resolve and last year it was MR14; guess what it is this year?  MR15.  Be sure to read the propaganda of the happy business owners who are proud of their young people sent around the world to murder innocent people; when was the last time Canada was threatened?  http://www.army-armee.forces.gc.ca/en/exercises-2014/ex-maple-resolve.page

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Here is a video of an overpriced truck used for military transport for DOMESTIC use.  The video was uploaded April 2015, but the comments indicate the video is much older. https://www.youtube.com/watch?v=i9e-4vWP8fE&list=PL46tkHPQTUkNI4emeh0zPF...

Crocodile's picture

Quote: "I truly believe that knowing when to be out of the market is the single most valuable trading skill anyone could develop." - Ivanhoff (see above)  Let us know when anyone does; most ridiculous statement ever!!

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Let me translate:  "The most profitable skill a person can learn is to know when the top of a market is and get out and where the bottom is and jump in!"  - Only an insider knows these things Sherlock.

JBilyj's picture

Sell Calls Buy Puts :D

Amy G. Dala's picture

with a rebel yell she cried moar moar moar!

Kirk2NCC1701's picture

Stock prices matter only if you're Sheeple.  If you get Money For Nothing and Checks For Free, stock prices do NOT matter -- as long as you get to acquire moar Real Assets for your paper chits.

The real dilemma, I suspect, is what do Austrian Economics Investment Advisers tell their libertarian clients?  What to invest in, or -- better still -- what to tell them, so they won't change their portfolios into cash positions?  Cause if they did, how the hell is an Adviser supposed to make money?

drdolittle's picture

stock market gets new highs while told to prep for crash. Zimbabwean market goes up nominally only. Insiders known what's up, sooner or later they'll scalp your 401 but in the meantime they're buying calls

moneybots's picture

"It's recently become popular to dismiss the record level of margin debt in the market as meaningless."

 

It is meaningless- until it isn't.  Then is it ever meaningful, as major margin calls go out, as leverage increases losses.