Jun

26

The basic premise of the book The Only Three Questions That Count by Ken Fisher is that only knowledge that is yours exclusively will help you make money in the markets. In his attempt to carry his point, Fisher gives anecdotes of occasions when what investors were taught was wrong, and contemporaneous charts that attempt to indicate the weakness or inadequacy of many of the things that investors believe in, (including, that yield curves are predictive, that presidential cycles matter, that you should buy when the media is bullish, that you should sell when there is fear in the air, that high price to earnings ratios are bad, that deficits are bad, that seasonal analysis works, that high gold prices are bad for inflation, that value stocks are better than growth, that a sinking dollar is bad for stocks, that the VIX is predictive, etc.).

Fisher believes that the reason we believe so many false things is that we are hard wired to fear heights, we tend to believe that what has happened in the past will continue, and we place undue reliance on authority. These reasons are offered up along with a dozen other shibboleths and unproven assertions of the behavioral/finance experts, who scientists like to call the promiscuous asseverators, because of their tendency to pull out one ad hoc hypothesis after another based on experiments in laboratory or college settings that have some explanatory power for some or other anomaly.

Fisher has a host of his own beliefs that he feels are true, and he gives many anecdotes, reports of performance analysis, and examples of columns that he wrote for Forbes, as well as a report of a ten year performance that beat the S&P by two percent a year after fees. In this way he feels like almost every other book that I have read in the last 20 years on this subject, including those on point and figure analysis. He shows that all movements are due to supply and demand, that capitalism is good, that the market has a tendency to go up, that an earnings yields greater than a bond yield causes merger activity to increase and thus buoys up stocks, that the French are bad and government spending is bad, that some sectors of the economy (like health care and consumer staples) are less volatile than the market as a whole.

All of Fisher's assertions are based on similar chart analysis, and selected anecdotes, to the beliefs that he decries. Some of his ideas are rather startling and original, including his view that an ensemble of forecasts as to how much a market like bonds or stocks will move during the year has much predictive value. He believes from a few self reported successes and anecdotal references that if there is a 'space' within which there is no forecast, then that is highly predictive of where the market is going to end up.

Another original idea of Fisher's is that he can predict bear markets by the extent, enthusiasm and pricing of IPOs — Fisher pulls no punches in this book, and he tells you what he thinks about almost everything! He is down on mutual funds, because of their high costs and high frictional costs, he hates the French and thinks we can do anything better than they can. The same goes for government, and academics he mainly has contempt for, as to their practical abilities. He feels that Buffet is highly overrated, and Hank Greenberg is much abused and underrated. He loves everything capitalist, and is a big fan of international diversification. 

The book is replete with endless direct and indirect plugs for his management services, and Fisher reports an excellent track record over the last ten years, for both his picks on Forbes, and the after fees record for his clients. In by far the most valuable part of the book, which has nothing to do with the three questions about what you know that others don't, and what behavioral finance biases you suffer from, he has a nice discussion of how a person should balance the need for cash flow at various stages of his life against a terminal value to leave to his younger loved ones. He also has some sound advice about the flexibility of selling losing stocks to offset gainers when you manage your own portfolio.

The book, and Fisher's approach, suffer from several grave defects. He asks at the end of the book for readers not to criticize him unless they have done some pencil and paper work, yet since almost half of the book seems to be a recap of what Laurel and I have written about in our two books and 700 columns, and documented with proper statistical analysis, I don't believe I would be remiss if I critiqued it. The main defect of the book is that there are a host of assertions in the about what works and what doesn't work, but they are not tested, thus, it is impossible to ferret out the one or two grains of valuable information from the totally worthless.

Fisher's main thread is that everything depends on supply demand, but this is what every book on investment says. The problem is to predict supply and demand, how it will change, and what is already anticipated in the price. Another main thread is that investors are subject to regrets and pride, and that these two tendencies are hard wired into our brains, along with our fear of heights. This apparently makes us buy when it's high and sell when it's low, but the evidence that this causes mistakes in stock market judgment and that it isn't accounted for by tens of thousands of psychologists and economists and their clients, is flimsy at best.

Fisher is one of those authors who is awed by high-school mathematics. He gives an example of how to compute the profits from an 'up two years and down one year' scenario, and wallows in how the formula, which every high school student is supposed to know, is of the higher mathematics. Fisher's discussion of the difference between a geometric mean and an arithmetic mean, and how the former must always be lower than the latter, is woefully misleading and inadequate. Also inadequate are his frequent uses of perfect information to show that if you knew when a market was higher than it's low, it's likely to have shown quite a rise.

One of the major messages of the book — that despite the tendency of the market to go up by 10% a year, the average investor by computing correlation coefficients can somehow predict when to get out of the market or reduce his exposure — is very fuzzy indeed.

The foreword to the book has one of the strongest recommendations that I have ever seen for a book, by Fisher's friend, Jim Cramer. Cramer himself says that this is not only the best book that an investor can read this year, but that it's much more valuable to read this book than to listen to his shows at all. He admits that the book changed everything he's always believed about the market and contains many a critique of his methodology.

It is regrettable that the book has so many lapses in its analysis, so many unsupported assertions, so much anecdotal evidence without any statistical analysis or awareness of uncertainty, variability, retrospection and multiple comparisons. Because of this the average reader is, unfortunately, likely to come away from this book with as much bad information as good.

As a final positive note, one thing that Ken Fisher claims in his book that sounds true to me, is that any fear that is widely broadcasted in advance will have no impact on the market. Or perhaps in more predictive terms, to the extent it's influencing the market, it creates a bullish situation because it's already encapped by the price, then price will increase when the fear subsides. Fisher gives many examples to carry his point, and if it weren't so hard to quantify this, and there weren't so many highways and byways to tie down, this would be a very good thing to study.

I feel that this point is highly relevant to sub-prime, and also to the asset seizure on the brokerage house that is famous for seizing the assets of its own customers, (how ironic).

Phil McDonnell reviews:

In his recent book, The Only Three Questions That Count, Ken Fisher provides a readable account of his brand of contrary thinking. His broad theme is to think against the crowd and the media. For example his three questions are:

1. What do you believe that is actually false?
2. What can you fathom that others find unfathomable?
3. What the heck is my brain doing to blindside me now?

The essence of the first query is that the media continually spews forth a kind of pop economics much of which is exactly wrong. If one avoids listening to the meme du jour and does the research personally then the much of the media silliness can be avoided. Simply eliminating the wrong and hurtful memes can improve one's investment performance.

In considering question two the author points out that there are many data sources available on the Internet which even relatively unsophisticated people can access. He describes how to calculate a correlation coefficient, a job which is done by a spreadsheet or stat program. Unfortunately he fails to mention the spurious correlations which arise from calculations based on levels. This is the most serious flaw in the book. Most of the evidence produced is based on correlations calculated on levels.

In his discussion of question three the author resorts to teachings of behavioral finance. This field is one I find suspect. Much of the empirical work is subjective. The analysis and explanation of the subjective results requires a Byzantine set of rules and rubrics to explain the evidence. Fisher also quotes some obscure papers in behavioral finance which he co-authored. Having said this, there is still much to be said for studying human psychology as it is reflected in the behavior of markets. The book offers a relatively pop account and explanation of the vocabulary of behavioral finance for the uninitiated.

As the Chair has recounted, the book is a thinly disguised pitch for the author's investment advisory services. His service is essentially oriented toward tracking the MS world index. The philosophy is to track the index as closely as possible and only to deviate when his three questions indicated that he should deviate by over weighting or by under weighting a sector or country. He calls these deviations "side bets." Generally his track record has followed the index in recent years but notably not underperformed overall.

This book is an irreverent, opinionated discourse on investing and researching market ideas. There are many pearls of wisdom and some notable flaws. Overall it is a fast and fun read and offers many macro economic hypotheses. Because of the technical flaws, testing the hypotheses should be viewed as an exercise for the reader.

Andrew West remarks:

I suspect much of Fisher's book was ghostwritten, probably with an eye to marketing. His Forbes column is occasionally intelligent. However, I lost most of my respect for him when I gave my name and address to his company, and was swamped by primitive and hucksterish marketing pieces in the mail for some time afterwards.

Makes me think of the Little Book of Value Investing, allegedly written by Christopher Browne. A true value investor would never pay for it, given its small pages, large type, and lack of new ideas. Sounds like marketing committees at investment managers are demanding that their figureheads publish books on investing. 


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2 Comments so far

  1. VJ on June 26, 2007 2:31 pm

    Many thanks for a masterful review.

    You’ve saved me money and, more importantly time and, most importantly reading this and getting “blindsided” into thinking some of this stuff actually worked. Though, I suspected as much about the book (I listened to his pitch on financialsense.com and so to, to christopher browne. un-inpressive. very egoistical!).

    Incidently the bit about ‘fear being broadcasted and having no impact’, i first encountered in Bill Lipshultz’s interview in the New Market wizards, albeit it was personal fear which didnt translate to price and he managed to get a good exit. Even Stanley Drunkenmiller in the same book, about Iraq War is kinda similar. I agree with the non-quantifiability (minor problem) and subjectivity (major problem) of this feature.

    The biggest problem in trading/investing is the plethora of knowledge which is a. uterlly useless (un-tested ramblings of some one time wonders or great marketeers) b. every idea available (in the public domain) is pre 1995 or a regurgitation of it.

    For someone starting out, one has to go over a lot of old material which makes sense but turns out un-profitable or has ceased to work regularly.

    thanks again.

  2. Jeff on June 27, 2007 10:36 pm

    While the book is on my schedule, I have not read it yet.

    I am a long-time admirer of the discipline you use and the imagination shown by you and your team.

    I wonder a little whether you are being completely fair in evaluating the book on its own terms. As an educator, investment manager, and blogger, I often find myself in the role of explaining what I know to average investors. There is no way to prove everything. They would not read such proofs, nor would they understand them. That sort of analysis is for a professional audience.

    Much of what I write takes my own conclusions about evidence and explains them in a way that a broader audience can understand.

    Perhaps I should not comment at all, since I have not yet read the book! But I can see where there is a place for this kind of work.

    Thanks for the review and your many enlightening comments.

    Jeff

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