Sunday, December 28, 2008

Monetary correlation and the death of Diversification

Good, anonymous, article entitled "all fall down" (subscriber only) in the FT.

The gist is simple enough: the investment theory of diversification was based on the fact that asset classes performances are uncorrelated and by spreading your bets, you will hedge your risk. Since the assets are uncorrelated, you never get stuck with all down. So when ALL asset classes go down in value, together, what does that tell you?

The article draws 2 conclusions 1/ one the monetary one, on a decreasing volume of money prices will go down as indexed on this money 'gauge'. Remember if inflation is always and everywhere a monetary phenomenon, so is deflation. When all prices go down together isn't it a sign of indiscriminate monetary impact? All boats go down in a low tide. 2/ investors are correlated, through psychology and leverage, in their selling behavior and if they are all diversified then all asset classes get hit which defeats the purposes of diversification in the first place.

Interesting... it means diversification in the short run is a mediocre strategy and in the long run is ultimately self-defeating. I think diversification just joined buy-and-hold on the heap of discredited and discarded investment strategies. RIP.

16 comments:

Bob said...

Well, if everything is down proportionally, then you're just as wealthy relative to everyone else as you were before. Diversification may not have helped you, but it also didn't hurt you.

The reality is that some things are down much more than others (AIG vs. BUD, for example), and diversification can help ensure that you don't have all your eggs in one basket and lose everything unnecessarily.

Marcf said...

Hey bob, I put diversification in the "lose everything unnecessarily" bucket, along with buy-and-hold.

Bill Burke said...

Funny,

I had my father in-law lecturing to me this Christmas on how I needed to diversify with him boasting, "I only lost 19% where the general market lost 50%". I preceded to tell him I lost 0% and actually pull in 5% tax-equivalent because I hold bonds and avoid fund like the plague. I'm probably a bad investor and too cautious, but IDC.

Marcf said...

Bill, good for you. Rock solid performance if you ask me. Average performance at Goldman was -25%. Pat yourself in the back and tell your inlaw to SYD. As Bob points out, relative performance is all the rage.

Arthur B. said...

If all prices truly go down, then why does it matter? Ultimately you care about what you can consume, not the monetary value of your assets. If your stock portfolio goes down 50% along with everything that you could possibly want to buy you're fine.

Stocks are historically the best performing assets. The buy and hold strategy is the best because it minimizes transaction costs and it is extremely hard to time the market.

I warmly recommend Barton Bigg's book, War Wealth and Wisdom on that topic.

Back to inflation and deflation:

Originally, inflation and deflation were - by their very definition - monetary phenomenons. The words respectively referred to inflation and deflation of the monetary mass. In an expending economy, you could have a steady drop of the price level without a "deflation".

The shift in definition to "change of the price level" was politically motivated. If inflation is a change in the price level, then surely the evil people who set the price can be blamed, or at least unknown market forces, not the government's press.

The policy aiming at stabilizing the price level is really an inflationary policy in an expanding economy.

But, if, as I said, all prices move in accordance, why does it matter? Inflation does not rain on the economy uniformly, it finds its way through the central banks, commercial banks, investment banks, businesses, capital goods. Production is diverted from consumer goods which in turn rise in price. Salaries rise last, interest payments don't rise at all. Inflation distorts the whole structure of the economy.

While there has been deflation recently, it is erroneous to call the fall of stock prices deflation. If I convince myself and everyone that I have an oil field in my garden, and then proceed to dig and find out it's not there, the fall in price of my garden's share is not "deflation".

Marcf said...

Follow your "oil field" example. If all of the sudden all asset classes are wiped out, do you still believe it is because everyone thought there was an oil field in EVERY asset class and it turns out there wasn't? It must be since they are uncorrelated, right?. Every single analyst was wrong on micro fundamentals? Get real.

The monetary level is a simple macro correlation, call it deleveraging or deflation of the monetary mass, it has the same final depressing effect on prices. The sudden movements are dynamics, the equilibrium driven by monetary levels.

Still reading Fisher on money btw, great read, thanks for the recommendation.

Negative on the first paragraph. Have you seen a CPI of -50%? Everyone IS poorer, and if you can avoid the carnage, you should, nay, you must! You are not sounding like a rational automata :)

Arthur B. said...

Follow your "oil field" example. If all of the sudden all asset classes are wiped out, do you still believe it is because everyone thought there was an oil field in EVERY asset class and it turns out there wasn't?

Pretty much yes. Everyone thought there was solvable demand for a lot of housing and it turns out there wasn't.

The monetary level is a simple macro correlation, call it deleveraging or deflation of the monetary mass, it has the same final depressing effect on prices. The sudden movements are dynamics, the equilibrium driven by monetary levels.

Deleveraging happens for a reason, the assets cash flow cannot pay for the underlying debt.

By the way you're still swamped in your tide metaphor. If all prices indeed lower at the same time, what's the problem? If prices do not fall at the same time, where's the correlation?

As for the first comment, it implies you value status in the eye of others above your own values, which I find slightly evil.

Ali said...

Makes sense; wish that FT articles were more accessible. David Bau made a similar point a little while back:

I Blame Markowitz

Marcf said...

Arthur B, trying to preserve capital is equivalent to being evil?!?! Are you 20 years old?

You don't know me, I don't know you. Manage your money like you see fit and don't throw moral judgments on others.

Ali, thanks for the link, it is a good read. The author seems to have a beef with the religious status of the theory. Efficient frontier is still a valid concept though. I think a lot of people are quite happy putting the nose of the quants to their own arrogant excesses.

Army No Va said...

Well, not ALL asset classes got killed. Gold has held up quite well. I sold my 1796 large cent collection in August for a nice profit. I've got some people beating down my door to buy CSA paper money too (interestingly both really rare and common stuff is pretty strong...mid-range is weak).

Arthur B. said...

Arthur B, trying to preserve capital is equivalent to being evil?!?! Are you 20 years old?

I never said such a thing.

I commented on,

"Well, if everything is down proportionally, then you're just as wealthy relative to everyone else as you were before."

by saying I found it slightly evil to find comfort when you lose capital in the idea that everyone else is also worse off. It's a mild form of schadenfreude.

I think one should be concerned with his own happiness, not his relative status. It's a personal philosophy, I did not mean to imply that the poster was himself evil, and I certainly, absolutely, did not say that capital preservation was evil.

Anonymous said...

本土成人貼圖站大台灣情色網台灣男人幫論壇A圖網嘟嘟成人電影網火辣春夢貼圖網情色貼圖俱樂部台灣成人電影絲襪美腿樂園18美女貼圖區柔情聊天網707網愛聊天室聯盟台北69色情貼圖區38女孩情色網台灣映像館波波成人情色網站美女成人貼圖區無碼貼圖力量色妹妹性愛貼圖區日本女優貼圖網日本美少女貼圖區亞洲風暴情色貼圖網哈啦聊天室美少女自拍貼圖辣妹成人情色網台北女孩情色網辣手貼圖情色網AV無碼女優影片男女情色寫真貼圖a片天使俱樂部萍水相逢遊戲區平水相逢遊戲區免費視訊交友90739免費視訊聊天辣妹視訊 - 影音聊天網080視訊聊天室日本美女肛交美女工廠貼圖區百分百貼圖區亞洲成人電影情色網台灣本土自拍貼圖網麻辣貼圖情色網好色客成人圖片貼圖區711成人AV貼圖區台灣美女貼圖區筱萱成人論壇咪咪情色貼圖區momokoko同學會視訊kk272視訊情色文學小站成人情色貼圖區嘟嘟成人網嘟嘟情人色網 - 貼圖區免費色情a片下載台灣情色論壇成人影片分享免費視訊聊天區微風 成人 論壇kiss文學區taiwankiss文學區

Anonymous said...

2008真情寫真aa片免費看捷克論壇微風論壇大眾論壇plus論壇080視訊聊天室情色視訊交友90739美女交友-成人聊天室色情小說做愛成人圖片區豆豆色情聊天室080豆豆聊天室 小辣妹影音交友網台中情人聊天室桃園星願聊天室高雄網友聊天室新中台灣聊天室中部網友聊天室嘉義之光聊天室基隆海岸聊天室中壢網友聊天室南台灣聊天室南部聊坊聊天室台南不夜城聊天室南部網友聊天室屏東網友聊天室台南網友聊天室屏東聊坊聊天室雲林網友聊天室大學生BBS聊天室網路學院聊天室屏東夜語聊天室孤男寡女聊天室一網情深聊天室心靈饗宴聊天室流星花園聊天室食色男女色情聊天室真愛宣言交友聊天室情人皇朝聊天室上班族成人聊天室上班族f1影音視訊聊天室哈雷視訊聊天室080影音視訊聊天室38不夜城聊天室援交聊天室080080哈啦聊天室台北已婚聊天室已婚廣場聊天室 夢幻家族聊天室摸摸扣扣同學會聊天室520情色聊天室QQ成人交友聊天室免費視訊網愛聊天室愛情公寓免費聊天室拉子性愛聊天室柔情網友聊天室哈啦影音交友網哈啦影音視訊聊天室櫻井莉亞三點全露寫真集123上班族聊天室尋夢園上班族聊天室成人聊天室上班族080上班族聊天室6k聊天室粉紅豆豆聊天室080豆豆聊天網新豆豆聊天室080聊天室免費音樂試聽流行音樂試聽免費aa片試看免費a長片線上看色情貼影片免費a長片

Anonymous said...

福~
「朵
語‧,最一件事,就。好,你西.............................................................................................................
..................

Anonymous said...

85cc免費影城 愛情公寓正妹牆川藏第一美女 成人影片 情色交友網 美女視訊 美女視訊 視訊情人高雄網 JP成人影城 383成人影城 aa片免費a片下載 a片線上看aa片免費看 ※a片線上試看※sex520免費影片※ aa片免費看 BT成人論壇 金瓶影片交流區 自拍美女聊天室 aa片免費a片下載 SEX520免費影片 免費a片 日本美女寫真集 sex520aa免費影片 sex520aa免費影片 BT成人網 Hotsee免費視訊交友 百分百貼影片區 SEX520免費影片 免費視訊聊天室 情人視訊高雄網 星光情色討論版 正妹牆 383成人影城 線上85cc免費影城 85cc免費影城 85cc免費影城 85cc免費影城 ※免費視訊聊天室※ ※免費視訊聊天室※ 免費視訊聊天室 85cc免費影片 85cc免費影片 080苗栗人聊天室 080苗栗人聊天室 080中部人聊天室 080中部人聊天室 免費a片下載 免費a片 AA片免費看 aa片免費看 aa片免費看 aa片免費看 aa片免費看 日本av女優影片 av女優 av女優無碼影城 av女優 av女優 百分百成人圖片 百分百成人圖片 視訊情人高雄網 電話交友 影音電話交友 絕色影城 絕色影城 夜未眠成人影城 夜未眠成人影城 色咪咪影片網 色咪咪影片網 色咪咪影片網 色咪咪影片網 色咪咪影片網 免費色咪咪貼影片 免費色咪咪貼影片 色情遊戲 色情遊戲 色情遊戲 色情遊戲 影音視訊交友網

Anonymous said...

視訊交友網 080視訊聊天室 ※免費視訊聊天室※ ※免費視訊聊天室※ 視訊聊天室 成人影音視訊聊天室 ut影音視訊聊天室 ※免費視訊聊天室※ 視訊ukiss聊天室視訊ukiss聊天室 視訊交友90739 視訊交友90739 情人視訊網 168視訊美女 168視訊美女 168視訊美女 視訊美女館 視訊美女館 免費視訊美女網 小高聊天室 小高聊天室 aio交友聊天室 aio交友聊天室 交友聊天室 交友聊天室 線上a片 線上a片 線上a片 線上a片 線上a片 免費線上a片 免費線上a片 嘟嘟成人網站 成人漫畫 情色文學 嘟嘟成人網 成人貼圖區 情色文學成人小說 微風成人區 情色貼圖區 免費視訊聊天 免費成人圖片區 愛情公寓 愛情公寓聊天室 寄情築園小遊戲 免費aa片線上看 aa片免費看 情色SXE聊天室 SEX情色遊戲 色情A片 免費下載 av女優 俱樂部 情色論壇 辣妹視訊 情色貼圖網 免費色情 聊天室 情人視訊聊天室 免費a片成人影城 免費a片-aa片免費看 0204貼圖區 SEX情色 交友聊天-線上免費 女優天堂 成人交友網 成人情色貼圖區 18禁 -女優王國 080視訊美女聊天室 080視訊聊天室 視訊交友90739 免費a片 aio 視訊交友網 成人影城-免費a片※免費視訊聊天※85cc免費影片日本線上免費a片 免費色咪咪影片免費色咪咪影片aaa片免費看影片aaa片免費看成人影城情人視訊高雄網sex520免費影片080聊天室080聊天室aa的滿18歲影片免費av18禁影片免費av18禁影片免費av18禁影片aa的滿18歲影片聊天室ut愛情公寓尋夢園聊天室