By: Tim Fortier — December 30, 2020
How to Win at "a Loser's Game"
In 1975, Charlie Ellis, a consultant to institutional investors, famously observed that investing was “a loser's game.”
In the classic Winning the Loser's Game, Ellis wrote that, like amateur tennis, investing is an activity where the victor often prevails because he makes fewer mistakes than his rival.
The parallel, Mr. Ellis wrote, was that investing had become dominated by highly skilled professional managers.
Because their transactions made up the vast majority of market activity, the professionals as a group represented pretty much the market return. Thus to beat the market, an investor simply has to make fewer mistakes.
(That dominance is even greater today than in 1975).
Mr. Ellis concluded that "If you can't beat the market, then you should certainly consider joining it."
Thus began the popularity of indexing, which at the time, was still in its infancy.
Now, if the goal was only to outperform 98% of other money managers, and to do as well as an index, then we could stop right here.
But what if the index is down substantially, as most were in 2008-2009?
Or March 2020?
Do investors really want to perform as well as an index?
In my opinion, investors need to realign their thinking.
I think Mr. Ellis had it at least partially right when he suggested that investors should consider making fewer mistakes. Anything which leads to loss of capital -- market declines, transaction costs, asset value loss, etc. -- and loss of time should be avoided.
That makes sense, right?
Yet investors continue chasing fads, hot tips, hot managers. They overreact to good news and bad news alike, and naively project recent results into the future.
That is no way to manage money!
The good news is that transactional costs have now basically become zero. Robinhood, Fidelity, Schwab and other brokerages offer commission-free trading. ETFs are available for single-digit basis point costs.
Investors have partially won.
Where I part ways with Mr. Ellis' conclusion is that I don't agree that as individual investors, our goal should be to simply mimic indices.
Indices are nothing more than convenient artifices that allow a level of organization and measurement.
It shouldn't necessarily be the goal of any investor to tether his performance and his financial future to some indeterminate index.
What is more important is to first assess your financial goals and needs.
Then assess the financial returns, both present and anticipated in the future, you'll need in order to meet them.
The difference could be considered your "personal index".
Ed Easterling of Crestmont Research is one of the finest market researchers around.
He has two published books to his credit: "Unexpected Returns – Understanding Secular Stock Market Cycles" and "Probable Outcomes – Secular Stock Market Insights".
Here's what he has to say in the latter book:
"First, secular stock market cycles deliver returns in chunks, not streams.
Second, most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears.
Third, investors do not get to pick which type of cycle comes first.
Fourth, investors need to be aware that they will likely encounter both types of cycles.
Those who experience secular bears during accumulation are generally better prepared than investors who are spoiled by a secular bull. A secular bull market is a pleasant surprise to retirees who endured a secular bear on the way to retirement.
For retirees who grew to expect a secular bull during accumulation, the unexpected secular bear can be considerably disruptive."
My point is simply that, by choosing "passive indexing" as their investing approach, investors risk consigning themselves to a financial/retirement trajectory dictated by the distribution of market returns.
Maybe that will be enough to fulfill their personal needs. But maybe it won't.
It's also worth remembering something I've mentioned before: Never before has there been a single secular bull market that lasted for two full decades.
With the current bull market now the longest in history, it's reasonable to assume that the next decade will look much different than the previous one did.
It is my belief that investors need to think beyond passive indexing.
They should consider other approaches that protect capital while allowing for growth.
What investors should seek are "risk-adjusted returns" achieved on a consistent basis. This is what allows for the compounding of wealth over time.
Fortunately, existing frameworks and methodologies make it easy for investors to achieve this level of success.
One such example is the framework provided by True Market Insiders.
Chris Rowe just wrote about this as well.
By simply following market direction signals, and by using relative strength to identify the very best opportunities, you'll have a framework you can use for the rest of your life.
Here's a quick example of what following market directional signals makes available to you.
Did you know that the U.S. stock market, specifically the S&P 500, is flashing a caution signal light now?
Here's a chart of the S&P 500 Bullish Percent Index (BPI).
It recently reversed to a column of O's. This is telling us that supply is beginning to overtake demand.
Even more interesting is the fact that even though the S&P is now nearly 500 points higher than it was in June of this year, fewer stocks have participated in this last surge to new highs.
In technical parlance, this is called a negative divergence.
The combination of the reversal down to a column of O's plus this divergence is indicating to me that it may be time to begin planning some defensive strategy.
As Charlie Ellis metaphorically observed, to win at investing is to first not lose.
Here's wishing you and your family a Happy New Year!
The best is yet to come,
Editor, True Market Insider