Everything returns about the rate of inflation

[Indices]

I've been thinking that everything returns about the rate of inflation given a long enough period. We know real estate does, and the myth of it being a great investment died in 2009. But I think stocks produce about the same rate too.

The Dow is about 11000 or so. The stock market opened in 1792. Plug 220 years into a calculator and compound 1 over that time by 6 per cent (the alleged returns of the US stock market) and you get over a 350000. But we're not at Dow 350000, we're at Dow 11000. Plug in 4.33 per cent and you get around 11000. And we've historically had about 4 per cent inflation.

Maybe I'm working with far too little data. But if I'm right, it would seem that this equity risk premium is baloney. The best an investor can do is find asset classes that aren't correlated and that one of them is going up most of the time. Like in the PP.

[stone]

Indices, if you think about it that has to be true. People collectively can never own more than 100% of planet earth. All that can happen is that ownership gets transfered from some people to other people. What has happened over the past few decades is that the cost of an hours labor gets you a smaller slice of the value of planet earth. That is the only elasticity in the system.
With stocks, the volatility means that there is potential for some stock holders to gain at the expense of other stock holders. Those who buy high and sell low, hand ownership over to the much fewer people who buy low and sell high. Personally, I get the impression that the stockmarket has recently become more sophisticated such that all buy and hold investors hand ownership over to traders who buy low and sell high. Perhaps us PP holders just about squeek in as buy low sell high traders. We certainly are eating the dust of ultra low latency trading platforms though.

[Indices]

I definitely think that at some point indexing will become so popular the market will become very inefficient and trading will be lucrative. I don't believe we are there yet. And I'm not sure how long this "window of opportunity" will last for traders. It could very well happen soon. Indexing is getting very popular.

[stone]

Indices, why do ultra low latency trading outfits now buy the most expensive computors in the world if trading does not work? They pay a fortune to be co-located with the NYSE computors in New Jersey so that they can be milliseconds ahead of the competition because the optical fibers are slightly shorter between then and the NYSE computors.

[Indices]

Indices, why do ultra low latency trading outfits now buy the most expensive computors in the world if trading does not work? They pay a fortune to be co-located with the NYSE computors in New Jersey so that they can be milliseconds ahead of the competition because the optical fibers are slightly shorter between then and the NYSE computors.

I don't really understand how day trading or high frequency trading works. Who is paying for the trades? Those expensive computers would have to impact returns no? It seems like paying for expensive computers, mathematicians to create complex models etc. are the same as paying for active management. I'm not really sure what advantage high frequency trading has over buy and hold investing.

[melveyr]

Indices,

The fastest of the HF traders turn profits every single day. They are playing a very different game than buy and hold investors. I imagine that their trading patterns are so different from most that their returns have very little correlation to other strategies as well. Hedge funds that offer low correlations are very popular with high net worth clients.

[Indices]

Indices,

The fastest of the HF traders turn profits every single day. They are playing a very different game than buy and hold investors. I imagine that their trading patterns are so different from most that their returns have very little correlation to other strategies as well. Hedge funds that offer low correlations are very popular with high net worth clients.

If it's a guaranteed higher return and profit then everyone would do it. So obviously it isn't. Traders use other people's money, not their own. Let's see the returns.

[stone]

Indices "If it's a guaranteed higher return and profit then everyone would do it. So obviously it isn't."

Doesn't the prop trading arm of Goldman Sachs have months on end of trading days without having a single down day with the typical daily profit being about $100M? They make the PP look volatile. If you employ the best of the best mathematicians, have the ultimate in computors etc etc and have a $2T portfolio then it all makes commercial sense. The reason why everyone doesn't do it is because not everyone has a $2T portfolio to justify the billions in running costs not to mention that it is hard to do. It is exactly the same reason why everyone does not start up a successful competitor to Apple or Pfeizer or whatever. The SP500 has made trillions of $ profit over the past dozen years and that has been distributed to shareholders. How do you square that with the total return loss of holding a SP500 index tracker if you are denying that trading works? If traders have been loosing money then how do they pay most of the political campaign funds, have big yatchs, spray each other with champagne etc etc .

I think some PP people overlook the extent to which the PP is actually a trading strategy all be it a low key, pedestrian one. The success of the PP seems to me to be largely down the "trading" aspect in built in the rebalancing.

[stone]

Didn't Mark Cuban say that the finance industry's recommendation that retail customers should "buy and hold" needs to be seen in the same light as the shampoo industry's recommendation that retail customers should "rinse and repeat"

[Indices]

I don't believe past performance is relevant for predicting future returns. If you believe Goldman will give you a guaranteed profit you should set up an account with them and drop the permanent portfolio. It doesn't make sense to make use of an inferior strategy for returns.

[Indices]

There is a superior strategy if you believe past performance is indicative of future returns. The OP states Goldman's traders produce consistent profits (past performance). Therefore if you wish for consistent profits and believe the past is indicative of the future, you should open an account with those traders.

The PP works for me because it has the least chance of failure. But it could still fail. And it will almost certainly be beaten by some other portfolio that I have no idea how to construct and will only show its superiority after the fact.

[stone]

Indices, don't get me wrong, I think the PP is the best option for a retail saver such as myself. You can't join in on the profits of the prop trading of Goldman etc unless you are a partner of that investment bank ie at the peak of wall street royalty. They need to be exclusive because the money they get is by diverting money from everyone else. It is a zero sum game.

[melveyr]

I don't believe past performance is relevant for predicting future returns. If you believe Goldman will give you a guaranteed profit you should set up an account with them and drop the permanent portfolio. It doesn't make sense to make use of an inferior strategy for returns.

I think the returns that Goldman's clients get are very different from returns that Goldman themselves get. In fact in some situations I would imagine they have perfect negative correlation

Also, you must admit that GS is in a powerful position. They are privy to information we could never dream of. GS trading is very different from Joe-Six Pack banging in an order for 10 shares of Apple with Cheeto encrusted fingers.

The idea that alpha is randomly distributed only works when everyone has the same information. I think GS has an edge.

[Indices]

There are more variables at stake than just having more information than most others. Remember, making trades on inside information is illegal. What if it were discovered that your trader made such a trade? You lose all the money you made and you may get sued. That is also a variable in working with Goldman. Don't think it can't happen.

Also remember, in the 1920s all the big traders made trades on inside information and stock pools, all of which was then legal. The game seemed rigged for the rich man. Then the market crashed. If everyone sells no amount of inside or special information will save you. We've seen this time and time again, including in 2008. How quickly some of us have forgotten.

[stone]

Indices, they don't just trade equities. They trade everything and anything with market liquidity- wheat, copper, treasuries, currencies you name it. As you say, inside information and price manipulation is illegal but there is ample scope for having a trading advantage without that. They can detect price movements and execute trades in milliseconds. They know in an instant that the optimal trade this millisecond is to sell Brazillian government bonds and buy cotton futures or whatever. Google are better at searching the internet than you or I would be without Google. It is like a private commercial Google but for trading not for searching if you get my drift.

[Indices]

Most asset classes show close correlation with stocks. And that makes sense. Wheat goes up with the stock market because we have economic growth and more people eating bread for example. The same for any commodity that is used in industry. So I don't see how "diversifying" into these asset classes makes a difference. They were saying the same thing about REITs before the last crash. "This time is different" mentality always gets us into trouble.

Again, the more trades, the more expenses. The more information, the greater the chance of illegality. Will Goldman's strategy work if the market is collapsing and servers are overloaded with sell orders? There are variables we haven't thought of in the event of a crash that will blow up Goldman's efforts. It always happens. Market inefficiencies such as the one you're talking about have a nasty habit of disappearing at just the wrong time.

[Gumby]

Maybe I'm working with far too little data. But if I'm right, it would seem that this equity risk premium is baloney.

I think a Boglehead would say that the reinvested dividends are the key to the success of stocks. Same idea with bonds. There are few Bogleheads who will admit to investing in anything that doesn't produce some kind of dividend or yield. Who knows how many of them actually reinvest their dividends/yields religiously.

I just find it curious that no one ever includes the monthly or quarterly dividend tax bite into those equations. Also, I think HB once said that the dividend from a mutual fund is offset from the money extracted from the NAV, but you still have to pay taxes on it.

I don't really understand how day trading or high frequency trading works.

Here's an excellent video on how High Frequency Trading (HFT) works and why its so lucrative:

http://vimeo.com/6056298

[Indices]

Here's an excellent video on how High Frequency Trading (HFT) works and why its so lucrative:

http://vimeo.com/6056298

I watched the video and it is very helpful but it doesn't stop me from having the same concerns:

1. Overcoming expenses related to computer hardware (including locating servers in expensive real estate areas next to market servers)
2. Overcoming expenses related to computer software
3. Overcoming expenses related to paying high priced managers
4. Dealing with over burdened servers in the event of a market crash when everyone is selling
5. Paying for research

Yes it may work in the future. It has worked in the past. Past performance is not indicative of future returns. HFT has to overcome more obstacles than passive buy and hold investing to succeed reducing its odds for success. Basically, it has the same problems as actively managed funds. I'm not saying it won't work, it's just that the odds are against it.

Random variables that could affect HFT:

1. Competition with other HFTs for bandwidth in panic selling scenario
2. Legislation hindering them
3. Power outage caused by storm or other natural event

I also do not see how HFT would work in a crash. If there are no buyers there are no buyers. Trading volume is not constant. If it falls below a certain point in a market crash or recession, if these trading companies can't afford their overhead, they go bust.

[stone]

Indices, we have already been through a crash in 2008 and all your scenarios played out. Goldman had lots of money tied up in credit default swaps in mortgage backed securities. On paper Goldman had hedged things so that even if the housing market collapsed, they would do nicely BUT their counterparty AIG was unable to honour the credit dafault swaps. So the US government stepped into the breach and rescued AIG, AIG was able to honour the credit default swaps and Goldman lives on to take more from us all . Remember there is a revolving door between them and the US treasury. They are joined at the hip with the SEC, the market is structured to maximize the trading advantage they can get. They bank roll all major politicians. Basically they own us. I don't mean  Goldman Sachs alone when I say "they", I mean the elite trading industry in general. Other investment banks, the investment banking arms of "universal banks" such as Barclays, hedge funds such as Ranaissance Technologies and Landsdowne Partners etc etc.

I get the impression that you are skeptical about the whole concept of trading. I agree that "momentum" effects rely on the assumption that future price action will be of a similar nature to what has happened in the past. That is only a small part of what everything is based on. You also say "what if everyone sells at once". These trading outfits do not have net long positions that would imperil them if the market moved. They take "spreading positions" so that they make money if the price goes up and down (eg as with the credit default swap example above). The PP is also a very basic "spreading" macro trading strategy IMO. Imagine  you have two assets that double and halve in price every year. You would get zero gain if you held one or both of those long term. If you rebalanced between them and one doubled when the other halved, then you would get a rebalancing gain. That is what the PP does when gold, stocks, LTT and cash get rebalanced. Look up the prices of say sugar and "short sugar" ETFs. Make up a pretend portfolio with 50%sugar:50%shortsugar. If you don't rebalance then you will just loose the management cost of the ETFs. If you rebalance, then you will get profits. Things don't need to be exact opposits to tap into that effect, they only need to be less than exactly the same. Go through the same exersize with Yahoo and Berkshire Hathaway stocks from 1995 until now and see the same effect. How do you suppose share buy backs result in distribution of profits to "share holders"?
You talk about transaction costs- those are just a barrier to outsiders. I suppose it is a bit like how, for a baker, the cost of bread is just the cost of the flour and heating the oven.
You also say "well every one would do that if it worked". Plenty are doing it. It is the pointless, time wasting distraction that is sucking the lifeblood of the world economy as we speak . The best mathematicians, engineers etc etc who could be developing clean energy or whatever are instead being employed to try and tweek ever greater levels of extortion from the real economy. I suppose if the current global economy had to compete with an alternative global economy that did not have that cost drag, then market forces might make things rational. That isn't the case though.

[Indices]

Stone think logically.  You sound like someone proclaiming REITs or CDS were the way to go circa 2007. Just because you and I can't come up with a variable that will screw up market beating returns doesn't mean it's not waiting dormant at some point in the future. Again, if you truly believe HFT is the way to go and a sure thing put all your money in or start your own HFT firm. I'll stick with the PP.

[stone]

Indices, as I said, for someone with my resources, the PP is the best option. Even if I wanted to, I could no more compete with a HFT firm than I could compete with Google. Anyway, my only aim is preserve the purchasing power of my houshold's savings. I don't want to be involved in extortion via Goldman Sachs style trading any more than via Mafia style extortion. IMO the utterly bizare thing is that you almost deny that they even exist.