© Bloomberg Finance L.P. as of 05/19/2016. For illustrative purposes only. Past performance does not guarantee future results.
What do I take from eyeballing these charts? The Narrative effect and the impact of the Common Knowledge Game have accelerated over the past two years (ever since Draghi and Yellen launched the Great Monetary Policy Schism of June 2014); they’re particularly impactful during periods when stock prices are otherwise declining, and they’re spreading to broader equity indices. That’s what it looks like to me, at least.
So what does an investor do with these observations? Two things, I think, one a practical course of action and one a shift in perspective. The former being more fun but the latter more important.
First, there really is a viable research program here, and what I’ve tried to show in this brief note is that there really are practical implementations of the Common Knowledge Game that can support investment strategies dealing with story stocks. I want to encourage anyone who’s intrigued by this research program to take the data baton and try this on your favorite stock or mutual fund or index. You can get the FOMC announcement dates straight from the Federal Reserve website. This doesn’t require an advanced degree in econometrics to explore.
I don’t know where this research program ends up, but it’s my commitment to do this in plain sight through Epsilon Theory. Think of it as the equivalent of open source software development, just in the investment world. I suspect it’s hard to turn the Common Knowledge Game into a standalone investment strategy because you’re promising that you’ll do absolutely nothing for 98 out of 100 trading days. Good luck raising money on that. But it’s a great perspective to add to our current standalone strategies, especially actively managed funds. Stock-pickers today are being dealt one dull, low-conviction hand after another here in the Grand Central Bank Casino, and the hardest thing in the world for any smart investor, regardless of strategy, is to sit on his hands and do nothing, even though that’s almost always the right thing to do. Incorporating an awareness of the Common Knowledge Game and its highly punctuated impact makes it easier to do the right thing – usually nothing – in our current investment strategies.
And that gets us to the second take-away from this note. The most important thing to know about any Mysterious Stranger story is that the Stranger is the protagonist. There is no Hero! When you meet a Mysterious Stranger, your goal should be simple: survive the encounter.
This is an insanely difficult perspective to adopt, that we (either individually or collectively) are not the protagonist of the investing age in which we live. It’s difficult because we are creatures of ego. We all star in our own personal movie and we all hear the anthems of our own personal soundtrack. But the Mysterious Stranger is not an obstacle to be heroically overcome, as if we were Liam Neeson setting off (again! and again!) to rescue a kidnapped daughter in yet another Taken sequel. At some point this sort of heroism is just a reflection of bad parenting in the case of Liam Neeson, and a reflection of bad investing in the case of stock pickers and other clingers to the correlations and investment meanings of yesterday.
The correlations and investment meanings of today are inextricably entwined with central bankers and their storytelling. To be investment survivors in the low-return and policy-controlled world of the Silver Age of the Central Banker, we need to recognize the impact of their words and incorporate that into our existing investment strategies, while never accepting those words naïvely in our hearts.
About Ben Hunt
Dr. Ben Hunt is the chief investment strategist at Salient Partners and the author of Epsilon Theory, a newsletter and website that examines markets through the lenses of game theory and history. Over 100,000 professional investors and allocators across 180 countries read Epsilon Theory for its fresh perspective and novel insights into market dynamics. As chief investment strategist, Dr. Hunt helps develop investment strategy for the firm, works with portfolio managers and key clients to incorporate his investment views into their decision-making process, and manages certain portfolios directly. Dr. Hunt is a featured contributor to a wide range of investment publications and media programming.
Dr. Hunt received his Ph.D. in Government from Harvard University in 1991. He taught political science for 10 years at New York University and (with tenure) at Southern Methodist University. Dr. Hunt wrote two academic books: Getting to War (Univ. of Michigan Press, 1997) and Policy and Party Competition (Routledge, 1992), which he co-authored with Michael Laver. Dr. Hunt is the founder of two technology companies and the co-founder of SmartEquip, Inc., a software company for the construction equipment industry that provides intelligent schematics and parts diagrams to facilitate e-commerce in spare parts.
Dr. Hunt began his investment career in 2003, first in venture capital and subsequently as a portfolio manager of two long/short equity hedge funds. He worked at Iridian Asset Management from 2006 until 2011 and TIG Advisors from 2012 until 2013. Dr. Hunt joined Salient in 2013.
‘Five “Must Ask” Due Diligence Questions Before Making Any Investment’ by Todd Tresidder
How To Avoid Losing Investments Before They Cost You Money
Key ideas:
1 Learn how to profit from the “business common-sense test.”
2 Discover the most important question you should always ask first… before anything else.
3 Get five extra bonus due diligence questions to protect your money.
Ignorance about investing isn’t bliss… it’s expensive.
What you don’t know about investing will cost you money.
But the cure is simple – due diligence.
Due diligence is the critical skill that separates professional investors from amateurs.
Amateur investors act irresponsibly by risking their hard-earned dollars on hunches, articles they read, brokerage investment advice, or hot tips without first performing due diligence. This invites unnecessary and avoidable risk resulting in catastrophic losses.
Professional investors do the opposite by investigating all investments first before ever putting a dime of capital at risk.
Sure, it’s a pain and sometimes takes hard work, but getting answers to the tough questions up front can save you from expensive losses down the road.
There’s simply no substitute for investment due diligence because it’s what you don’t know about investing that will cost you.
Below are the five due diligence questions you must ask yourself before making any investment.
Due Diligence Question #1: How Can I Lose Money With This Investment?
This question is so important I’m tempted to throw away the remaining four questions and just repeat it over and over again until you get it in your bones.
You don’t know an investment until you understand all the ways you can lose money with it.
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
— Warren Buffett
I can’t overemphasize the importance of this question. You must first focus on the return of your capital, and only second concern yourself with the return on your capital.
The first question in my mind when analyzing any investment is to find all the ways I can lose money by identifying in advance all the major risks that can lead to losses.
Once these risks are fully identified, the second step is to proactively manage away whatever risks are manageable. I explain this two-step due diligence process in greater detail below:
The First Step in Risk Management is to Identify the Risk Profile
Your first job is to identify all the ways you can lose money with a particular