A Canadian on Wall Street

I’ve been looking back at my performance in 2006 and 2007, years where I drastically underperformed the commodity-heavy TSX and dallied around the S&P 500, and it’s amazing to recall trades that I don’t remember doing, or trades that I made but which, in hindsight, are totally at odds with my core tenets when buying or selling equities. At least three times during that period I went predominantly into cash, only to succumb to the siren song of “doing something”. Each time, sitting pat would have done me more favours. Although I had some big winners in those years, my profitability was undercut by these haphazard and ill-considered trades, often done with very little insight into market structure or sentiment. As I get older, this awareness of the overarching market becomes more important and stronger in me (I think?).

In 2004, another year which performance I was unhappy with, I recall exactly what led to it. I had done very well the year before, and was telling this to a friend of mine who, sitting on a substantial cash hoard, asked me to manage it. Being a neophyte in those areas (still am, in my opinion), I tried for several months, but was unhappy managing someone else’s money. I ceded control back to him, and he proceeded to dabble and then wholeheartedly trade while I was still under the impression I was a “medium-term investor” and buying Benjamin Graham reprints. Since I’m only human, I’d hear about the big gains (never the losses) that my friend would make, and how he was pulling money out of the markets like nobody’s business. It started to affect how I made my decisions, and I started to do things like daytrade and hold very short-term positions, things I had never done up to that point. Now, that might be a profitable way to work for some, but for me it was poison to my account, and that year I barely eked out a gain. My friend went on to lose the bulk of his account on a highly leveraged trade; he came back a year later with an additional sum he had kept back (”never to be touched”) and saw the bulk of it disappear when his large holdings of VIX options expired worthless. I’ve never been touched by a substantial loss that has blown me out, thankfully, and I hope that by living vicariously through him I won’t have to experience it firsthand, although I suspect it’s a difference in our temperaments that was a major factor.

That said, that doesn’t explain 2006 or 2007, most of which happened because I wanted the feel of “being in the market” without the work of actually watching regularly what was going on, seeing what factors were influencing it, and devoting real attention to it. Part of it was that I was working a job that took a lot of focus and didn’t allow for that kind of attention; one of those was going to suffer, and in the end it was my investing. It’s only now, that I’ve started to shift that balance, that I feel I have a better grasp of things. I’m a poor short-term trader, I am sure of it now, and don’t enjoy its tick-by-tick lifestyle. I like the bigger picture, the vast global interplay of factors, only a few of which I might have a handle on. Nobody knows everything (or anything, if William Goldman is to be believed). It’s been an interesting past while. I don’t consider myself an investor in the vein of Warren Buffett anymore, if I ever did, and it feels weird to have my site named as it is, but I’m not really a “trader” either. Is there something in between?

On a related note, I’ve started reading the various Market Wizards books by Jack Schwager, which have been recommended by various people I know. They’re interesting books, in that they expose you to the philosophy and personality of various traders, successful at the time of writing. The earliest of the three from 1989, Market Wizards, contains the most profiles of “old hand” traders, many of whom are still doing well. The latest one from 2001, Stock Market Wizards (not to be confused with The New Market Wizards (1992) — Schwager obviously likes his brand, maybe a little too much), is in some ways more interesting to me because it contains interviews with less well-known traders. One of them, Michael Lauer (mentioned here), was indicted on fraud earlier this year, while some are untraceable, even to Google’s all-seeing eye.

The guy that stands out for me from the last book is Stuart Walton, who current runs Trek Capital. I identify a lot with his story; there are a lot of things I see in myself, notably his interest in writing and drawing and the ability or need to work alone. The main difference to me is that he started really trading during the boom years of the 90s (a.k.a. the years when people quit their jobs to trade because it was “easy money”), after numerous failures and false starts, and did very well until 1999, when his Reindeer fund at the time took a loss for the year and he closed shop. (The performance is here in PDF form.) He then started a new fund, which lost 35% for the year, closed that, and now his latest, open since 2002, appears to still be viable. I wonder if the techniques and philosophies he developed in boom times are still serving him well or if he’s adjusted? I feel like he must have, much like I have — that’s the market, a movable feast.

(Similarly, I recently read Andy Kessler’s book, Running Money, another guy who ran a fund from the mid-90s to 1999 and then shuttered it — funny how that worked! I guess I have to give them credit for realizing when they couldn’t keep making people money.)

It does make me wonder about hedge funds, though — it’s been pointed out quite often that there’s a confirmation bias at work with them, where the indices that measure them often don’t factor in survival rate. For me, it would be instructive to revisit some of these traders, rather than solely interviewing them at the top of their game. Maybe there’s an epilogue and I haven’t gotten to it yet. It reminds me a little of the issue I have with the financial media, from major news outlets to bloggers — things can be said, analysis made, without any accountability at a later date. So rarely do people revisit the stuff to see what one’s track record really says.

It’s very difficult to write a site focusing on financial and investing related topics without veering too close to the realm of the “analyst”. I’ll be honest, it does seem utterly amazing that we have such a plethora of people who are dedicated to coming up with reasons, some rational, some not so much, to invest our money in a particular stock or sector. Although sales and analysis are often considered separate arms of the finance industry, it strikes me that analysis is essentially a form of marketing. Whether it’s the analysts of the big banks’ investment arms or the analysis of blogs and newsletters and various independent investors, there’s never anything completely impartial in the views and opinions that are put forth. We listen, because there’s a veneer of empiricism to it, but compared to science (which, too, can be co-opted by marketing — see the pharmaceutical industry for a good example of this), financial analysis, such as it is, can often be a pretty depressing landscape to survey. As anyone schooled in doubt and skepticism might ask, what has been truly verified? Except for behavioural finance and economics, there’s very little that’s made sense to me of current financial thinking. People are still smitten with pseudo-scientific methodologies based on arbitrarily chosen statistics, developing applications and algorithms that act without awareness of psychological events, when it seems to me the only thing in investing that really matters is to be conscious of the mass psychology and to take advantage of it, whether that’s done through “value” (usually implying that a stock is not well liked and hence has not been pushed up in price) or “momentum” (taking advantage of the herd mentality).

Here’s a question: what’s a value stock that never goes up in price? Was it still valuable if it remained unloved? The value investors have convinced themselves that, yes, there is some intrinsic value that was always there. But the fact is, price (and value — even though some people like to imply these are separate) is a psychological construct (gold is a case in point) that can’t be tied to specific attributes of a company in the abstraction of the market. If people were able to sustain a mania indefinitely, then prices would never fall, even if a company was actually doing poorly. But when a company does poorly, or for a variety of other reasons, that mania becomes harder and harder to maintain. Reality intrudes. But is reality really a “return to value” or just the pendulum swing, a reflection of cyclicality that is present in so many natural forms? And is the market chaotic in a way that is predictable or not? How can individuals really understand the interaction of so many competing forces?

I think we stick to our seemingly rational analysis of stocks, P/E ratios and earnings reports because otherwise it would be a fool’s errand to try to synthesize all that information. It’s easier to focus on a few numbers and try to make it represent the whole. When an analyst is right, we ascribe skill to them, as if they were a scientist who had hypothesized something and had their hypothesis confirmed, because if we were to think otherwise, it would really undermine a whole industry. What? I think people look at finance and investing, and see numbers, and think that because there are numbers that it’s completely quantifiable — ultimately though, I think we’re in a casino where there is no house and no odds, because by its very nature the market’s rules are constantly changing.

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I wrote the above last night as I was going to bed, and didn’t post it, thinking it sounded a little kooky and speculative and not particularly cogent, but in light of today’s bloodbath (all red) in the markets, I figured it was strangely appropriate and dare I say… prescient? Let’s see how the “analysts” attempt to rationalize what was probably only moderately rational and mostly a lot of stampeding for the exits — the psychology of herds.