Wednesday, December 17, 2014

Sears, The Indomitable Investor, 2d ed.

Steven M. Sears, probably best known for his options column in Barron’s, wrote The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails in 2012. Wiley recently issued a second edition with a new preface. Although I reviewed it when it first came out, it’s time for another look.

Sears focuses on the “make or break” things most investors blithely ignore, such as risk and when/how to sell. With respect to the latter, he writes: “Selling is Wall Street’s essence just as surely as buying is Main Street’s. … If you don’t learn to be a disciplined seller, you risk losing more money than you make. … Selling is not about timing the stock market. It is about managing the risk of your own investment portfolio, and tempering your decisions.” (pp. 23, 24) There’s no single right philosophy of selling, although Bernard Baruch’s timeless advice to “sell while the stock still is rising or, if you have made a mistake, to admit it immediately and take your loss” (p. 35) remains a good place to start.

At home in both the stock and options markets, Sears contrasts the two, saying that “the options market is driven by fear” and “the stock market is driven by greed.” He admits that “this is an oversimplification—but not by much.” (p. 89) The SKEW Index, an option-based indicator that measures the risk of 30-day S&P 500 returns two or more standard deviations below the mean, can be a useful guide for the risk-conscious stock investor. “When the SKEW Index is at 100, it means that the probability of a steep stock market decline is minimal. When it rises above 100, the odds of a sharp decline increase.” (p. 90) Its all-time low was on March 21, 1991, as the recession that had begun in July 1990 was winding down. Its all-time high—146.88—was in October 1998 during the Russian debt crisis and the unexpected Fed move to lower interest rates. It was also high in March 2006, shortly before the housing bubble burst. Using the SKEW Index in conjunction with the VIX can be especially helpful.

Sears also describes an alternative approach to asset allocation, relying on the work of Mark Taborsky, then at PIMCO. This was a strategy that Mohammed El-Erian’s Harvard team tried to execute but found very difficult to quantify and optimize. As El-Erian outlined the strategy in When Markets Collide, “The ideal situation is to come up with a small set (three to five) of distinct (and ideally orthogonal) risk factors that command a risk premium. The next step is to assess the stability of the factors and how they can be best captured through the use of tradable instruments.” (p. 233) Instead of relying on historical asset class performance patterns and assuming that markets are mean reverting, Taborsky explained, PIMCO looked at factors such as risk, volatility, correlation, interest rates, or even time.

These short takeaways from The Indomitable Investor offer only a glimpse into the richness of Sears’s book. Investors who are serious about managing their money and who want to be among the few who succeed can learn a great deal from Sears.

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