“Davidson” submits:
If one has been paying attention there are two heavily promoted investment methodologies currently, i.e. Technical Analysis/Trading and Financial Planning/Asset Allocation&Rebalancing. Both have evolved and rely heavily on computer analysis. In fact, recently, the concept of ‘Robo-Advisors’ has been introduced by some firms. This virtually eliminates human beings in the investing process. With computers providing investment guidance makes this ‘investing by recipe’. A computer? Robo-Advisors? Really? Can they actually be serious in thinking that only a ‘better recipe’ without human input is the solution to understanding markets?
There is no simple recipe to investing. My investment approach is based on understanding how human beings work towards common ends to improve our collective standard of living. Investments are an integral part of this human system. No computer can incorporate the human elements on which our economy and investment marketplace are based. An investment analysis must include both Top-Down and Bottom-Up perspectives and recognize that no bull market is ever repeated with the precision required for valid computer output. Anyone who has been investing for more than 20yrs understands that forecasting market prices and target dates based on historical precedent has never worked in the past. Market prices are based on market psychology and circumstances at the time. Market psychology and circumstance never repeat! This is why we continue to have unpredictable investment bubbles as investors always seem to lurch into believing that some situation is somehow without precedent.
Investment bubbles are fairly common. Markets ran up on over-inflated perceptions of the Internet in the 1990s following fairly closely on the ‘Japan Inc.’ bubble in early 1990s. In 2012 it was all about China, Peak Oil and Hyperinflation. Investors chased prices to extreme levels in the belief that great investment gains would accrue. Not one of these investment bubbles were predicted by anyone. Certainly they were not predicted by computer nor were they navigated successfully by computer. Today we cannot predict what will be next price bubble nor can we predict when it will occur nor how high it will go. Market psychology never repeats in the same way just as circumstances which lead us into these bubbles never develop in the same way. Nonetheless, Robo-Advisors are becoming the next rage. Robo-Advisors use elements of Modern Portfolio Theory (developed by Harry Markowitz in 1952) and an asset allocation technique (developed by Gary Brinson in 1983) using past market price action to manage through future events. (Did you know that Gary Brinson retired in 2001 once he realized that his asset class allocation methodology was no longer effective after the crash of the Internet Bubble.)
There is no recipe for investing.
Market prices are set by investors based on what they believe stocks should be worth. The pricing is only as good as is the judgment of investors. Since most investors are price trend followers, i.e. Momentum Investors, then for most of the time market prices lack fundamental valuation input. I see investors as falling into two categories, i.e. Momentum and Value. It is only Value investors who seem to invest using GDP as a rate of return benchmark. It is the Value Investor perception which creates broad market lows during recessions. It is Momentum Investor perception which gives us the major market tops and bubbles. Investing by computer is a disservice to investors in my opinion. Markets are never monolithic. Markets must be seen as a composite of differing points of view. There are periods during which those leaning to one side of the spectrum of Value to Momentum dominate market pricing.
My approach is fundamental, very fundamental. What I do could be said to be a throw-back approach but this would be wrong. I have taken several hundred years of investment perceptions and merged the best observations with our modern economic data. Adam Smith and Friedrich Hayek identified fundamental aspects to the workings of our economy but they lacked the modern economic measures we have today. Knut Wicksell postulated his concept of “The Natural Rate’ in 1898. The research I do looks at how ‘Human Action’, a term coined by Ludwig von Mises, creates value by adding creativity, intellectual input to non-animate things which results in an improved human standard of living. The iPhone introduced in 2005 was one of these non-animate creations which significantly improved the global human condition. Steve Jobs when he was still at NEXT described what he eventually created in the iPhone during an interview with the Smithsonian Institute Oral History Interview April 20, 1995. No one could have predicted he would finally bring his vision to reality in 2005. No one could have predicted the iPhone’s global impact. But, if one looks closely can see creativity occurring in individual companies that is more or less predictable. One can see how portfolio managers exercise their judgment and their thinking is also more or less predictable. Certainly Knut Wicksell was as much a genius as was Steve Jobs.
While each market cycle requires general improvements in retail sales, lending, employment, consumption of raw materials and etc. the general order does not follow a fixed recipe. For instance, today’s economic recovery is the first in which single family construction has lagged. Even the order of which asset classes rise and fall first, second, then third is not preordained. Nonetheless, across the cycle one can pretty much expect each asset class to have its period of being in favor. No computer program can manage through such cycle differences. Period! To gauge what is happening, to gauge if a price is too-high-a-price or too-low-a-price requires human judgment of fundamentals.
While there is no recipe, there is a logic. Markets do eventually respond to fundamentals even if they do not do so in the short term. Knut Wicksell saw it first in his ‘mind’s eye’ concept of ‘The Natural Rate’. This is the rate of growth of GDP against which all other rates of return are benchmarked in the long term.
If there were a mathematical/computer solution , a recipe, to investing we would have done it long, long ago.