A Canadian on Wall Street

I’ve been reading the second edition of Robert J. Shiller’s Irrational Exuberance, with its 2005 additions and a part-focus on the numerous real estate bubbles that seemed counterpart to the stock bubble that initiated the book. He makes the excellent point that real estate has actually been a pretty mediocre investment except for in a few rare, short timeframe situations — one of which we happen to be in now, but for how much longer? Much of the long-term gains disappear in the light of inflation. He also makes a good point in one of his syndicated columns that real estate as an investment was not a very common thing for much of the past century, that talking about real estate the way we do now even a few decades ago would have been analogous to collecting cars — it was done, but not commonly and the house was not viewed as an investment vehicle, but as it is: the place you live.

Before the real estate boom of the late 1970’s, hardly anyone was worried about rising home prices. A search of old newspapers finds surprisingly few articles about the outlook for home prices. Those that did appear generally seem to be based on the assumption that minor fluctuations in construction costs, not massive market swings, drove the modest home price movements that they noted.

Indeed, hardly anything interesting about home prices was ever reported at all, aside from an occasional comment in an article about something else. For example, an article in The Times of London in 1970 argued that rising home prices reflected the switch to a new British Standard Time (imposed as a three-year experiment in 1968 to facilitate commerce with Western Europe by putting Britain in the same time zone). The article claimed that the change raised costs by forcing British construction workers to perform more of their jobs in relative darkness. Speculative investment behavior was hardly an issue in those rare instances in which home prices were discussed.

To understand the nature of the subsequent shift, consider that it is hard to find anyone today who worries that automobile prices will soar because rising demand in China and India for steel and other materials will push automobile prices out of reach in the future. Though a small group of collectors invests speculatively in antique or specialty cars, the idea of speculating in automobiles just is not in the public consciousness. That is how it was with housing until the late 1970’s.

Anyhow, very appropriate reading these days. It’s been an interesting past week, with various pundits arguing back and forth about whether this is a temporary blip versus a longer duration thing. I’ve sold out of most of my positions, with some moderate gains and some moderate losses, because I’m a little bit wary — I really have thought the market was overpriced and slim pickings, but I was still putting money in speculative stocks when I probably should have remained in cash or moved strictly to dividend-based investing. Why was I doing this? Because it’s hard to sit on one’s hands when you’re babysitting a cash hoard; the tendency is to want to be active, to make “moves”. Anyhow, I don’t know what the market will do in the next while, but I felt uncomfortable where I was — I had some exposure to emerging markets, too — and so I just had to follow my instinct and sell. I may be wrong, but don’t kid yourself that there’s some empirical basis for buying or selling. It still always comes down to hunch.

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.

The purchase of the privately held Standard Broadcasting by Astral Media announced over the weekend caught my attention, mostly because I had recently been invested in Astral for a short time around the time I owned Alliance Atlantis, buying some of the news about potential further consolidation in the Canadian media landscape. (Although, honestly, it was probably more likely that Astral would be the buyer in any deal — some speculated they’d buy Corus, but I had my doubts. As is usual, the buyer’s stock isn’t doing so hot this Monday morning, so I’m glad to have got out with a modest profit.) What with the planned merger of XM and Sirius Satellite Radio in the US (and its consequent fallout for their Canadian arms), the competition arena for radio shifts again.

It’s hard to say whether or not this Astral-Standard deal is really that much to be impressed by. Radio is fragmenting, and even with their new 81-station grip on the Canadian radio market (Corus Entertainment holding on to second with around 50-odd stations, I believe), it’s a little like that saying about exchanging deckchairs on the Titanic. Not that I think radio is dying, but with the surprising (to me) popularity of podcasts, streaming online radio, iPods and their own custom playlists and the sheer number of ways NOT to listen to the radio, I suppose it is somewhat impressive that radio, in either terrestrial or satellite form, is still alive and mostly kicking. With Google now in the radio ads realm (along with other players like Software Media Exchange and Bid4Spots) there are obviously some people who think radio will continue as a strong, stolid revenue source. It certainly won’t be a major growth industry (the attempted consolidation of satellite radio so quickly in that young industry, with its plateauing subscription numbers is an indicator of this) and I don’t know how practical it is to make bets on potential buyout targets, given that most of the public players have already bulked up considerably. Lately, I’ve been moving back to a more traditional value stance, and less about trying to exploit special situations, since these always seem much harder to call.

As a postscript to this entry, I realized that although Interactive Brokers is a really powerful individual investor brokerage, now that ETrade has flat 9.99 CAD pricing per trade (for those with a minimum 50K balance), IB is no longer the best brokerage for commissions at a certain level of investing. ETrade becomes cheaper if you start buying more than, say, 1-2000 shares (depends on which exchange you’re buying on) with a mid-five digit total dollar value. For instance, if you bought 4000 shares of a stock at 12 USD at IB, it’d be 4000*0.005 = 20 USD, since the max cap is 0.002*48000 = 96 USD according to their current rate schedule. For Canadian stocks, it’s worse: 4000*0.01 = 40 CAD. Something to keep in mind.

So I got out of my positions in Alliance Atlantis and Astral Media recently, mostly because I felt the opportunity cost of waiting for the Canwest buyout to close in the first case and for a buyout or major event in the second case was too high, considering the size of the position I was taking. I was definitely disappointed that no bidding war occurred with AAC.B to push the price up, and even though I don’t have any particularly good ideas for new investments, I felt like my gains in both stocks were marginal at best and I really don’t like holding a stock when I’m close to break even for long periods of time.

On a side note, I finally got back on Interactive Brokers after having left it a long time ago for some arbitrary reasons (no EFT at the time and market data fees that were cutting into what little I kept in the account), in no small part due to this convincing write-up on them (although it turns out the strategy to overcome the lack of interest on the balance less than $10,000 isn’t so perfect). Although the website is a bit of a hodgepodge of links and windows and so-so user interface choices (why is it all accessed from a drop-down box?), it’s great to have the better commission charges and foreign exchange rates (the FX trader interface seems pretty slick although I have no point of comparison, having never tangled in the dicey realm of forex trading) and access to much more global markets, even though I suspect the bulk of my investing will still go towards Canada and the US.

The Netherlands is the new tax haven (at least where royalties are concerned). Surprise, surprise: the Rolling Stones and U2 are big users of these shelters.

I like how that title implies that risk has a positive or negative connotation. I’ve seen people talk about “positive” risk, which is a corruption of the original meaning, but I can’t think of a better word that indicates the improbability of being one of the high-flyer Buffets or Tudor Jones’s of the world. This is all by way of saying that after Sacha’s positive review of Jeff Rosenthal’s book on probability, I’ve been thinking about how the profit and success of the totality of people invested in the market, from the extremely short term to the extremely long term, probably fits the good ol’ Gaussian distribution, meaning that on average there are a lot of people that have middling returns, some that are doing well and some poorly, and some people being taken to the cleaners (my friend, he of RIM shorting fame is a case in point) while others have more money than the GDPs of most medium-sized countries. Although I’m not a believer in efficient market theory and have my doubts about any form of mathematical modelling being signficantly better at outperforming, I’m pretty sure this distribution holds, which means that for all the scrabbling and statistical analysis and financial document reading we all do, on the whole most of us aren’t going to do all that well, optimistic though we may be. Or am I wrong to assume such a distribution? I don’t know, and I think I might do some more research into this, but it seems that if somehow enough investors were savvy enough to shift the Gaussian’s middle to the right (this is apparently called negative skew), that this would not be an equilibrium condition, that the underlying set of investors would modify their strategies accordingly and the effectiveness of the investing that allowed the skew to exist would stop and the distribution would become symmetric again. This is all just hunch and I don’t know if it’s supported by any research in finance, but it does make me wonder if an individual investor can actively “displace” someone else who is also attempting to succeed. That is, if I go about my day thinking I will do very well in the market, and I am able to develop “skills” (arguable that this is a skilled game, still) to do well, to balance that out, due to the zero-sum nature of investing, the other side of all my trades will have negative effects. Is that the mechanism that ensures such a distribution? Without people blowing up, would it be possible for Buffett to exist? Or put another way, does Bill Gates have a fortune because a million other companies went out of business?

I probably sound pretty naive with respect to the underlying math, but it’s something I wanted to get down so I could explore it more later. I don’t think it is incompatible with the concept of skill in investing, but if it were true, it would imply that it’s not really possible to actively work towards being Buffett — Buffett’s success is in good part the winning of a lottery ticket, as he’s been quick to say (although he meant in terms of a genetic lottery, where he gained the propensity for “investment skill” through birth). In his essay The Super-Investors of Graham and Dodd-ville, he puts forth the idea that the sheer number of successes among the top investors is due to their common value philosophy, but is it also not possible that at the time when all these people were building their fortunes, that value philosophy worked? If Buffett and co did not exist, and we looked at a different timeframe, would there be a growth investor out there writing an essay about how the top investors in the world all seemed to search for growth? How does the success of a small subset of investors in a relatively short span of time (less than a century) indicate the worth of their philosophy? Were there value investors throughout the ages, Buffetts of their time? In the longer scheme of things, say over a thousand years or ten thousand, will his methodology stand up? I suspect that the mid-century success of Buffett may be more anomalous than he thinks, and less attributable to his modification of Graham’s philosophy. In my opinion, it was likely a lucky confluence of that strategy and the environment that have made the majority of his fortune. One factor that comes to mind is the rush of money that has come into the stock markets since the time he started, making the earliest investors the most successful, but can we honestly use the past character of the market to predict the future movement of the market? “The market always goes up in the long run?” Says who? Not to implicitly doomsay, but I can think of a number of markets that no longer exist, or exist in a decrepit form. Why is this homey aphorism considered to be a truism now? It’s something to think about. As William Goldman once wrote, “Nobody knows anything.”