January 2023
Indexing and the World Cup
ARK had a rough year
Forecasting is hard
The 5 worst days
Kiyosaki is at it again
Game Theory can earn you free flights
Update: Go to cash for the next 7 years?
It’s January, which means it is time to revisit and learn from “bold contrarian calls” that too often get flooded out-of-mind from the media deluge of attention-competing clickbait. Mildly contrarian calls do not make headlines, not like Jack Dorsey’s 'Hyperinflation' will soon 'change everything' or Robert Kiyosaki’s The Biggest Crash In History Is Coming, so it’s go-big-or-go-home. By Thinking in Likelyhoods, investors can properly discount such calls toward greater objectivity in assessing the evidence.
This is the second of six annual Likelyhoods updates to KCI Research’s controversial call in January 2021 that It's Time To Go To Cash For The Next 7 Years. Leaving no ambiguity, one year later in January 2022 the author stood by his bold contrarian call:
"With starting valuations still extremely poor, I'm sticking to my outlook that the average investor will be better off simply holding cash over a seven-year time frame, dating to the January 20th, 2021, publication of the original article in this series."
“This article generated a lot of discussion, and was controversial because it argued that simply being in cash would be a better alternative for many traditional investors over the forthcoming seven years, because collectively investors were starting from their worst valuation point in modern market history.”
Last year I crafted what I consider a reasonable good-faith trade to test the author’s call:
The author does not detail his prescribed move to cash, a position of which could be built in countless ways. Since the author chose 7 years, let’s assume the author’s cash position is established in a low-risk 7 year Treasury Note (“T-Note”) which as of January 29, 2021 yielded 0.79% annually. (footnote: T-Notes pay a fixed interest rate every 6 months, is exempt from state and local taxation, but is subject to federal taxation. The calculations herein are simplified projections that do not perfectly reflect the outcome of an actual investment in T-Notes and excludes consideration of their tax-advantaged benefits. The information herein is not personalized investment advice nor an investment recommendation on the part of Likely Capital Management, LLC)
On the other side, let’s assume the author buys VOO, Vanguard’s low cost S&P 500 Index fund, as a proxy for the broader market exposure that the author wants to avoid for 7 years.
Good, now we will track these two positions for the 7 year window from January 31, 2021 through January 31, 2028.
Well, it’s two years into the call and this is about as favorable of an outcome as KCI Research could have hoped:
Source: Likely Capital Management, LLC
The past year saw inflation-induced volatility and fears of a recession that brought equities prices down to parity with T-notes. Apart from avoiding volatility-induced stomach aches, what compensation would T-note investors have at this point? Importantly, for the T-note trade to pay off, VOO would need to stay below a 3.95% price appreciation over the next five years. What is the Likelyhood of that happening?
Well, the most recent 5 year period in which that happened was January 14, 2008 thru January 14, 2013 - just as the financial crisis bear market was rolling over and the S&P 500 Index appreciating 3.84% in those 5 years.
Is the market at the tip of a similar financial crisis market rout that will take 5 years to recover? Whatever Likelyhood you assign to that scenario, that is precisely what it will take for this “go to cash for the next 7 years” trade to pay off. Of course it is possible that cash finishes ahead of the S&P 500 Index - but not Likely.
Peter Lynch reminds us of the perils of predicting corrections:
“Far more money has been lost by investors trying to anticipate corrections, than lost in the corrections themselves.”
--Peter Lynch
Likelyhoods is on-the-beat, I’m coining this the next unofficial Buffett-Seides bet. Next January we will again update the status of this “go to cash for the next 7 years” trade for your reading pleasure.
Buffett vs Seides version 1.5
Speaking of, readers know of my keen interest in the aforementioned Warren Buffett vs. Ted Seides bet that passive indexing would outperform 5 actively managed hedge funds over 10 years. Buffett won 85.4% to 22.0%, Seides paid his $500k ante to Buffett’s preferred charity Girls Incorporated of Omaha, and Seides got the there’s-no-such-thing-as-bad-press attention that he parlayed into a notably successful second act with his Capital Allocators book and podcast.
In the many interviews Seides gave after losing the bet, he nevertheless stood behind his confidence in active management. Allegedly, those particular 10 years were not very favorable for hedge funds, and his hedge funds would have won in many other 10 year windows.
Here’s Seides in a 2021 ThinkAdvisor interview:
“I came away thinking I’d probably been a little bit overconfident. But I still thought the odds of success were pretty high. I think the same now. If you went back to January 1, 2008, and made the same bet over 10 years, I think you’d win seven out of ten times picking hedge funds.”
Well, last month Yahoo Finance revisited the Bet and noted that Buffett would have won the same bet had it been in place from 2013 through 2022.
Seides was the only hedge fund manager to take Buffett’s bet. No other manager was willing to put their money where their mouth was. Why? In my humble view, they knew the Likelyhoods were against them! If the odds were actually in their favor then the rational play would have been to take the bet.
Rather than continuing to do 10 year lookbacks every year - just as I am doing with KCI Research’s “go to cash for the next 7 years” call - it is perhaps more instructive to think about why every other hedge fund manager declined to take the bet.
Seides has also defended the hedge fund industry by reframing their objectives away from direct comparisons with passive indexing. He notes that most hedge funds do not try to beat the S&P 500 Index, rather they seek to provide equity-like returns with lower volatility or lower correlations. Here’s part of a Power Lunch interview where Seides makes that point:
HOST: Is the bet that you made one that could reverse itself over the next 10 years given that trend that we’re starting to see?
SEIDES: It’s very easy to grasp the word “could”. Could hedge funds beat the market over the next 10 years? Of course. Anything can happen in markets. Those two are very different things, and I talked about that 10 years ago and talk about it today. Hedge funds really don’t try to beat the market. They’re really trying to deliver a nice, equity-like uncorrelated return, but could it happen? Sure. And how might it happen? These types of market conditions, higher interest rates, more volatility, are certainly more conducive for differential returns in securities selection. And that’s where hopefully a talented manager can deliver the value-add that they try to for their investors.
HOST: Well certainly some hedge funds try to beat the market. Some hedge funds try to deliver alpha, that’s the main purpose that they tell their LPs of their existence, and the justification for paying the 2-and-20 fees. And you know, when you bet Warren Buffett, you took a basket of fund of funds and related it to what Warren Buffett was betting in terms of the Index, and looked at the outperformance there. Is what you’re saying, am I understanding correctly, that the purpose of hedge funds has shifted over the last 10 years, and that those uncorrelated returns are becoming much more of a value proposition for their investors?
SEIDES: Well that probably was always the purpose. I can’t speak for the lion’s share of investors, but most of the institutions, the institutions I talk to on my podcast, really are focused on hedge funds as a way of delivering an equity-like return stream that has either less or low correlation to the markets. That was the case 10 years ago and it is today. To make that direct comparison with the S&P is a little bit of an apples and oranges comparison.
HOST: They’re different asset classes.
SEIDES: Yes.
HOST: Even long-short equity, you would not compare that to the S&P.
SEIDES: There’s more correlation in long-short equity for sure. But again, it’s not quite what hedge funds are trying to deliver.
I must note, however, that IF the hedge fund industry as a whole was reliably beating the S&P 500 Index on average over long time horizons, you better believe they would loudly and proudly promote that performance to investors.
ONE MORE THING…
Indexing and the World Cup. What can Indexing teach us about World Cup success? An Index Approach to World Cup Success
ARK had a rough year. Analysis-Wood’s ARK slammed by higher interest rates in 2022 along with other growth funds
Forecasting is hard. Wall Street's stock-market forecasts for 2022 were off by the widest margin since 2008: Will next year be any different? Wall Street expects S&P 500 to finish 2023 at 4,000 after missing mark by the widest margin since 2008 - MarketWatch
The 5 worst days. Never know when they will come however, must stay invested and manage downside to take advantage when markets go on sale. These five trading days accounted for nearly all of the S&P 500's losses in 2022 - MarketWatch
Kiyosaki is at it again. Kiyosaki again predicted doom - and again was wrong. Robert Kiyosaki Predicts US Dollar Will Crash by January — Suggests Buying Bitcoin
Game Theory can earn you free flights. New York Passengers Engage In Game Theory, Take Airline For $1100 - View from the Wing
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