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Surprise, Surprise, Surprise: Prediction Doesn’t Work

Excerpt:

“This has basically never happened before in my whole life. I can remember 1½ percent rates. It certainly surprised all the economists. It surprised the people who created the life insurance industry in Japan, who basically all went broke because they guaranteed to pay a 3% interest rate. I think everybody’s been surprised by it, including all the people who are in the economics profession who kind of pretend they knew it all along. But I think practically everybody was flabbergasted. I was flabbergasted when they went low; when they went negative in Europe – I’m really flabbergasted. How many in this room would have predicted negative interest rates in Europe? Raise your hands. [No hands go up]. That’s exactly the way I feel. How can I be an expert in something I never even thought about that seems so unlikely. It’s new territory…

“I think something so strange and so important is likely to have consequences. I think it’s highly likely that the people who confidently think they know the consequences – none of whom predicted this – now they know what’s going to happen next? Again, the witch doctors. You ask me what’s going to happen? Hell, I don’t know what’s going to happen. I regard it all as very weird. If interest rates go to zero and all the governments in the world print money like crazy and prices go down – of course I’m confused. Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly.”

Shout out to Charles Munger, age 91, vice chairman of Berkshire Hathaway.

How Does Buffett Make So Much Money? Not How You Think!

Excerpt:

Berkshire Hathaway has realized a Sharpe ratio of 0.76, higher than any other stock or mutual fund with a history of more than 30 years, and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha becomes insignificant when controlling for exposures to Betting-Against-Beta and Quality-Minus-Junk factors. Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks. Decomposing Berkshires’ portfolio into ownership in publicly traded stocks versus wholly-owned private companies, we find that the former performs the best, suggesting that Buffett’s returns are more due to stock selection than to his effect on management. These results have broad implications for market efficiency and the implementability of academic factors.

Buffett’s record is remarkable in many ways, but just how spectacular has the performance of Berkshire Hathaway been compared to other stocks or mutual funds? Looking at all U.S. stocks from 1926 to 2011 that have been traded for more than 30 years, we find that Berkshire Hathaway has the highest Sharpe ratio among all. Similarly, Buffett has a higher Sharpe ratio than all U.S. mutual funds that have been around for more than 30 years.

We document how Buffett’s performance is outstanding as the best among all stocks and mutual funds that have existed for at least 30 years. Nevertheless, his Sharpe ratio of 0.76 might be lower than many investors imagine. While optimistic asset managers often claim to be able to achieve Sharpe ratios above 1 or 2, long-term investors might do well by setting a realistic performance goal and bracing themselves for the tough periods that even Buffett has experienced.

In essence, we find that the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails. Indeed, we find that stocks with the characteristics favored by Buffett have done well in general, that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a low financing rate, and that leveraging safe stocks can largely explain Buffett’s performance.

Don’t trust the legends, verify.

Source: Andrea Frazzini, David Kabiller and Lasse H. Pedersen, “Buffett’s Alpha.”

“He is so confident in his approach that he offers an extraordinary guarantee: you will never lose money.”

Run to the Hills
Run to the Hills

A listener sent this in:

You’re gonna love this guy. Ladies and gentlemen, the next Bernie Madoff! How Does This Hedge-Fund Manager Make So Much Money?

“Meyer guarantees clients will never lose money with his system.”

Say what?

Run for the hills!

All Forms of Government Rigged Economic Manipulation Are Gross

Economic Loser
Economic Loser

Feedback in regarding my podcast here:

I think he’s referring to that guy who wrote Chavez was great…

[David Sirota] used to have a column in one of the daily papers here in the NW. He’s been an economic kook (technical term) for decades. Seems to think that the State owes us all something. Probably didn’t pay enough attention in college and flunked Econ 101 and 102.

Look, capitalism isn’t perfect (and you correctly point out that our current “crony capitalism” is a perverse version that will lead to bad outcomes), but all you have to do is compare Singapore and Cuba from the time that both started the current regimes (mid-1950’s) and the outcomes are so startlingly different that there can be no debate about which system is better. End of rant.

[Name]
Seattle, WA

Thanks.

If You Can’t Write It Down… How Can You Trade It?

A great line from one of the oldest running trend followers:

“I’m very uncomfortable with black box trading where I’m dealing with algorithms I don’t understand. Everything we do we could do on the back of an envelope with a pencil.”

That “back of an envelope” remark must be a revelation for those people that imagine trading to be wildly complex. The real lesson here is the discipline to stick with rules during tough times.

Write It Down
Write It Down

Never Ending Trend Following Confusion

Feedback in:

Hi Michael,

I thought you might like this. I found a cute little paragraph about trend following (use of technical analysis) in CFA level 2 Schweser notes. Love the last sentence:

Cheers,
Peter Schenk, Portfolio Manager, CIM

Trend Following Confusion
Trend Following Confusion

Thanks. Not surprising. Misinformation on top of misinformation.

Ep. 424: The Wizard Jeremy Siegel Filleted with Michael Covel on Trend Following Radio

The Wizard Jeremy Siegel Filleted with Michael Covel on Trend Following Radio
The Wizard Jeremy Siegel Filleted with Michael Covel on Trend Following Radio

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Today on Trend Following Radio Michael Covel profiles Jeremy Siegel. Jeremy describes himself as “The Wizard of Wharton.” His website claims that he is credited with contributing and expanding the great bull market of the last two decades. Jeremy is also bestselling author of “Stocks for the Long Run.”

Michael moves right into playing a few clips from appearances Jeremy has made on CNBC. The first clip has Jeremy outlining his predictions in early November 2015: The Dow will surpass 20,000, oil can’t go much lower, and the dollar can’t go much higher. His predictions are perfect examples of predictions without any substance. They have no timelines, or data to backup why he feels the way he does.

Excerpt #2 was filmed around December 13th. The Dow at that time was at 17,300. The S&P was at 2020. Jeremy moves right into more predictions and generalizations. He doesn’t say “buy at this time” and “sell at this time.” Jeremy proceeds to use words like “tremor” and “relief rally.” It is hard to have wrong predictions and forecasts when you use words that have generalized meaning.

Excerpt #3 is from February 8th, 2016. Jeremy had to back peddle because his November and December forecasts had not come to fruition. He admits to being too bullish…sort of. He blames his wrong predictions on the market not doing what the market was suppose to do. Michael weaves in his commentary throughout the clips. The podcast ends with one of Michael’s favorite classic songs from the 1920’s.

In this episode of Trend Following Radio:

  • Predictions
  • CNBC Analysts
  • What is a bull and bear market?

“Jeremy Siegel is one of the great ones. [His article at the market top was] one of the most stark and prescient calls I have ever seen.” – Jim Cramer

Mentions & Resources:

Listen to this episode:

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