This is one reason why macro tends to have high volatility. These events are hard to figure out, but they’re even harder for people whose jobs are not really about thinking about the macro situation. So it’s hard to figure out how economies react to large events like these, and just because one works in macro doesn’t mean one gets it right most of the time and everyone else gets it wrong. But by having your job be about analyzing historical macro trends and having the data to think it through (which requires both quantitative capabilities and historical interprative abilities), your errors should have a lower standard deviation than other peoples. That translates to a higher sharpe ratio, even if you are no better at predicting the actual size of outcomes. However, there are fewer independent bets that you are going to be making every year, which is why returns tend to be more volatile.
Palantir Wrote: ------------------------------------------------------- > to the OP, why would you divert your energies from > value investing considering it is a proven > strategy that many people have used to generate > good returns? As you said, value investing is hard > enough as it is, why pick out a more complicated > strategy that, while being more interesting, may > not even make you money? JMT. I probably wouldn’t 
I just wanted to know why macro doesn’t really work for individuals, and get a feel that others here agree. I’m interested in stock picking and macro economics and markets. With a loaded gun to my head, I’d express more interest in the latter, and I’ve heard and believe that you should follow what you’re most interested in. But there are limits to that advice, unfortunately. I can sit here and read up on econ and the markets all day but the chances that it allows me to generate 10-15% CAGRs on my money or gets me a spot at Moore or Soros are quite low, which I’ll readily admit even as I sit here brimming with confidence in my own abilities (as I’m sure most of us do). To add to the very insightful comments already shared, I’ve recently read about how Keynes, who we can probably all agree had a solid handle on the economies of the world, eventually turned into a stock picker/value investor. I know that being an economist does not mean being a good trader or macro investor, and Keynes just proves that point. If someone like he felt his investing odds were better away from the macro, I’m tempted to follow his lead, however appealing macro might be intellectually.
If you are an individual investor, you may be more likely to uncover a stock that is undervalued, underappreciated, and can therefore generate high levels of returns with a margin of safety. Just realize that a lot of what you’re capturing is could be levered by a stock’s beta, and it is not guaranteed to be so much alpha. In a rising stock market, if you have noisy high-beta stocks, you can generate high return levels and find relatively low valuation levels now and then, and there are thousands you can try to screen for. But be careful, because if you have high beta in your portfolio, you have to neutralize the beta in a downturn. And in a steep downturn like 2008, really wierd stuff can start to happen as people try to free up cash. All of a sudden people start selling really undervalued stuff because they just have to sell everything, and that’s what they were holding when it happened. Sure, you can call it a buying opportunity as it’s happening, but if you don’t actually have any cash around to take advantage of it, it’s all just academic. In other words, it’s hard to do macro as an individual and generate outsized returns, but a big part of it is because there is opportunity to leverage up your portfolio with a stock’s beta. And there is a larger universe for individuals to investigate. The other reason that it’s hard to do macro as an individual is just that the models between the variables can get quite complex and it’s hard to figure out what to pay attention to. I find it helps to have an organization that helps you collect information and have a way to process and discuss it. Finally, macro can involve an awful lot of leverage, particularly with currencies. Individual-sized accounts often can’t handle the margin requirements without taking on ridiculously sized risks.
thanks bchadwick
I never understood it, why value investing is so popular, when it’s highly unrealistic. To me value investing looks like a cult, where the reader is tricked into believing so many assumptions in the name of academic sophistication, that he can’t even question it’s validity. What’s the basic premise of value investing?.. it works… just like the basic premise of religion that god exists!
Bernanke, mind if I ask what you do with your personal account?
darkxfriend Wrote: ------------------------------------------------------- > Bernanke, mind if I ask what you do with your > personal account? Trading, mostly on technicals and macro, little bit fundamental investing but mostly just trend following in equities and sometimes indexes!
What is “highly unrealistic” about a strategy of hunting for bargains? Sounds to me like you’re confusing value investing with the EMH or something.
Captain Windjammer Wrote: ------------------------------------------------------- > What is “highly unrealistic” about a strategy of > hunting for bargains? Sounds to me like you’re > confusing value investing with the EMH or > something. May be but please don’t misunderstand the tone. I’m not saying that it’s worthless… I’m not even qualified or experienced to accept or reject it’s invalidity or validity. What I am saying is that, I never felt intellectually satisfied despite my efforts to understand the value in value investing. I can understand the rationale for investing in a company in a business segment which will be booming in coming time… AND, market is highly unaware of that. So somehow if you can gauge the changes in market resulting from the social shifts or change in people’s lifestyle or some invention of some new technology, and you have uncanny ability to see management’s potential, then it makes perfect sense to invest. That’s what entrepreneurship is, precisely, and that’s what entrepreneurs do, and those are essential qualities of successful entrepreneurs. But numbers, and intrinsic value, discount rates assumption, growth rates assumption, this and that… that I can’t digest properly. If you are saying entrepreneurs and value investors are essentially the same kind of people, then it’s fine. But if you are saying, one has uncanny abilities to see through idiosyncratic factors and other is good with numbers, that I don’t understand!
Bernanke Wrote: ------------------------------------------------------- > > May be but please don’t misunderstand the tone. > I’m not saying that it’s worthless… I’m not even > qualified or experienced to accept or reject it’s > invalidity or validity. What I am saying is that, > I never felt intellectually satisfied despite my > efforts to understand the value in value > investing. > > I can understand the rationale for investing in a > company in a business segment which will be > booming in coming time… AND, market is highly > unaware of that. So somehow if you can gauge the > changes in market resulting from the social shifts > or change in people’s lifestyle or some invention > of some new technology, and you have uncanny > ability to see management’s potential, then it > makes perfect sense to invest. That’s what > entrepreneurship is, precisely, and that’s what > entrepreneurs do, and those are essential > qualities of successful entrepreneurs. > But numbers, and intrinsic value, discount rates > assumption, growth rates assumption, this and > that… that I can’t digest properly. If you are > saying entrepreneurs and value investors are > essentially the same kind of people, then it’s > fine. But if you are saying, one has uncanny > abilities to see through idiosyncratic factors and > other is good with numbers, that I don’t > understand! At the risk of turning this into a value vs macro war, I’ll just add my 2 cents Value investing is a very vague term - most people would have a different interpretation of it. However the situation you described seems to be more commonly associated with growth investing. Many times identifying trends, or determining discount rate, growth rate etc. is not necessary for value investing. If a widget maker also happens to own some income producing real estate and a portfolio of blue chip stocks, and excluding the properties/stock the widget business can be bought for low single digit p/e, then it is a value stock and there’s no need to make any assumptions on WACC or growth or whether Spain will default. Macro is important. As Howard Marks said you can’t predict but you can prepare. For value investors it is good enough to be prepared for macro turns without trying to predict it.
I dont’ see why value investing is so unrealistic, but I do agree that some value investing afficionados really seem to get dogmatic and almost religious about how it’s the *only* legitimate way to invest. I happen to think that the dogmatic attitude is bunk, but value investing is definitely a respectable discipline. There are legitimate ways to question value investing. It may be rarer and rarer that you get a significant discount to fair value (and thus a good margin of safety). That doesn’t mean that the philosophy is bad, but simply that it is harder to find good values these days. This is particularly problematic when there is substantial deterioration in the macro situation. Often times it looks like one should be buying more as prices drop, but to the extent that the price drop represents genuine reevaluation of earnings prospects and the value of current assets, it can lead to disastrous outcomes if these are not reevaluated correctly (which in itself is very difficult to do). Basically, as the macro situation deteriorates, your margin of safety has to increase substantially, which may mean that you shouldn’t be buying even though the price looks juicy based on previous analysis. Secondly, value investing doesn’t really have a good explanation about why stocks should be available at a discount in the first place. And if you can’t explain that, then you have a hard time justifying an expectation of return to fair value. Maybe something is available at a 10% discount to fair value, but whether it returns to fair value in 1 month or 10 years makes a big difference. And then, of course, maybe the discount to value is because of some reason overlooked. Diversification across value assets can help this, but it also will tend to force you to reduce exposure to what you think are your best ideas.
The explanation under your “secondly” point seems easy enough – there are many, many publicly traded stocks, few of which are actively covered by the sell-side, and many of which are below the radar due to cap reasons or the “boring” nature of their businesses. Also, many firms are short-term oriented in their analysis, making it possible for a company to be significantly undervalued based on it’s long-term prospects (even after accounting for a reasonable risk premium addition to the discount rate). I feel that this is hard to debate, but maybe that is dogmatic of me.
I understand the point that prices can drift around intrinsic value for one of many reasons… people disagree about future earnings and/or what discount rate to use to compute the present value. But margin of safety is basically to account for those kinds of uncertainties. If something is available at a discount that exceeds the margin of safety, then presumably it is cheap “even after” considering reasonable differences on discount rates and future earnings. Things may be available at a discount because the companies are small cap or off the radar or poorly followed, or boring, but why will they not continue to be small cap, or off the radar, or boring into the future? The best answer I’ve seen to this is the idea of looking for a catalyst… somethign that puts it on people’s radar. This can be an acquisition announcement, or some new product announcement, or anything else that gets people to sit up and take notice. Of course, detecting a catalyst before it actually catalyzes is pretty tricky. Momentum can be a catalyst too. Low valuation plus recent momentem seems like a pretty sensible screening technique for me. Anyway, my point isn’t that value investing is bunk. I think it’s a perfectly reasonable approach to things and that there are plenty of intelligent, capable people that practice it. It’s just not the watertight philosophy that many claim it to be. I think that investing is really about applying the knowledge one has to maximize the risk-adjusted return on your capital, and searching for value using Graham, Buffet, or Greenwald’s methods is just one of many arrows in the quiver, albeit a very useful one.
Yes, I agree it is one of many viable approaches, and perhaps the most consistent / reliable, which may be why some people get very dogmatic. I have yet to see a good argument against value investing though (EMH is clearly incorrect IMO).
Exactly, that’s the point. Much of the return from value investing is attributable to general increase in productivity and technological progress because of the large time horizon which averages out bubbles and busts, and improvement in technology is something inevitable. Now, selecting “dogs” after each bust makes sense because of the discount created by prevalent irrationality, at that time discount might be confusing, you can say, for some, the correct pricing came little early and others are actually trading at discount, but how do you make that distinction. Often, recessions result in restructuring on economic level, and predicting the structured economic landscape is a daunting task as lot of idiosyncratic factors go into that. So while you have lot of cheap stuff, you are unable to figure out what might turn into gold, leaving aside the cases where success of firm is correlated with economic sentiment but they are close to extreme events such a possible bankruptcy. All in all, everything ends up being idiosyncratic, so value investing must be a risky strategy as lot of subjective judgement is required?. This is the case with bust to boom part of timeline, what about the case of value investing which averages out boom and busts and economic shifts and technological changes, what goes in that analysis, idiosyncratic factors and lots and lots of subjective judgement?, meaning much more riskier strategy. The whole point is, while every strategy is criticised and stripped naked until every risk is figured out, no one ever seem to criticise value investing, why so? Why it’s considered as something with best risk/reward ratio (pardon me if I’m wrong, but that’s the impression of value investing texts on me) It’s a fine strategy like every other strategy, but like every other strategy why value investing deserves a special treatment, and no one seems to talk about risk vs reward case for value investing? why no one criticises value investing, criticising is part of prudent analysis I guess? On the other hand, value investing is seen as a holy writ while any other strategy is considered like playing with knives where warnings about risks proceed possibility of return and chances of success equates chances of failure, why value investing enjoys the skew in expectations? And if, value investing really offers best risk/reward ratio, why invest in any other strategy, OR may be value investing is not truly the best thing you can do with your investments and it’s just a default case (like something is better then nothing), if you don’t have anything better. With that rationale, value investing must be the pretty much average strategy just like many other strategies with it’s particular risk reward characteristics, with nothing specially great in it. I’m sorry, if it does seems little bit tautological!
bchadwick Wrote: ------------------------------------------------------- > Buying a stock at a 10% discount to fair value > will not make you money if the macro situation > goes into the cr@pper. We tend to have once in a > lifetime economic/financial events every 5 years > or so, somewhere in the world. > > > The reason you don’t just buy AAPL is not simply > that you are uncertain that AAPL will make you > money in the future. The reason is that you want > diversification of your risk exposures. You may > also need to have diversification of risk exposure > across strategies. Growth may not outperform > Value over the very long term, but a Growth/Value > portfolio in the right proportion outperform > either one on a risk adjusted basis if it is > reblanced regularly. > > The other issue is to ask yourself what is it that > you are good at analyzing and thinking about. If > you have a feel for macro issues that others > don’t, then the way you add value to the process > is to use that knowledge in that context. It’s a > comparative advantage issue. Buying at a 10% discount to fair value isn’t value investing. Value strategies tend to focus on picking much larger discounts. If the macro situation goes in the crapper, pretty much any long oriented strategy will hurt, value is not alone in that. Regarding diversification, since you cannot predict whether growth or value is going to outperform in the near term, if you’re diversifying to growth stocks just because you are unsure that “value” will outperform, on what basis do you think that “growth” is going to do well that you’re willing to move money away from value? Diversification is fine if you have no confidence in your picks, but then why would you invest actively? Anyways, why the distinction between “growth” and “value”? At their core the concept is the same, you’re looking for good companies selling for a serious discount to fair value whether that company is AAPL, GOOG, or GIVN.
Oh, did I say 10%? Man, you got me!
Amazingness
Bernanke Wrote: ------------------------------------------------------- > Exactly, that’s the point. > > Much of the return from value investing is > attributable to general increase in productivity > and technological progress because of the large > time horizon which averages out bubbles and busts, > and improvement in technology is something > inevitable. Now, selecting “dogs” after each bust > makes sense because of the discount created by > prevalent irrationality, at that time discount > might be confusing, you can say, for some, the > correct pricing came little early and others are > actually trading at discount, but how do you make > that distinction. Often, recessions result in > restructuring on economic level, and predicting > the structured economic landscape is a daunting > task as lot of idiosyncratic factors go into that. There is so much more to value investing than looking at long-term technological productivity gains. This is a fraction of the return to good value investing, not “much.” Selecting “dogs” probably wouldn’t be much of a value. Good businesses at low prices are a value, dogs at low prices are… dogs that happen to be selling at low prices. Predicting the restructured economic environment on an industry specific level is not as difficult as you might think. There is some subjective judgment, but most good value strategies rely on an equal part of quant and qual analysis. To me, it seems a lot less subjective than “guessing” about what the price of oil is going to be tomorrow or what China’s growth is likely to be for the next five years. I hope this does not come across as an antagonistic post because it’s not mean that way, but I feel that you do not even grasp the basics of value investing. All of the things you described are the opposite of value investing.
^ Yes, may be. But that’s what I said earlier, I am trying to understand what value investing is, in action. I’m just taking the position against value investing in the debate as I’m myself more biased towards trend/momentum/sentiment following, it’s just matter of different tastes but it’s nice to argue :)! What I was saying is that, idea of investing in “good” companies selling at “heavy discount” is great, what i’m trying to figure out is, how to do it! To me the whole thing sounds really really difficult to pull off with reasonable accuracy! Anyway, Lot of good openions on this thread, seems to clear the air quite a bit, I guess the thread has reached it’s threshold and diverting now, it would be better to start the new thread for “how to do value investing”, and special thanks to BChad for really detailed posts on macro world :)!