Today’s Skill

Today’s skill is intermediate-term market timing.

Three Articles

In None Dare Call it Skill, I wrote:

“Have you ever reflected upon what people say about skill?”
..
“The fact is that, if you can gain a consistent advantage, you have skill.”

“Skill does NOT mean that you have to trade often. Skill does NOT mean that you have to be able to measure valuations more accurately than others. Skill can be as simple as knowing how well you evaluate companies and markets. If you are accurate in your self-assessment and if you act upon that knowledge, you are displaying skill EVEN IF you decide to invest passively.”

It really is silly: the extent to which people will go to deny that what they are doing is evidence of skill.

None Dare Call it Skill

In Asset Weighted Mutual Funds, I identified an article that shows that individuals generally do a good job of selecting investments. Where they fail is in their timing. They rush in at market peaks. They buy when valuations are sky high. Today, valuations are sky high.

Asset Weighted Mutual Funds

In Why People Ignore Valuations, I wrote:

“Why Do People Ignore Valuations? In the past, it did not matter. It did not affect stock allocations. Today, it does.”

Edited: Why People Ignore Valuations
Why People Ignore Valuations

Advances and Setbacks

Following each major advance, we see it taken to an irrational extreme.

After Benjamin Graham taught people how to analyze stocks, people carried analysis to extremes. It was much later when David Dreman quantified the accuracy of earnings estimates. They are notoriously inaccurate in spite of tremendous sophistication.

Yet, Benjamin Graham’s insights are still valid. David Dreman, Lowell Miller, James O’Shaughnessy and others have built upon his foundation.

The failure of stock analysts led many to give up on stock selection and focus on the market as a whole. By paying constant attention to cost and long-term returns, index funds have succeeded exceedingly well.

The success of broad market index funds (S&P500) has led many to believe a series of assumptions that form a working hypothesis. They often work well as a first approximation. They never describe reality.

Instead of learning how to adapt to the limitations of analyst estimates, they actually believe that it is impossible for anyone to possess skill of any kind. Faced with the absurdity of such an extreme position, advocates acknowledge the existence of a few special cases. Pressed harder, they twist and distort definitions so that they can claim that what they are doing cannot possibly be evidence of skill. And, because it cannot possibly involve skill, it produces superior returns.

Carried to extremes in the presence of an extended Bull Market, we have been told that a high stock allocation is ALWAYS the best choice. Although stated in other terms along with meaningless disclaimers, any other choice is evidence of a personal deficiency.

Now that we have the tools to quantify the effect of valuations, we can confirm that a high stock allocation is USUALLY a good idea. When P/E10=20 and below, it is the best choice. Only when we approach today’s valuations do high stock allocations lead to ruin.

[NOTE: there is always a chance of being blindsided, regardless of the quality of reasoning. It is far from trivial].

Short-term timing is exceedingly difficult. There is a tremendous amount of volatility over the course of three or four years. As we approach the intermediate-term of 10 to 20 years, we can take advantage of its much greater predictability.

Today’s skill is intermediate-term market timing. We can use it to enhance the solid foundation laid by Benjamin Graham, David Dreman, Lowell Miller, James O’Shaughnessy and others.

Have fun.

John Walter Russell
November 3, 2006