Date post: | 01-Nov-2014 |
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Economy & Finance |
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Bubbles, Ponzi Schemes, and Investments
Dale DeBoer, Ph.D.2013
How would you know?
•The (ab)normal market
•There is no such thing
•Historical performance
S&P 500
S&P 500
5.7%
S&P 500
8.7%
S&P 500, P/E
15.7
Thinking about P/E ratios
•Suppose P/E = 10
•Price = 10
•Earnings = 1
•Rate of return?
Thinking about P/E ratios
•P/E = 15.6
•Rate of return?
Thinking about P/E ratios
•P/E = 15.6
•Rate of return?
•1÷15.6 = 6.4%
Thinking about P/E ratios
•Issues
•Backward looking
•Dividends
S&P 500, P/E
18.1
Importance of P/E ratios
•1 point increase above long run average correlates with 25% reduction in subsequent return
•Statistically significant at 1%
•Only captures 30% of variability
S&P 500
1.8%
Wilshire 5000
4.9%
DOW
2.3%
Can this be beaten?
•Without fraud!
•Risk-reward tradeoff
Can this be beaten?
•Without fraud!
•Risk-reward tradeoff
•Leverage
•Hedge funds
•$100 invested
•10% return
•$10 earned
•$100 invested
•Same investment, but only 10% down
•Interest rate 5%
•10% return on investment
•$10 earned - $4.50 paid in interest
•Rate of return?
•$100 invested
•Same investment, but only 10% down
•Interest rate 5%
•10% return on investment
•$10 earned - $4.50 paid in interest
•Rate of return? 55%
Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Bubbles and the greatest idiot theory
Text
https://en.wikipedia.org/wiki/File:Tulip_price_index1.svg
2,400% over 3 months30,417,400% over 1 year
http://www.economist.com/blogs/dailychart/2011/11/global-house-prices
7.1% per year
https://www.google.com/finance?cid=13756934
40.6% per year
Series average: 3.7%“Bubble” average: 12.3%
Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
http://www.finra.org/web/groups/sai/@sai/documents/sai_original_content/p337731.pdf
Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
•Insider information
http://www.sec.gov/spotlight/insidertrading/cases.shtml
Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
•Insider information
•Ponzi schemes, pyramids, and Herbalife(?)
Charles Ponzi
•International exchange coupons and arbitrage
Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Initial promise: 50% every 90 days
•Subsequent promise: 50% every 45 days
Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Making the payments
•Withdraw or reinvest?
Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Making the payments
•The importance of the individual at the center
A pyramid
•The “Prosperity Club” letter
•Denver, 1935
http://www.silcom.com/~barnowl/chain-letter/archive/me1935-05-20br_sd_club.htm
A pyramid
•The “Prosperity Club” letter
•The power of exponentiation
•8 rounds: 390,625
•15 rounds: 6,103,515,625
The Herbalife question
•Bill Ackman
•Pershing Square Capital Management
•“Pyramid schemes like Herbalife [are] particularly vulnerable to product-quality concerns”
The Herbalife question
•Bill Ackman
•Multi-level marketing
•Is it different from a pyramid?
•The question of product
An economists simple look at
investing
Paul Samuelson
•“Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or grass grow.”
•The parable of 64 monkeys
The Efficient Market Hypothesis•Markets (and market prices) reflect
all information
•What information is this?
•The question of $20 on the sidewalk
•Evidence?
http://www.ifa.com/Media/images/PDF%20files/Malkiel_PassiveInvestmentStrategiesandEfficientMarkets%20(2).pdf
Even if not true...
•Can you beat 31,000?
Even if not true...
•Can you beat 31,000?
•7 milliseconds!
Even if not true...
•Can you beat 31,000?
•7 milliseconds!
•You are not the bank
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
•Sloth: Overlooking Costs
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
•Sloth: Overlooking Costs
•Envy: Wanting to Join the Club
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Wrath: Failing to Admit Failure
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Wrath: Failing to Admit Failure
•Gluttony: Living for Today
Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/
SB10001424127887324906304579037163080446646.html
•Wrath: Failing to Admit Failure
•Gluttony: Living for Today
•Greed: Following the Herd
Four “Rules”
•Save enough
Four “Rules”
•Save enough
•Control expenses
•Management fees
•Trading costs
•Taxes
Four “Rules”
•Save enough
•Control expenses
•Diversify
•Does this conflict with “control expenses?”
•The virtue of ETFs and Mutual Funds
Four “Rules”
•Save enough
•Control expenses
•Diversify
•Reallocate