Dave Canal's blog

If you created a computer system that could send signals close to the speed of light, would it make you a successful investor?   You might respond, “What does the speed of light have to do with investing?  That’s astrophysics.”  You would be correct; it has nothing to do with investing.   So why have astrophysicists made most of the money in the investment business for the past 10 years?  It’s not because of their investment acumen.  They’re using knowledge few others have … to legally steal money because of a tenuous legal distinction. 

In a speech before the House of Commons, Winston Churchill paraphrased a phrase first said by Harvard professor George Santayana.   Churchill’s statement that, “Those who fail to learn from history are condemned to repeat it” became instantly famous because of its undeniable truth.  This is especially so in the investment business given its historical cyclical boom and bust periods.  Nonetheless people still like to think, “This time is different.”

The recent pullback in the stock market has caused much angst in the media.  The strength of the economy is questioned daily.  It’s reminiscent of the investment chatter after the October “crash” of 1987.   The “coming recession” that never happened.   In my opinion, both periods were impacted more by the structure of the market rather than the economy.   In 1987 it was the buildup, and subsequent unwinding, of portfolio insurance.   In 2018 it’s been the buildup of passive investing and the start of its unwinding.  Both were intended to reduce risk.   Neither did.

For the past decade, the overwhelming and universally accepted narrative in the investment world has been, “no one can beat the market due to the 1% management fee.”  Nothing could be further from the truth.  The real cause of active management underperformance has been the high, and historically unusual, degree of stock market correlation.  It has been unprecedented. 

When I was young, I thought a business would last forever.  After all, J.C. Penny still exists and it’s a 114 years old.  But I was to learn, in 1973, why the saying, “Technology is a business that eats its young” was so true.  My understanding began with the initial public offering of Prime Computer.  It had a great business, but one that was to last for just 26 years.  That lifespan was very different than J.C. Penny’s.

If we could choose a genetic gift, most of us would probably choose to be a creative genius.   To be someone such as Elon Musk or Michelangelo would be perfect.   Or at least, we think it would be.   Who could not be happy creating something that didn’t exist before?   Unfortunately, this “gift “often comes with a heavy emotional price.  Creative people often experience addiction and depression issues.   But are these issues the cause of creativity or the result?  It’s not unlike the Alzheimer debate.

My first experience with the speed of light was as a young caddy.   As I looked across a fairway I saw a golfer hit a tee shot some distance away.   The player hit the ball, finished his swing, and then – what seemed seconds later in the hot humid air – I heard a CRACK sound.   I was puzzled.   At the time, I didn’t know the speed of light traveled 671,000,000 MPH which was dramatically faster than the speed of sound (761 MPH).   But I did experience it.   It was my introduction to something that would occur much later in my life, high-frequency trading.

We like to believe we control our conscious thought.  But I believe our subconscious – the “hard drive” part of our brain – is far more powerful.  It not only records our experiences but is utterly ruthless in the recall of anything which impacts us negatively.  My first business encounter with that was the day I received a U.S. Treasury certificate having a stated face value of $50,000.  That was an immense amount of money in 1966.  At the time, it was a period of rising interest rates … much as it is now.

The active manager cannot control his own destiny in times of high market correlation, but when correlation is a normal 26% - or lower - he can “hammer” the market.  Correlation is the degree that different securities move together in tandem.  The norm of 26% goes back close to a hundred years.  Sudden increases in correlation are always related to macro events.  The crashes of 1929 and 2008 are examples.  Both happened because of too much debt; stocks at 10% margin houses at 5%.

Today it might be hard to grasp, but when I was 21 there were clients who hired me because I was “a kid.” They hoped I would become “a gunslinger.”   Even in the 1960s, fear of the market still existed from the crash of 1929.  To be called a Gunslinger was an accolade applied only to the best money managers.   Of course, I wasn’t one of them.   But I did have two of the attributes; I was young and without fear.  Fortunately, for my new clients, I was under the spell of Robert F. “Pete” Lawson one of the first portfolio managers at Fidelity Investments.