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STREETWISE: Don't rely on Madam Marie for prudent investment decisions

Sarasota Herald-Tribune logo Sarasota Herald-Tribune 5/29/2021 Lauren Rudd
a close up of a man: Lauren Rudd © Herald-Tribune archive Lauren Rudd

What do you do when there is a temporary downturn in the financial markets? Always remember that quality is quality, and the length of time a company’s shares are on sale is always temporary. Investment success is often defined as acquiring the shares of companies whose returns your research indicates will, over time, outperform, while still meeting your risk requirements.

Notice I ignored investing in companies that some parasitic investment letter, TV performer or commission-based stockbroker says you must buy right now. Believe me if they really knew what stocks to buy and when, they would be buying them and not living off subscriptions, advertisers, and commissions.

There is nothing wrong with reading about or listening to investment ideas. It is when you act on those ideas without doing your own due diligence that losses occur. Act imprudently and the market will take its toll with no remorse.

Market timing is as tempting to investors as the Sirens of Greek mythology, whose enchanting voices lured sailors to their doom. Short-term moves on Wall Street do not hold a news conference in advance. Moreover, deciding to sell means you double the probability of an error, i.e., the sell decision and a followup buying decision.

William Sharpe, the 1990 Nobel Memorial Prize winner in Economic Sciences, calculated that in trying to time the market, you would have to be correct 74% of the time on both a market decline and recovery to outperform the S&P 500 index long-term.

Investment timing gone awry can leave you feeling powerless, fearful and in a panic. Panic is never productive and is generally expensive. Nonetheless, for some reason Wall Street appeals to the gambling instinct in all of us. It hinges on the notion that maybe you can, “Beat the House.” Lotteries count on this.

Those planning on timing the market would have been more productive with the late Madam Marie of Asbury Park, N.J., and her crystal ball. Yes, there really was a Madam Marie, whose real name was Marie Castello, both a psychic and an inspiration to Bruce Springsteen.

When Springsteen was a teenager hanging around the boardwalk, Marie foretold that he would become famous. He did, and he returned the favor by making her famous in his 1973 song, "Sandy."

A more quantitative approach is the efficient market hypothesis (EMH). Developed by Eugene Fama, the hypothesis states that stocks always trade at their fair value.

There are three variants to the hypothesis: "weak", "semi-strong", and "strong.” The weak form claims prices reflect all past publicly available information. Perhaps.

The semi-strong form claims that prices reflect all publicly available information and that prices instantly change to reflect new public information. No, probably not.

The strong form says that prices instantly mirror even hidden "insider" information. A degree of illegality here. The only information that is not priced in is tomorrow's news.

Another often tried technique is to mimic the moves of successful investors. For example, Robert Shiller, another Nobel laureate economist, has pointed out that many people try to mirror the strategies of investors who are considered experts in their field.

The difficulty there is that by not understanding exactly how someone makes decisions, you cannot fully duplicate the process.

A 2008 study by Gerald S. Martin of American University and John Puthenpurackal of the University of Nevada, Las Vegas, showed that when SEC filings reveal changes in the Berkshire Hathaway portfolio, the stock prices of any newly acquired companies had an abnormal one-day increase, averaging 4%.

But wait. A paper by R. David McLean of Georgetown University and Jeffrey Pontiff of Boston College pointed out that the effectiveness of investing strategies diminishes by more than 50 percent after publication.

A followup paper indicated that the one-day positive surprises on firms' earnings announcements accounted for virtually all the ongoing outperformances. Why? Probably because forward projections of corporate earnings are often positive but erroneous.

You can write to Lauren Rudd at Lauren.Rudd@RaymondJames.com or call him at 941-706-3449. For back columns go to RuddInternational.com.

This article originally appeared on Sarasota Herald-Tribune: STREETWISE: Don't rely on Madam Marie for prudent investment decisions

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