The title says it all:
We, as traders/investors, should not be thinking like this at all. There is no magical truth or trading system that will work through all time frames, and for all eternity.
Anyone who steps back to take a look at the forest instead of the trees will recognize that we are not in the early part of the business cycle, but the twilight. We are not in a market where company valuations have been driven into the ground (like 2002 and 2009), and any value play is pretty much a guarantee of success. We are at the opposite end of the spectrum. The business cycle is long in the tooth and we are in a traderâs market, not an investment market. Yes, you still find good investments but they are a needle in a haystack. You should not be surprised to find that your value strategies are not working, simply because most of the value plays are gone and the vultures are picking over the remains.
Once you recognize the above, then you must understand that it isnât a question of â2 bad years, statistically provenâ. We are in a place that designers werenât designing for, a late business cycle traderâs market. Value investing will surely make a recovery, but not until a bear market is unleashed and the poorly managed companies are washed away, while the remaining companies are potentially excellent investments.
We are in a strange place right now because politics and fed reserve agenda are superseding the business cycle. Once upon a time, recessions were perceived as a necessary evil. The weak companies should be cut down so the strong can prosper and gain new heights. But for whatever reason, politics now dictate that recessions as a bad thing, even though they are a necessary evil to ensure the long-term fitness of the economy. Thus we see the length of the business cycle pushed out, the weak are allowed to carry on indefinitely, at the expense of the well-managed companies.
Once you realize that one trading system canât fulfill all business cycle conditions, whether it be early or late, then you also realize that investment strategies are not static. We must adapt to the changing conditions. There are two ways of doing this of course. The first is to become a superhuman analyst, a lot of work fraught with human error and no guarantee of being right. The second way is to use modern technology at hand to identify the current trends and attempt to capitalize on these trends. The second approach is considered by some as black magic, and perhaps it is to some extent. But the first approach (superhuman analysis) can only be theoretical, there are no metrics to tell you whether your analysis is correct either now, in the past or in the future.
Instead of the superhuman approach, I prefer to look at (1) how do I identify current trends; (2) how long can I expect the trend(s) to last (i.e. persistence); and (3) how do I recognize when the trend is coming to an end. If you start thinking along these lines, then you may begin to understand the importance of optimization and the importance of backtesting optimization strategies.
One other point of note I would like to discuss is the concept of Discounted Cash Flow analysis. While it is an interesting analysis, it has been pretty much established that it is NOT a useful analytical technique except for companies with an economic moat that have very predictable forward growth figures. One also needs to have a host of bull/bear narratives and use the bearish narratives to come up with a tradeable present value for a stock. Morningstar is a leader in this approach and has demonstrated some moderate success with the MOAT ETF (see attached image).
Keep in mind that the Morningstar approach is supported by hundreds of professional analysts. I donât believe that P123 can compete in this venue. We simply donât have the human manpower to accomplish what Morningstar is able to achieve with the MOAT ETF. BTW You can also subscribe to Morningstar and see their valuation figure for any stock.
However, everything is not lost. There is no reason why we canât stand on Morningstarâs shoulders. P123 now has the stocks held by MOAT over time and in fact all ETFs for that matter. There are other ETF strategies that P123 subscribers may be interested in. So P123 management, if you are listening, please give us the ability to select an ETF as a guide for an underlying stock universe. It has to be adjusted over time, the same as the underlying ETF swaps out companies over time. This feature will allow model designers to not only build upon the great work being done at Morningstar with economic moats and stock valuation, but also add our own additional P123 strategies on top of that. We get the best of all worlds⌠stock valuations by a company with much larger human analyst resources, and our own custom strategies that may supercharge the results.