Sep

28

The NY Times and Bloomberg wrote about this new paper (August 2017) that purports to show that Tbills outperform almost all stocks over the long run–and that a tiny number of stocks account for all of the returns. I just read it. I recommend that you read it too–since it is counter intuitive.

I see several unrealistic/unspecified methodologies in this paper including (1) equal weight holdings from IPO to delisting of every stock; (2) no clear explanation for how the capital from mergers, acquisitions and spinoffs are handled; (3) where the new investor capital comes from to buy fresh IPO's and where the cash goes when a company is acquired for cash. I also didn't study his statistics carefully. Since most every company goes through a life cycle, it's intuitive that most will disappear or be acquired/acquire, so I need a better explanation for the investor's portfolio management/cash to really understand the practical. What other problems or unique insights do you see in this paper? Something just feels wrong here.

Do Stocks Outperform Treasury Bills?

Hendrik Bessembinder, Arizona State University. Revised August 2017.

Abstract:

Most common stocks do not. Slightly more than four out of every seven common stocks that have appeared in the CRSP database since 1926 have lifetime buy-and-hold returns, inclusive of reinvested dividends, less than those on one-month Treasuries. When stated in terms of lifetime dollar wealth creation, the entire gain in the U.S. stock market since 1926 is attributable to the best-performing four percent of listed companies. These results highlight the important role of positive skewness in the cross-sectional distribution of stock returns. The skewness of multiperiod returns arises both from positive skewness in monthly returns and because the compounding of random returns induces skewness. The results help to explain why active strategies, which tend to be poorly diversified, most often underperform market averages.

Victor Niederhoffer writes: 

This ridiculous paper from anti stock which I haven't read and goes counter to the carefully worked and accurate work of the triumphal trio duly reported in all their yearbooks is an absurdity. Of course most stocks will underperform. That's the nature of cross sectional returns. The distribution has quite a few good winners. It's probably true of a normal distribution also. Certainly for the kind reported in the NYSE year book. Certainly for the stocks in any variant of the pareto distributions. How far will they go to undermine the value of equities. It's so absurd I can't begin to say how it would apply to most any real life distribution in any field like IQ's.

Stefan Jovanovich writes: 

Index investing works because it allows people to avoid the risks of trading; and most of us are lousy traders.

Enterprise ownership beats public investment in terms of ROI (not "Radio on Internet"); but the public markets offer the only way for entrepreneurs to cash out. We still own one of our start-ups; its annual payout as ROI has been greater than 40% annually for the last 38 years. But, we cannot not "cash out" by selling it to someone else. The actual market for private businesses that makes hundreds of thousands, not millions, does not exist. We have been able to "retire" - i.e. extend the life of the business beyond the time we directly manage it - by doing a private variation on an ESOP; our former employee now runs it as a part owner.

As for the tug of war between "capital" and labor, we have been lucky enough to escape Marxism almost entirely. The cash flow from the business is distributed using the New England whaling ship model of "shares". Keith, the captain and part owner, sails out into the unknown every month and we get our cut on what the barrels that he lands in New Bedford. What we all share - Keith, Eddy and her Mom, your pontificating correspondent, and everyone else in the crew - is a 19th century American sense of equality. We are all equal members of the enterprise in dignity and responsibility and everyone understands that what people "make" is a function of talent and timing, not innate worth.

P.S. Every business failure in my life has been a situation where the people in charge (including me) thought that talk about the business as "family" and a mission statement on the web site would do the trick. It didn't; it can't. 

Rocky Humbert writes: 

I read his paper again and was able to tease one critically important fact out of it.

Page 15 and table 2A/Panel C: 70.5 % of the stocks that are in the largest decile by market cap outperformed the Tbill with a 1 decade horizon. And 81.3% of those stocks had a positive return. It's only for the smallest market cap groups that a substantial percentage substantially underperformed Tbills. Look at that table carefully and you can look at your own portfolio and it all makes sense.

In essence — if you own the biggest companies, you have beaten the Tbill (as we know from experience), but if you own the smallest market cap stocks, you have not. This makes intuitive sense since there are only two kinds of small cap stocks — those that start small and end up big. And those who were once big and are on their way to 0. It's a rare and bizarre company that starts small and always stays small!

The press reports and paper abstract are written in a bearish sensationalistic manner. For whatever reason, he chose not to include the key point mentioned above in his abstract. Now that I found this fact, I feel like everything else is noise — except for reinforcing one lesson that I've discovered anectodally: individual price momentum on the way down matters. If you have a stock that was once a $100 billion market cap and is unfortunately now a $10 Billion market cap, you should take your tax loss and reinvest whatever is left in another stock. And not wait for it to go to zero…and definitely not keep averaging down. In contrast, if you bought a $50 Billion market cap stock and it's now a $100 Billion market cap stock, don't sell it because it went up a lot. The skew and history suggest that it will continue to do well. (Until it doesn't).


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3 Comments so far

  1. Weighing The Week Ahead: Does Economic Strength Equal Stock Market Strength? – Seeking Alpha – The Conservative Investor Daily on October 1, 2017 2:01 am

    […] Poorly designed and biased analyses from those on a mission. Victor Niederhoffer questions the TBills beat stocks argument. […]

  2. Weighing The Week Ahead: Does Economic Strength Equal Stock Market Strength? | Feed My Greed on October 2, 2017 1:33 am

    […] Poorly designed and biased analyses from those on a mission. Victor Niederhoffer questions the TBills beat stocks argument. […]

  3. Edwin Mizrahi on October 2, 2017 1:53 pm

    Rocky Humbert, thank you for your observations. I believe the advice to let your winners run and cut your losses is apt in most cases. The lesson you point out is one that seems to expand on the aforementioned general advice, which now makes me look at companies in a different light. Thank you.

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