Regrettably, Mr. Dever is correct in his assessment. The belief in rational, efficient markets has been a core tenet of the investment faith since the 1950s. Only recently has the investment community begun to reach the conclusion that every successful practitioner already knew by instinct or learned through experience: humans are not always rational, and humans acting as a group are often even less rational than humans acting as individuals. And, again contrary to efficient market dogma, rather than avoid unnecessary, uncompensated risk, investors often engage in risk-seeking behavior (i.e. taking more risk than is necessary)—which is Dever’s definition of Jackass Investing.
Michael Dever is the founder of Brandywine Asset Management and a long-time technology entrepreneur. He is also a “macro,” top-down investor with a unique approach to allocation. Rather than look at asset classes (i.e. large cap stocks, emerging market bonds, etc.) Dever looks at return drivers, or the underlying fundamentals that drive the investment performance of a given asset. “Diversification” is not simply shifting money between asset classes—which, as 2008 demostrated with brutal efficiency, all tend to fall in lockstep during a crisis—but allocating your precious funds across different investing and trading strategies that exploit different return drivers.
Dever’s thought processes are not altogether different than those we apply in the Sizemore Investment Letter. We diversify based on durable macro themes—such as the rise of the Emerging Market Consumer or the coming of age of the American Echo Boomers—and not based on arbitrary asset class distinctions. Dever dedicates his book into exploding a series of myths that “permeate common financial wisdom”:
- Stocks Provide an Intrinsic Return
- Buy and Hold Works Well for Long Term Investors
- You Can’t Time the Markets
- Passive” Investing Beats “Active” Investing
- Stay Invested So You Don’t Miss the Best Days
- Buy Low, Sell High
- It’s Bad to Chase Performance
- Trading is Gambling—Investing is Safer
- Risk Can Be Measured Statistically
- Short Selling is Destabilizing and Risky
- Commodity Trading is Risky
- Futures Trading is Risky
- It’s Best to Follow Expert Advice
- Government Regulations Protect Investors
- The Largest Investors Hold All the Cards
- Allocate a Small Amount to Foreign Stocks
- Lower Risk by Diversifying Across Asset Classes
- Diversification Failed in the ’08 Financial Crisis
- Too Much Diversification Lowers Returns
- There is No Free Lunch
I initially took issue with Dever’s claim that stocks provide no intrinsic return. After all, stocks represent ownership shares of businesses and those businesses earn profits and (ideally) pay dividends.
But while this may be true, Dever correctly points out that the stock market returns realized by investors are driven by two (and in the end, only two) return drivers—the earnings generated by the companies comprising the market and the multiple that investors are willing to pay for those earnings. And except over the very long term, it is primarily investor psychology—the multiple investors are willing to pay—that determines stock returns. On that count, there are not guarantees. Your returns are at the mercy of the fickle and emotional whims of other investors.
As for Myth #2 on long-term, buy-and-hold investing, Dever points out that “All of the real stock market returns earned over the past 111 years can be attributed to a just an 18 year period—the great bull market that began in August 1982 and ended in August 2000. Without those years, the real, inflation-adjusted returns of stocks, without reinvesting dividends, was negative.” Investors today would no doubt nod their heads in understanding. Excluding the modest returns earned from dividends, investors have seen virtually no returns in over a decade. After adjusting for inflation, the returns are well into negative territory. Dever also correctly points out that for much of the period of time covered in long-term stock market studies, the United States was an “emerging market,” with the higher rates of growth that this implies.
Furthermore, studies that demonstrate “market” returns are meaningless because until recent decades, no one bought “the market.” Index funds didn’t exist, and stock market investing was a hobby primarily of the wealthy, not the middle class. And returns came primarily from dividends. “Just because something happened in the past does not mean it will reoccur in the future,” writes Dever. “We must first understand all of the return drivers, and then determine whether those return drivers are still valid.”
Well said.
Lest this review turn into book by itself, I’ll spare readers a review of the remaining 18 myths. I will, however, share one of Dever’s more amusing market analogies—the George Costanza trader.
Dever recounts the Seinfeld episode in which Costanza realizes that “every decision I’ve ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be. Every instinct I have, in every aspect of life… It’s all wrong.”
Costanza then decides to do the opposite of what his instincts tell him to do, and his life turns around. He gets a gorgeous girlfriend and the job of his dreams. This is the essence of contrarian investing; doing precisely the opposite of what our emotions—and the actions of other investors—tell us to do. Or, as Warren Buffett succinctly puts it, “being greedy when others are fearful and fearful when others are greedy.”
Overall, Jackass Investing is an entertaining and informative read. Consider adding it to your 2012 reading list.