Has Investing Changed?Don Shaughnessy
On 10 October 2008, 11.5 billion S&P 500 shares changed hands.
For context, from January 1951 to December 1969, there were fewer than 25 billion shares that moved.
In the decade of the 2000’s four times more shares traded than in the entire history of the index to that point. Prior to 2000 stock prices and volume were correlated. .82 R-Squared in the 90’s. In the 2000’s not so much. R-Squared of .01.
We have learned that knowing things is nice, but knowing what they mean is better.
Knowing that volume and price are no longer correlated could mean that the old ideas about how markets work and how one should design a portfolio, may be defective. If that is true, then passive investing may not be a good tactic.
Have you heard of “Project Express?”
It is a $300 million Trans-Atlantic fiber-optic cable that will exchange data between London and New York 5.2 milliseconds faster than existing cables. A few electronic trading firms will have exclusive access to it. The 5 millisecond speed difference gives them a huge advantage over their competitors in electronically traded stocks. Enough to pay off the $300 million investment at least.
That makes me wonder two things.
- Is an index that is created by trades where a 5 millisecond difference matters, the same as an index built on the activities of people who were buying and selling, as investors, over a period of years?
- And if it is not the same, does Modern Portfolio Theory and its derivatives really make sense?
All of the indicators like alpha, beta and the Sharpe ratio might be misleading. Does anyone know what volatility and risk mean in the electronic trading world? Not likely. Most of those trades are not speculative. They lock in a price anomaly and keep the difference.
I don’t know the answers to the questions.
I do know that if you are basing your investment decisions on what you read in last week’s Forbes or yesterday’s Financial Post, and then executing trades through an on-line brokerage, you are not playing the same game as the people who are trading the bulk of the stock. According to Tabb Group LLC, a market research firm, 55% of current trading volume comes from firms using high frequency trading tactics. You, on the other hand, are a cave-dweller who is more than 5 milliseconds behind.
Over the years, I have decided that it is not smart to play games when you don’t know the rules, who is on the opposing team, and how they keep score. So, it could be that a common sense approach to investing will make more sense. Pay less attention to statistical material and more to the underlying businesses you are acquiring.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. email@example.com