Weekly Index Investing Review
Below are some interesting research pieces that caught my attention this week
This will be updated on a weekly basis with research relevant to Long Term Index Investors
8th - 15th of August
Stop reading Financial News (and grab a good book)
CFA Institute has complied a good summary of news/headlines you can avoid that will bring nothing to your investment process. They also highlight classic issues with psychological biases in investing.
That’s also the reason why this website aims to focus solely on investment research that is relevant for the medium/long term investor.
Not only is it impossible to predict future events but even if we did have that capacity second and higher order effects can change the logic of the first order effects or even reverse it (remember the butterfly effect?)
Every action has a consequence, and each consequence has another consequence. These are called Second-Order and higher Effects. Every change you make to a system will have Second-Order Effects, which may affect the system’s functionality. Be careful when making changes, they may have the opposite effect of what you aimed for.
Take COVID-19. Even if you correctly anticipated the market impact like Ackman did by looking what was happening in Asia (what were the chances of doing so) it would have been nearly impossible to predict the second order effect. That was a historically unprecedented FED reaction (and the lack of a second leg down that most anticipated) or High Yield bonds rallying in the middle of a pandemic because of the FED Bond Purchase Programme. Essentially the second order effect (FED reaction) completely erased the first order effect of COVID-19 on parts of the Equity Markets and NASDAQ quickly hit all time high (you get the idea). Wrong timing would have had catastrophic consequences). A lot of market participants only focused on first order effects (crash) and some partially cashed out in March.
The purpose of long term asset allocation research is to construct portfolios that are fairly robust so that you don’t have to focus on the noise (aka daily Stock Market News)
Nicholas Taleb, that analysed the role of randomness in the Markets believes that news are random and priced in immediately and you can’t use it to increase your returns
In the book Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets he concludes “It takes a huge investment in introspection to learn that the thirty or more hours spent “studying” the news last month neither had any predictive ability during your activities of that month nor did it impact your current knowledge of the world”
At the very least stop reading if headlines start like:
- “The Market Moved.”
- “Jeff Bezos is $10 billion poorer.”
- “If you had bought . ..”
- “This market pundit .”
- “This reliable indicator is flashing red.”
- “Warren Buffett . . . ”
- “Stocks rallied because . . . ”
- “The Paradoxes”
- “The 10 Must-Have Stocks”
- “The company blew expectations as EPS rose X%.”
The list could be much longer. Another one you can also add to this list is any article that starts with Dow Jones
A heuristic that Taleb recommends is the Lindy effect – which could be applied to Financial News (which essentially means most news are a waste of your precious time – you should probably use that time to grab an interesting book):
The Lindy Effect is the idea that the older something is, the longer it’s likely to be around in the future. It applies to non-perishable items (things like information, intellectual production, etc.) e.g.:
2nd - 8th of August
The Case for China Exposure
Overview of Chinese Stock Market
This research piece from Matthews Asia while released a few months ago is interesting in that it does a deep dive into the underallocation of China in Equity Portfolios (I talked about it in my guide to Long Term Investing and the guide to International Equity ETFs)
As I wrote, China now accounts for 40% of Emerging Markets ETFs but only c.5% of Global Equities
This review includes:
- History of Chinese Equity Markets
- The ABC of Chinese Stocks
- Passive Investing including the concentration to some technology firms e.g. WeChat’s Tencent or Alibaba
China's Big Tech - Tencent and Alibaba make up c. 30% of MSCI China
China is a strong reason to invest in Emerging Market ETFs
"In 2010, 30% of the index was in cyclical sectors such as Energy and Materials. Today, the weight of these sectors has dropped to less than 15% with significant improvement in balance sheets" (...) "The weight of Internet and Technology has steadily increased over the last decade and today accounts for one-third of the index"
The MatthewsAsia research comes before the release of an interesting piece from GMO on why it makes sense to invest in Emerging Markets highlighting the benefits that China gives:
- The weight of vulnerable countries in the index has declined significantly
- China’s weight in the index has increased substantially
- Sector Composition has moved from Cyclical Sectors to Technology and Consumer Sectors
- While Financials have historically made up about a quarter of the index, their composition is considered less risky now
- Ability to handle Covid-19 is better than some Developed Markets and growth prospects remain strong
