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Yesterday was a pretty big down day for the market. The media blamed it on fear about a war in Syria. If the market sold off every time there was a war or fear of a war in the Middle East then the Dow would be at 100 by now. What you had was a market that was slightly overbought in the short term, a week when tons of people are on vacation, and an excuse to take profits. Moves like this are disconcerting but at the end of the day they are just noise. For Syria to cause a real market decline it would have to morph into a massive war that engulfs the entire Middle East. I don’t see that happening.
News You Can’t Use
Whenever we have a big move in the market some of the media coverage you see is interesting in how misleading or useless it is, I picked up these quotes yesterday:
The S&P 500 has surrendered 4 percent of its robust 2013 gains, and market experts are preparing for the downturn to intensify, possibly turning a routine pullback into a deeper correction that could continue through autumn.—WHICH EXPERTS? THE SAME ONES WHO GET EVERYTHING WRONG CONSISTENTLY?
The significant prospect of official U.S.-led intervention against Syria following the suspicious use of chemical weapons against its population by the Assad regime is knocking the stuffing out of North African and Middle Eastern stock prices,” said Andrew Wilkinson, chief market strategist at Miller Tabak. WHY DO I CARE ABOUT NORTH AFRICAN AND MIDDLE EASTERN STOCKS?
We have been pretty active over this past week based on market volatility. We sold a bunch of our positions in our Trend Aggregation Strategies into strength before the selloff and starting buying some of them back yesterday into weakness.
Modern Portfolio Theory Works Just as Well as it Did in the 1990′s, Which is Not At All
One of the criticisms that I often hear about Modern Portfolio Theory (MPT) is that it doesn’t work as well as it did in the 90′s. That is not true, MPT works just as well as it did at any time in history, which is not at all.
The main idea behind MPT is that there is an optimum portfolio where the combination of non correlated assets creates an overall mix that can have a better risk/reward profile than the individual asset classes on their own. From an academic standpoint MPT is very interesting because the optimum portfolio mix does exist. The problem is that I can tell you what it was yesterday but I have no idea what it will be tomorrow, and that is where MPT becomes useless in real life.
In order to decide how much to allocate to each asset class you need to predict:
1. The future returns of each asset class
2. The future volatility of each asset class
3. The future correlation of each asset class
If you could accurately predict all three of those things then MPT would work great. You would have predicted the crash in stocks in 2008 and the rise in bonds, along with the lack of correlation. An MPT portfolio would then have 100% bonds and investors would have been protected. Unfortunately, you can’t predict any of these variables, making MPT interesting to study but of no practical use.