Most Popular ArticlesJuly 28, 2009
After World War II, the West, led by the United States, unleashed the power of the free market system. Capitalism fueled technological innovation, which in turn bolstered global economic expansion. As a result, the stock markets enjoyed the most powerful and the longest advance in human history. The unprecedented secular bull markets skyrocketed 1,000-fold and lasted six decades. All academic research sudies focused on this post-WWII era naturally concluded that no one can beat the markets. The efficient market theories had little to do with B/H’s success. The B/H strategy was the Holy Grail simply because of the secular bull markets.
Then came 2000. The markets tumbled and B/H faltered. Researchers who clung to six decades of flawless records with a seemingly sound theoretical underpinning were perplexed. Since bull markets always returned in the past, they waited, only to get hit again in 2008. They continue to hold, wait, and hope. Â Â Â
As an engineer surrounded by financial scholars and investment geniuses, I feel like the little boy watching the naked Emperor in the parade. I point out the obvious with no fear of embarrassing myself. President Clinton once said, “It’s the economy, stupid!” I holler, “It’s the bull markets, Professors!” The truth is that B/H works wonders during economic expansions, but it underperforms during economic slowdowns or contractions. If there were no bear markets, B/H would indeed be the Holy Grail!
Diversification in time
The Modern Portfolio Theory tells us not to put all your eggs in one basket. The B/H strategy calls for holding all your eggs in one continuous “basket” of time. That sounds like a risky proposition to me. Market timing is not witchcraft. It reduces risk through temporal diversification. There are times to hold, and there are times to fold.
Active investment management with market timing works not by forecasting the future, but by following major maket trends. By way of example, let me illustrate how the 6-month MAC system described in Part 1 and Part 2 realizes temporal diversification. Figure 4 shows the difference between $1 investments in B/H and in MAC made in January 2000. How have the two systems performed through the 2000 Internet Bubble
and the 2008 Systemic Meltdown, to June 2009? I’ll let you be the judge. The MAC system doesn’t predict the markets, it follows the trends. It doesn’t sell at peaks or buy at bottoms. But it’s effective in preserving wealth in bear markets and accumulating wealth in good times.
Now you know why the B/H strategy that worked so well in the past has proven so fallible since 2000. The question is whether you believe the secular bull of the past is likely to return after the current recession is over. If you think that the next decades will not match the good fortune of the post-WWII era, you should start looking for an alternative investment approach.Â
* Theodore Wong graduated from MIT with a BSEE and MSEE degree. He was General Manager of several Fortune-500 companies that designed sensors for satellite and military applications. He started a hi-tech company via a LBO in partnership with a private equity firm. He now consults on management and investment best practices. While studying for his MBA, he discovered his true passion was investment research. He combines engineering analytics with econometrics modeling to enhance quantitative investment analysis. He seeks absolute returns by active risk management in both up and down markets. He can be reached at .
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