Security In an Unsecure World
Comment of the Day

March 27 2018

Commentary by Eoin Treacy

Security In an Unsecure World

Thanks to a subscriber for this transcript of a talk given by Benjamin Graham in the 1960s. Here is a section but it is well worth taking the time to read in full:

They are returning to the idea that for the smart investor the question of stock market fluctuations does not have to be considered to any great extent. There is a two-fold emphasis here, which slurs over the reality of stock market fluctuations. The first is the general conviction that the market can be counted on to advance so emphatically through the years that whatever declines take place are comparatively unimportant; hence if you have the true investor’s attitude you don’t have to concern yourself with them.


As I see it, the real truth is exactly the opposite, for the higher the stock market advance the more reason there is to mistrust its future action if you are going to consider only the market’s internal behavior. We all know that for many decades the typical history of the stock market has been a succession of large rises, in good part speculative followed inevitably by substantial falls. Consequently, the substantial upsweeps of the past have always carried with them warning signals of unhappy consequences to come. It does not necessarily follow that a large rise in the price an individual stock or in the market average must be followed by a decline; but the only reason to view with confidence the future price of a security that has already advanced substantially in the presence of external reasons, other than the actual price movement itself, which would justify such confidence. Hence a large advance in the stock market is basically a sign for caution and not a reason for confidence.

Eoin Treacy's view

One of the benefits of being locked in a metal cylinder for 14 hours is I get to catch up on my reading. The first thing that occurred to me on reading this paper is how little things change. We might have different names for popular financial products but the basic psychology of investors does not change.

With Warren Buffett so recently having declared victor by investing in an ETF over a fund of hedge funds the confidence investors have in the security and stability of investing in the “market” through ETFs is worth considering.

If we ask ourselves a simple question then perhaps we can come to some illumination on this topic. When does stock picking work best? The easy answer is when there is a big difference in the performance of shares. However, the question itself raises a topic that value many investors would take umbrage at. Do some strategies work better during different parts of the cycle? The Graham method obviously opines that there are better times to invest than others and holds to a value proposition to tell the difference between the two. However, that also ensures that the biggest part of an acceleration is completely foregone.

There is no doubt that value strategies work wonderfully after a big market decline. That is when bargains abound and a focus on fundamental value will highlight sound opportunities. On a chart that decision making and rotation process creates a choppy market environment consistent base formation development and even the early part of a trend.

The next phase is when prices have been advancing for a while and investors are more willing to come around to the idea that a trend is underway. The buy and hold strategy works well in this environment because the market is generally rising and a great deal of luck is required to successfully trade in and out at exactly the right time to beat the Index. As this stage progresses however the value proposition will begin to suggest that weightings in stocks should be reduced in favour of bonds.

The next stage is when the success of buy and hold over all other strategies is considered so obvious that no other strategy should ever be considered. That is generally observable when the trend has become very consistent with most shares rising. Stock picking finds it very hard to outperform because if one does not own a small number of often highly leveraged stocks then the chances of outperforming are virtually zero. It’s also at this stage that value investors lament there is nothing worth buying.

We have just had two major downdrafts in the space of six weeks which at a minimum is a reality check for the buy and hold strategy. It is now possible to outperform again with a long/short strategy and that alone is a major change in the market which is contributing the new more volatile environment. The extent to which recent lows hold will inform us as to whether this is likely to remain a range or is a medium-term top formation. 

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