Noise & The 10 Best Days

I should snicker, to sneeze, to smile, to stoop and kiss a grasshopper, and slobber in a coal bucket and see a son of a sea terrapin stick his head through the barbed wire fence backwards and cut off his tail in the slop barrel.

Did the above not make any sense? How about this one:

One a zog, two a zog, zig zag zain. A bob tailed nanny goat, tickle tog tain. Harem, scarem, sinctum, sanctum, rhythm, rathem, buck.

Still not making sense? It shouldn’t – they are nonsensical poems my grandmother taught all of the kids when we were growing up in North Carolina. It mainly kept us busy during family vacations to the beach. She would give us $1 when we got it right. What does this have to do with investing?


You hear it all day on CNBC, the WSJ, blogs, and in the lockeroom. Gold up! Stocks down on profit taking! Bear Stearns goes under! Buy low P/E stocks! etc etc. It is dangerous to your wealth to listen and act on most of this info, and does not aid in the portfolio management process whatsoever. All of the behavioral evidence goes to show that it works to hurt your returns. Even worse, the comments are often misleading and even completely wrong.

Take this cliche for example: “Market timing is a fools game. As an example, look what would happen if the investor missed the 10 best days in the market.”

I HATE HATE HATE this comment. I can’t tell you how many times I have seen this on a PowerPoint slide to justify buy and hold.

Most pundits fail to mention what would happen if you missed the ten worst days as well. There are some people that have examined the effects of missing the top 10 worst days and top 10 best days. A good example is from CXO who posts a review of the paper “Black Swans and Market Timing: How Not to Generate Alpha“. From the abstract:

The evidence from 15 international equity markets and over 160,000 daily returns indicates that a few outliers have a massive impact on long term performance. On average across all 15 markets, missing the best 10 days resulted in portfolios 50.8% less valuable than a passive investment; and avoiding the worst 10 days resulted in portfolios 150.4% more valuable than a passive investment. Given that 10 days represent less than 0.1% of the days considered in the average market, the odds against successful market timing are staggering.

The author does a great job on the paper, although comes to the unfortunate conclusion that it is impossible to predict when these rare bad months will occur. I agree it is very hard to predict, but a simple timing model can help protect you nonetheless.

Richard Ahrens takes up the topic with his “Missing the 10 Best Days” pdf. He finds that most of the best days are followed by some of the worst days/declines. He comes to the following conclusion:

The best days in the market are nothing more than interesting statistical anomalies. The argument that missing the best days would reduce the final return of a buy-and-hold investment is true, but it also provides no information regarding the question of whether or not one can time the market. A simple moving average cross-over system will cause you to miss nearly every one of the best days and you should be happy to watch them pass by, because you’ll also be missing the more-than-offsetting declines those “best” days are invariably tied to.

Paul Gire shares my sentiments. He had a GREAT piece in the Financial Planning Journal here. He goes as far as to state that using this market statistic is possibly an ethical violation!

For years Wall Street and the mutual fund industry have advanced the concept that investors should buy and hold. A common piece of evidence to support this recommendation is various versions of “Don’t Miss the Ten Best,” which show that missing just a small percentage of the market’s best days dramatically reduces investor returns.

A closer look reveals that all may not be as it first appears, that this may be a misleading characterization of market history. If so, “Don’t Miss the Ten Best” could be construed as an ethical violation of both the CFP Board’s Code of Ethics and Professional Responsibility (Code of Ethics), and the Securities and Exchange Commission’s Rule 206(4)-1 under the Investment Advisers Act of 1940.

In light of these findings, advisors may want to consider either refraining from future reference to such studies, or add an additional disclaimer.

Here is a table from the article:

I decided to run another study. I was concerned that the previous data, dominated as it was by the singular event of the 1929 crash, may have skewed my findings. So I tried to achieve a more balanced view by examining one of the most bullish periods in Dow history, from 1984 to 1998. In addition, I examined the impact from missing not just the 10 best and worst days—I also examined the 20, 30, and 40 best and worst days. Here’s what I found:

* The buy-and-hold return for this 15-year period was 17.89 percent—one of the most bullish periods in market history.

He states:

* In the majority of cases, large percentage gainers were no more than 90 trading days away from a large percentage loser, sometimes before and sometimes after.
* One exception was the large one-day gain on September 5, 1935, in which there was no large losing day associated with it.
* In 50 percent of the cases, gainers and losers were separated by no more than 12 trading days.
* When looking at Nasdaq’s 20 largest gainers and losers (not shown) of the 20 largest one-day gains, all but two of them occurred during the bear market of 2000–02, when the Nasdaq crashed 78 percent.

Not only does missing both result in superior returns—imagine the knock-off benefits from lower volatility, especially on client psychology. As many advisors have learned since the 2000–02 bear market, it’s one thing to encourage clients to stay the course when markets are trending steadily higher, quite another when bear markets rapidly erode the gains from years of careful saving and investing. In 30 months the 2000–02 bear market erased half of the market gains of the previous 26 years—since 1974.

Time To Buy Gold Stocks?

I posted awhile back on the attractiveness of gold stocks using a very simple indicator. The Hussman model looks like it is flashing green as well (more here):

Not surprisingly, the combination of all of these is rare but extremely powerful. In the rare instances when 1) The rate of inflation has been higher than 6 months earlier, 2) Treasury bond yields have been lower than 6 months earlier, 3) the NAPM Purchasing Managers Index has been below 50, and 4) the Gold/XAU ratio has been above 4.0, the XAU has soared at an astounding rate of 123.63% annualized. In contrast, when none of these have been true, the XAU has plunged at -53.21% annualized. That’s a gaping difference.

GDX is the gold miner ETF.


I’ve been cleaning out some old folders, and came across a great paper by Acadian Asset Management in 2005 titled, “Why Do We Do What We Do?“. A couple other good papers of theirs:

“The Final Frontier: Investing in Frontier Emerging Equity Markets”
“Is Dividend Yield Dead?”


Want to grab lunch or buy me a beer? I added a feature on the sidebar that updates any upcoming work trips out of town. If you’re in SoCal, I’ve always wanted to goto Urasawa. . .


Looking to hire? A good buddy of mine with portfolio management experience and a CFA is looking at jobs in SoCal. Contact me with any opportunities. . .

Charge It! Mastercard at new highs.

I like the idea of aggregators, and considered building one with Bloggerator. The problem with the ones like RealClear Markets is that they are 1) poorly designed 2) have too much information/links 3) not edited with useful value added information.

A much better model is any of the below sites:

Abnormal Returns

Value Investing News (which actually shares revenue with the users).

IMO, for the site to work you either need to have value added editing, or user based participation where it gets rewarded. . .Seeking Alpha works because they have a nice (edited) layout, and were first movers. They will lose out to the next best designed competitor that either 1)does a better job of sending traffic to the blog’s site, or 2) shares revenue with the bloggers. Rempel had a good couple posts on the business of blogging here and here.

Forbes had a shot but is doing their best to muck it up. Take 60% of your revenue then just run ads for the Forbes blog network for two months? Ridiculous.

What are some other good examples of aggregators that I have missed? Any that share revenue with users?

(Edit: As soon as I posted this I received an email from Newsflashr. Good idea, terrible design. World Beta is ranked 24th best business blog. )


Re-read this great paper this morning: The Rewards of Multi-Asset-Class Investing. The paper begins with this quote. If you extrapolate land=real assets, business=stocks, and reserve=bonds, then that is pretty close to the endowment allocation:

“Let every man divide his money into three parts, and invest a third in land, a third in business, and a third let him keep in reserve.” —Talmud Circa 1200 BC–500 AD


Lone Pine, Blue Ridge, Tiger, and Viking all hold Mastercard (MA) – at all time highs here.


The first active ETF begins trading today, the Bear Stearns Current Yield Fund (YYY). Yawn.


Lots of Ibbotson Charts here (nod reader SF).


Do you think the folks at FUNDX / Dal Investments read my paper? A new offering (nod to reader RD). Sounds interesting, although their FUNDX fund basically pegs the MSCI World Index:

FundX Tactical Upgrader Fund (TACTX)

The FundX Tactical Upgrader Fund (TACTX – Inception 2/29/08) uses the NoLoad FundX Upgrading Strategy to select funds and ETFs that are top ranked by our performance-based ranking system.

The Fund also overlays a quantitative, disciplined methodology for moving in and out of a fully invested position. The Fund will – at times – take deliberate action to possibly reduce exposure to market risk.

Under normal market conditions, FundX Tactical Upgrader Fund will typically hold core equity mutual funds and ETFs, as well as some more concentrated funds and ETFs. When the Fund’s tactical model indicates a more defensive portfolio, a substantial portion of the Fund’s portfolio will be invested in money market instruments and ETFs that short the market (move inversely to broad market indexes), providing a hedge against the remaining long positions. When the tactical model indicators turn positive again, the portfolio will return to a fully invested position.

This Fund may not be appropriate for investors seeking regular income, for those pursuing a short-term goal, or for taxable investors interested in limiting their exposure to taxable gains or losses from a mutual fund.


I think it would be interesting to see a list of traders that have lost the most money in their lifetime. This fellow would certainly make the list.

When thinking about people who blow up from too much leverage, I am reminded of this great quote. I mean, have you ever heard anyone say in the morning, man I wish I had more to drink last night, I could have used a few more shots of tequila. . .

“We never repent of having eaten too little.” – Thomas Jefferson.


A new multi-strategy hedge-like mutual fund launches: Anchor Multi-Strategy Fund (AMSGX).


Strange – my white paper over on SSRN has been downloaded almost 9000 times, which puts it in the top 50 dowloaded papers ever (out of about 140,000). And this entire time no one emailed me the spelling and grammar mistake? Maybe they are just downloading it and using it for fire starter. . .(Uploaded the official version today.)


In the mail : A Splendid Exchange: How Trade Shaped the World by Bernstein.


Did you take Vitamin C, err I mean Airborne, in the past few years? Well, they just lost a lawsuit for making unjustifiable claims about curing the flu or something – claim your $40-$60 here.


Sign up for the alphaCLONE private beta here.

Taking a Mulligan

I promise I will not use a mulligan when I launch any funds (SSRN Paper here).

This paper provides the first systematic analysis of performance patterns for emerging managers in the hedge fund industry. Emerging managers have particularly strong financial incentives to create investment performance and, because of their size, may be more nimble than established ones. Performance measurement, however, needs to control for the usual biases afflicting hedge fund databases. Backfill bias, in particular, is severe for this type of study. After adjusting for such biases and using a novel event time approach, we find strong evidence of outperformance during the first two to three years of existence. Controlling for size, each additional year of age decreases performance by 48 basis points, on average. Cross-sectionally, early performance by individual managers is quite persistent, with early strong performance lasting for up to five years.


Radiohead hosts online video contest. Maybe I should hold a cover design contest for my book?


“Why the Fed must act in unfamiliar ways” by El-Erian:

In intervening to stabilise the system as a whole, the authorities end up protecting certain people and institutions from the consequences of their ill-advised actions, thereby undermining the discipline that is crucial to market efficiency. As unpleasant as this is, the moral hazard risk is inevitable at this advanced stage of the crisis. Indeed, the question is not just what happens to irresponsible lenders and imprudent borrowers. It is also about the damage that is being inflicted on others as the financial system freezes.


If you have never been to the touring Banff Mountain Film Festival, I highly recommend it.


And another round of Really with Seth and Amy…

I Want My Two Dollars!

With the recent Bear Stearns news I can’t stop thinking about the film “Better Off Dead” starring John Cusack as Lane Meyer…“I want my two dollars!” . . .


BlackRock plans a listed fund of hedge funds! Hooray! Oh, wait, it’s in London. Nevermind.


I (re)read Inside the House of Money on the plane last night, and the interview with Jim Leitner is a classic.


Some great soundbites from Jim Rogers:

On why Bear Stearns was bailed out:

You know the reason they did it this way was because, if Bear Stearns had to declare bankruptcy, you’d realize that Bear Stearns paid out billions of dollars in bonuses in January – six weeks ago. If he let them go into bankruptcy, they all would have had to send back their bonuses.

On letting banks fail:

Investment banks have been going bankrupt since the beginning of time. What are you talking about? Let somebody go bankrupt – it’s not the end of the world.


The hedge fund Implode-O-Meter has been pretty active lately. . .


I’m currently car shopping, and if oil keeps ripping, I may have to put down a deposit on an Aptera instead of that ’67 Camaro or old FJ40.


Rempel on how the aggregators still don’t get it.


Is your portfolio caught in a downdraft? Watching too much CNBC? Maybe the obvious answer was right in front of you the whole time. . .(nod to reader CC.)

Awareness Test – Watch more free videos

Winning By Not Losing

I believe avoiding loss is the most important consideration in this business. But don’t take my word for it – below are a few of my favorite quotes on investing (& losing), by some of the top investors in the world.

“The first rule is not to lose. The second rule is not to forget the first rule.” – Warren Buffett

“Whenever I buy or sell something , I always try and make sure I’m not going to lose any money first … my basic advice is don’t lose money. ” – Jim Rogers

“A loss never bothers me after I take it. I forget it overnight. But being wrong – not taking the loss – that is what does damage to the pocketbook and to the soul.”
-Jessie Livermore in “Reminiscences of a Stock Operator”

“I am always thinking about losing money rather than making money.” Paul Tudor Jones

I published a paper last year to focus on the topic in the title of this blog post – “A Quant Approach to TAA“. It took inspiration from the Policy Portfolios of the Harvard and Yale endowments to come up with a simple strategic asset allocation – 20% each in US Stocks, Foreign Stocks, US Government Bonds, REITs, and Commodities. This portfolio can be easily implemented with low-cost ETFs or mutual funds, and rebalanced every so often. It then applied a smiple tactical overlay to reduce risk and drawdowns – ie winning by not losing. This technique would have had you out of US Stocks the end of 2007, out of Foreign Stocks the end of January, and out of REITs way back in June of last year. And of course you would still be happily in 20% bonds, 20% commodities, and 60% cash.

I have received a handful of emails asking to post the monthly return series online, and below is a PDF you will have to click on to enlarge and view. As you can see, the returns in 2006 (when I first circulated the paper) to 2008 out-of-sample are quite representative of the previous 30+ years. 36 profitable years and counting – including this year (so far), a pretty difficult year for those who are long stocks. (All figures below are gross of any management fees, commissions, taxes, or bid/ask spreads. The original paper also understated the cash returns a bit and is corrected here.)

And at the request of a reader – returns since 2006:


For once I agree with Goldstein. I mean, I was driving around LA this morning and passed a billboard with a huge ticker for a pink sheets gold mining company. . .And buying a hedge fund is somehow more risky? Pffftttt. One Enron is still bigger than all the hedge fund fraud combined.

This issue hits close to home as our lawyer is very nervous about my blogging and launching some funds. I am either going to have to be very careful or shut the blog down. TBD which one.


Interview with Marc Faber on CNBC:


New blog added to the blogroll – The Stalwart.


Bones are not the only fossils.


I can’t stop singing a little Sinatra while watching commodities right now..

Fly me to the moon
Let me play among the stars
Let me see what spring is like
On a-Jupiter and Mars
In other words, hold my hand
In other words, baby, kiss me

Fill my heart with song
And let me sing for ever more
You are all I long for
All I worship and adore
In other words, please be true
In other words, I love you

Fill my heart with song
Let me sing for ever more
You are all I long for
All I worship and adore
In other words, please be true
In other words, in other words
I love … you


Buy and hold got you feeling a little queasy lately? That can (case) of Duff may only help you forget the market for a little while.

By following the simple timing model I published last year, you would be pleasantly watching this stock market dump with a 60% cash / 20% bonds / 20% commodities allocation. Not a bad portfolio for the past month. How is everything else holding up? Below is an update of a post I made in January on the listed alternatives here in the US – click on the chart to zoom in on the numbers:

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