Market "melt up" and the Airplane Game

[animule]

The market "melt up" over the past month and the rapid change in sentiment among small investors (reported by USA Today and others) makes me think about the Airplane Game.

There was a time maybe 15 years ago or more in my area where this was all the rage. It was basically an illegal Ponzi scheme where people recruited new "passengers" and everyone who had joined the game earlier moved up a row. Once people became "Pilot" and "Co-Pilot" they "cashed out." Trouble was that many of these airplanes "crashed" before the late joiners made anything on them.

The reason I bring this up is that this market has the same feel to me as that game did. Even on this forum, you see a discussion like the "Two Comma Club" with over 125 posts in a relatively short period of time. This is too much giddiness, too quickly.

Is it just me? Or does anyone else feel like this?

They say that stocks are the only "product" where demand rises when the price doubles, and we're literally seeing that now. The way I look at it, this market is twice as risky as it was a few years ago.

[Alex Frakt]

So what should we do about it?

[umfundi]

It's noise. Read this:

http://www.portfoliosolutions.com/2013marketforecast/

I am persuaded we are basically in decent shape. What the market does in weeks and months does not matter.

Keith

[Rainier]

You mean posts like: "I've had a large amount of cash on the sidelines the past few years now I want back it. The market looks safer now."

[animule]

You mean posts like: "I've had a large amount of cash on the sidelines the past few years now I want back it. The market looks safer now."

Bingo.

The market has doubled, now it's "safer." Yikes.

Great time to become more conservative, not less.

[Rainier]

Exactly.

[nisiprius]

I felt that way once, and while I didn't do anything extreme or drastic, I did spend the next year gradually lightening up on stocks.

It was at the end of 1996, just after Alan Greenspan made his "irrational exuberance" speech.

Point being, if one perceives that one might be seeing a mania, that doesn't tell you what to do about it. Anything more extreme than rebalancing to your target asset allocation is questionable.

[EmergDoc]

You should definitely feel less comfortable buying stocks now than in Fall 2008. That said, I have no idea if it is better to buy them now or in two years. I buy when I have the money. Sometimes I get more shares than other times.

[zaboomafoozarg]

Bingo.

The market has doubled, now it's "safer." Yikes.

Great time to become more conservative, not less.

How about this?

Exactly as conservative this year as last year. Exactly as conservative next year as this year.

[tpm871]

Yeah, I saw this quote in an article this morning:

Mechling, 47, a married market researcher with no kids from Portland, Ore., admits that the fear of missing out on gains has given her a new sense of urgency to get invested. With the market near a new high, "it's definitely safe to invest now," she says.

http://www.usatoday.com/story/money/markets/2013/01/24/new-stock-highs-lure-main-street-back-to-market/1861789/

That's totally illogical, and makes me want to sell everything now (but I won't, since I stay the course).

[SSSS]

Yeah, I saw this quote in an article this morning:

Mechling, 47, a married market researcher with no kids from Portland, Ore., admits that the fear of missing out on gains has given her a new sense of urgency to get invested. With the market near a new high, "it's definitely safe to invest now," she says.

http://www.usatoday.com/story/money/markets/2013/01/24/new-stock-highs-lure-main-street-back-to-market/1861789/

That's totally illogical, and makes me want to sell everything now (but I won't, since I stay the course).

And the next paragraph describes her as "a buy-and-hold investor".

[Browser]

I recently doubled my stock allocation from 0% to 0%. I plan to keep on doubling it as the market goes up. I will do the same if it goes down.

[SSSS]

I recently doubled my stock allocation from 0% to 0%. I plan to keep on doubling it as the market goes up. I will do the same if it goes down.

Be very careful not to divide by 0.

[momar]

I figure this sounds like a perfect opportunity to hang on for another 25-40% then cash out the taxable to pay off the mortgage.

And if it doesn't happen? Oh well, I'll just hang on until it does. But maybe we get it in another year or two.

[animule]

Bingo.

The market has doubled, now it's "safer." Yikes.

Great time to become more conservative, not less.

How about this?

Exactly as conservative this year as last year. Exactly as conservative next year as this year.

Hi Zabooma,

This means that you would be more conservative this year, than last, simply because you are one year older.

One thing I have never quite understood about asset allocation is the wide range of alternatives. No two mutual fund companies seem to agree on the precise stock/bond split based on age.

My wife's 403B recommends Vanguard Target 2025 for her, which is 29% in bonds despite the fact she is 50. Our actual allocation (I am 50 too) is around 37% in bonds and cash, which feels low in this environment, so we will be changing this in the near future to get closer to age in bonds.

[umfundi]

I hate to bring this up, but:

If I have cash and it is now too risky to be investing, should not those who are invested be selling?

Keith

[BBL]

I recently doubled my stock allocation from 0% to 0%. I plan to keep on doubling it as the market goes up. I will do the same if it goes down.

Be very careful not to divide by 0.

Pfffttttt. Come on now, everyone knows only Chuck Norris can divide by zero.

http://mike.wordpress.com/2005/12/05/ch ... the-facts/

[epilnk]

For those of us who rebalance, volatility is a good thing.

[bottlecap]

Couldn't we say the same thing every time the market nears the high?

JT

[nisiprius]

I recently doubled my stock allocation from 0% to 0%. I plan to keep on doubling it as the market goes up. I will do the same if it goes down.

Be very careful not to divide by 0.

Affine fix to get into! It's just a matter of fi-NaN-ce. Disguise the limit!

One thing I have never quite understood about asset allocation is the wide range of alternatives. No two mutual fund companies seem to agree on the precise stock/bond split based on age.

In an Ibbotson Associates report on Lifetime Asset Allocations: Methodologies for Target Maturity Funds, they present a chart of the "equity glide paths of the largest target maturity fund families."

A common element is that none of them follow a straight line like "age in bonds," but rather all of them agree on the general idea of starting out changing slowly, getting most of the "de-risking" done from about age 40 to 60, and then leveling off again.

But they disagree completely in their vertical height, that is their overall conservatism or aggressiveness. Notice that at age 57 there is a full 40%-of-portfolio difference in stock allocation between the most conservative fund (45% stocks) and the most aggressive (85%).

To me, this just expresses the truism that there is no objective right or wrong choice; individual investors differ in their risk tolerance. It is a pity that they do not make this explicit, but make an arbitrary choice--different fund companies making different arbitrary choices--and allow investors to have the impression that their arbitrary choices have been made objectively and scientifically.

Another, rather devastating Ibbotson paper, Bait and Switch: Glide Path Instability, shows that many or most target-date funds have not stuck to a consistent glide path, anyway. And Vanguard is one of the offenders; see figure 2 from that paper.

[foxfirev5]

My ISP and AA allow me to take some profits (rebalance) if things start to get crazy high. Keeps it simple

[animule]

In an Ibbotson Associates report on Lifetime Asset Allocations: Methodologies for Target Maturity Funds, they present a chart of the "equity glide paths of the largest target maturity fund families."

A common element is that none of them follow a straight line like "age in bonds," but rather all of them agree on the general idea of starting out changing slowly, getting most of the "de-risking" done from about age 40 to 60, and then leveling off again.

But they disagree completely in their vertical height, that is their overall conservatism or aggressiveness. Notice that at age 57 there is a full 40%-of-portfolio difference in stock allocation between the most conservative fund (45% stocks) and the most aggressive (85%).

To me, this just expresses the truism that there is no objective right or wrong choice; individual investors differ in their risk tolerance. It is a pity that they do not make this explicit, but make an arbitrary choice--different fund companies making different arbitrary choices--and allow investors to have the impression that their arbitrary choices have been made objectively and scientifically.

Another, rather devastating Ibbotson paper, Bait and Switch: Glide Path Instability, shows that many or most target-date funds have not stuck to a consistent glide path, anyway. And Vanguard is one of the offenders; see figure 2 from that paper.

Holy smokes, I wasn't aware that Vanguard's Target Date funds went from something like age minus 5 in bonds to age minus 25 or so in bonds in one fell swoop. Wow! Thanks for the tutorial, Nisi.

In contrast with Fidelity Freedom’s seemingly chaotic glide paths, during the Vanguard Target
Retirement Funds family’s much shorter history, there are clearly two distinct regimes depicted
in Figure 2. Prior to 2006, the Vanguard glide paths were much more conservative than they
were starting in 2006. This graph does not explain what the cause of this shift was, nor does it
tell why it occurred. But it does alert investors that a relatively dramatic one-time change
occurred and could potentially occur again in the future.

[umfundi]

Holy smokes, I wasn't aware that Vanguard's Target Date funds went from something like age minus 5 in bonds to age minus 25 or so in bonds in one fell swoop. Wow! Thanks for the tutorial, Nisi.

In contrast with Fidelity Freedom’s seemingly chaotic glide paths, during the Vanguard Target
Retirement Funds family’s much shorter history, there are clearly two distinct regimes depicted
in Figure 2. Prior to 2006, the Vanguard glide paths were much more conservative than they
were starting in 2006. This graph does not explain what the cause of this shift was, nor does it
tell why it occurred. But it does alert investors that a relatively dramatic one-time change
occurred and could potentially occur again in the future.

Vanguard got more aggressive for competitive reasons: The competition was advertising better returns.

With Vanguard Target Fundsit was pretty explicit, but that sort of drift has been around for a long time. The current phenomenon is that more funds are becoming index funds, whether they say so or not.

Keith

[rkhusky]

I recently doubled my stock allocation from 0% to 0%. I plan to keep on doubling it as the market goes up. I will do the same if it goes down.

Be very careful not to divide by 0.

Pfffttttt. Come on now, everyone knows only Chuck Norris can divide by zero.

http://mike.wordpress.com/2005/12/05/ch ... the-facts/

I thought only Bruce Schneier could do that?
http://www.schneierfacts.com

[Tom_T]

Some people are getting excited/nervous over the fact that the Dow is approaching the all-time high it reached six years ago?

[Easy Rhino]

A relatively slow rise in the market doesn't sound like a "melt up" by any stretch of the imagination. That terms describes things like the gold or commodities markets a few years ago.

However, retail investors are often terrific contrary indicators. I'll have to check my bond allocation tomorrow and make sure I own enough.

[FredPeterson]

Some people are getting excited/nervous over the fact that the Dow is approaching the all-time high it reached six years ago?

Yes excited because its safe to invest, gotta get in on those gains! The same missing out as the dotcom, albeit not the same level.

Nervous because many still see the economy as having not improved enough to warrant the "high" prices of things.

[Default User BR]

My investing philosophy is based on the principle that I have NO special knowledge or skills that would allow me to time any market at any point for any reason.


Brian

[The Wizard]

Isn't it simple enough just to maintain your AA and sell an increment of stock funds if that part of your allocation gets more than a few percent above your target?
I mean, we're talking to other Bogleheads here on this forum, right???

Talking about what other semi-anonymous folks are doing is one way to get a thread locked here.
The focus should be on: what does this Main Street Investor effect mean for our own portfolios?

[umfundi]

Isn't it simple enough just to maintain your AA and sell an increment of stock funds if that part of your allocation gets more than a few percent above your target?
I mean, we're talking to other Bogleheads here on this forum, right???

Talking about what other semi-anonymous folks are doing is one way to get a thread locked here.
The focus should be on: what does this Main Street Investor effect mean for our own portfolios?

Well, it's not just that.

I have to continually explain and defend our investing strategy to my wife and family. All this noise gets them asking questions. Even if it is not to question our investments, my wife can get very cautious about spending and planning for things like vacations.

Keith

[HardKnocker]

I remember the Airplane game but it was in the late 1980's where I was.

It was about $5,000 to get a seat on the plane.

[animule]

More evidence of performance chasing - from today's Wall Street Journal:

Small investors are jumping back into the stock market after abandoning it during the financial crisis.

Many analysts and strategists say individual investors are providing another source of fuel for the stock market. One piece of evidence: A total of $6.8 billion shifted into U.S. stock mutual funds in the first three weeks of 2013, according to mutual-fund tracker Lipper Inc. That is the biggest move since 2001.

http://online.wsj.com/article/SB1000142 ... 43528.html

Article notes that the real shift may be waiting for the fed to raise rates, which will hurt bonds. What the article doesn't say is that stock returns are also influenced by interest rates, and a rise in interest rates will also hurt stock returns, maybe somewhat later down the road, but higher rates do not benefit stocks either.

Note: the "year to date" return on VFINX - Vanguard 500 Index is 5.28%. Annualized, that works out to over 60%. I don't know when the "melt up" will end, but I'm glad there is a new crop of buyers to take some shares off of my hands so I can rebalance to a more sleep-inducing stock allocation.

[Browser]

I was trying to think of a game analogy for investing in the stock market. It's kind of like being on a treasure hunt in an area where there are hidden drop traps that you might occasionally fall into unexpectedly and lose half the treasure you've managed to pick up, or maybe even more if it's a real deep trap. You know the traps are there and that you'll fall into them from time to time, but there's nothing you can do to avoid it if you want to participate in the treasure hunt. Others who have played the game in the past have said that if you're willing to play it you'll come out with some of the treasure you've found when the game is over, perhaps a bit bruised from falling into the drop traps. But nobody knows for sure if that will happen in the future if you start playing the game now. Sounds like a crazy game doesn't it? It's certainly a game I'd avoid playing unless I really needed the treasure and/or enjoyed adventure. I don't know if there is an actual game analogy for it - haven't thought of one yet.

[nisiprius]

I was trying to think of a game analogy for investing in the stock market.

It's like playing in a casino where the "house percentage" goes the other way.

[umfundi]

I was trying to think of a game analogy for investing in the stock market.

It's like playing in a casino where the "house percentage" goes the other way.

I was thinking the same thing. Except, your edge is mostly better than the house has in a casino.

Keith

[Valuethinker]

I was trying to think of a game analogy for investing in the stock market.

It's like playing in a casino where the "house percentage" goes the other way.

I was thinking the same thing. Except, your edge is mostly better than the house has in a casino.

Keith

Actually not:

- the impact of taxes is large-- historically very large

- the impact of transactions costs is large (sufficiently so that DFA has built a business around trying to minimize them)

- insiders do better than outsiders. That's got all kinds of implications, from high executive compensation (pay without performance), through to the whole IPO underperformance puzzle, discounts on Closed End Funds etc.

- indices are manipulated and traded against. Ditto the whole problem of High Frequency Trading/ Algorithmic Trading

- as Nisi has pointed out many times, the performance of stock markets is fractal-- you cannot really tell if there is an upward trend, and for any sub period you cannot predict there is an upward trend (something like 7 independent observations of 30 year periods, where for the first 2 we aren't sure about the data, is really not enough to assert anything)


Stocks are anything but a 'no brainer'. Taking into account transactions costs and taxes, investors do not achieve those Ibbotson graphs.

This was brought home to me by an economist friend who was also a significant fund manager in India. He told me that 'despite economic growth, the growth in value for non-insider shareholders in India was actually quite poor, the gains acrrue to the majority controllers of these companies'. (that data might be out of date). But there are lots of stock markets in the world where this has been true for very long periods (China worries me in this regard). Japan was the ultimate case in point-- a giant Ponzi scheme which finally got called.

What you can do is exploit human frailty. *other* people are tempted to trade too much. Other people pay too many fees to fund managers. You benefit from the liquidity they create, and the more efficient pricing of assets.

If you are in Vanguard TSM, you don't trade too much. In theory at least, some of the DFA products (enough to offset higher fees?). The rest of us in the world don't have access to quite the same opportunities as a stock market fund at 7 basis points. The rest of the market's friction is something you are benefiting from.

It really does circle back to John Bogle as one of those rare geniuses in human affairs-- truly creative. Who creates something truly new, leading to vast benefits for consumers, but not necessarily for stockholders. The anti Bill Gates, you might say. A truly disruptive innovation (he did not invent it, but neither did Jobs nor Gates, but he drove it into consumer markets, just like Jobs and Gates did).

Whether stocks in the long run is truly a good idea is something we cannot really say, what we can say is that if it is, the best way to play it is Vanguard TSM and/or its global equivalent.

[nisiprius]

Just the techie speaking here, with my chessboard and my supply of wheat grains handy...

The casino's house percentage is many many orders of magnitude larger than the historic real annual return of the stock market, because the house percentage is per play.

I've spent a total of about twenty minutes in casinos in my lifetime, and fifteen of those were walking through it to get to the bank of elevators at the back of the hotel so that I get get to my room, so I don't know how long a typical casino "play" lasts--how many minutes between spins of the roulette wheel, pulls of the slot machine lever, or deals of the cards--but I'm thinking, I dunno, probably less than ten minutes? And the percentage per play is somewhere on the rough order of 1%? Now, to be fair, we have to ask how long the average player plays per day, and while that undoubtedly approaches 24 hours less bathroom breaks for some players, I dunno, let's say 8 hours, ten plays per hours, 80 plays per day. I can't even believe the numbers... I'm getting... let's say 50 plays per day. So the house percentage per day is 1 - 0.99^50 = about 40% per day. Annualized, thats...
...jeez, the Mac calculator displays 0.99^(50*365) as an exact zero.

Can someone verify my calculations on that?

It seems that if you took the gross national product of the United States, $15 trillion, with a house edge of 1% it would take only 3,000 plays to cut that down to $1.26.

[Leesbro63]

I accept that the current market rise COULD just be a debt fueled bubble that bursts. That being said, my father points out that all through the 1950s, many (not Warren Buffett) were convinced that the return of the Great Depression was just around the corner and was the real normal to revert to.

[neurosphere]

The casino's house percentage is many many orders of magnitude larger than the historic real annual return of the stock market, because the house percentage is per play.

Can someone verify my calculations on that?

I don't think that's how it works. When one talks about a casino's "house percentage" it does not refer to a fee, or cut taken at the outset, per play. I.e. it's not as if you give the casino 1% of your bet with each bet.

Instead, the house percentage varies depending on the actual GAME being played. Let's take a hypothetical roulette wheel with 101 possible numbers. When you play on a number and win, you'll win 100 times your bet. Your odds of winning were 1 in 101, but your WINNINGS if you win are only 100 times your bet. THIS is the house percentage. In theory, it means that with an INFINITE number of plays, the casino aka house is going to win about 1% in this case. In an actual roulette wheel, there are 37 (38?) positions, but winning bets only pay out 36 times the bet.

[rkhusky]

Just the techie speaking here, with my chessboard and my supply of wheat grains handy...

The casino's house percentage is many many orders of magnitude larger than the historic real annual return of the stock market, because the house percentage is per play.

I've spent a total of about twenty minutes in casinos in my lifetime, and fifteen of those were walking through it to get to the bank of elevators at the back of the hotel so that I get get to my room, so I don't know how long a typical casino "play" lasts--how many minutes between spins of the roulette wheel, pulls of the slot machine lever, or deals of the cards--but I'm thinking, I dunno, probably less than ten minutes? And the percentage per play is somewhere on the rough order of 1%? Now, to be fair, we have to ask how long the average player plays per day, and while that undoubtedly approaches 24 hours less bathroom breaks for some players, I dunno, let's say 8 hours, ten plays per hours, 80 plays per day. I can't even believe the numbers... I'm getting... let's say 50 plays per day. So the house percentage per day is 1 - 0.99^50 = about 40% per day. Annualized, thats...
...jeez, the Mac calculator displays 0.99^(50*365) as an exact zero.

Can someone verify my calculations on that?

It seems that if you took the gross national product of the United States, $15 trillion, with a house edge of 1% it would take only 3,000 plays to cut that down to $1.26.

A bit of Googling finds that most games have house odds more than 1%, e.g. roulette is 5.3%, craps is 1.4%, blackjack with optimal play, but no card-counting, is about 0.5% (unskilled players lose about 2%).

[Faith20879]

...This is too much giddiness, too quickly...

I disagree. If you read OP's again, it was a long period of LBYM and saving to reach where he is today. Where is the giddiness in that? As to the 120+ responses, it was a pad on the back from the fellow BHs for a job well done. That's a common practice in any support group which I consider we are too.

Now if the OP reached the point by flipping and trading, I could see the giddiness come in.

Regards,
Faith

[MrWinky]

I started averaging into the market in 2008. I supposedly missed a lot of the 2008 losses, and three of the four years after that were great for both stocks and bonds.

Then I tried to back-of-the-envelope my returns since 2008. My 5-year annualized returns come out to about 3.5% nominal. It was a shock to realize that the market did awesome, and we managed 1% real before taxes. The majority of the increase in our net worth was from new contributions. It's supposed to be downhill from here?!

[Valuethinker]

I started averaging into the market in 2008. I supposedly missed a lot of the 2008 losses, and three of the four years after that were great for both stocks and bonds.

Then I tried to back-of-the-envelope my returns since 2008. My 5-year annualized returns come out to about 3.5% nominal. It was a shock to realize that the market did awesome, and we managed 1% real before taxes. The majority of the increase in our net worth was from new contributions. It's supposed to be downhill from here?!

Your returns don't quite sound right, but it does depend on how much money you invested, and when.

Depending how old you are, you will get +20% years in your investing career.

The problem is you have some -20% ones, too.

What we can say from here is that US Treasury bonds, bought now, are unlikely to provide real returns (they might, but at 2% nominal yields, that will be hard).

Stocks are likely to provide real returns, over the very long run of 3-5% pa, and probably more towards the lower end of that range-- say 3%.

[Ranger]

I was trying to think of a game analogy for investing in the stock market.

It's like playing in a casino where the "house percentage" goes the other way.

I was thinking the same thing. Except, your edge is mostly better than the house has in a casino.

Keith

Actually not:

- the impact of taxes is large-- historically very large
Since we are comparing Casino to Stock Market, betting in Stock Market is favorable with respect to taxes. Gambling taxes are higher and losses can not be deducted I believe. Here one can do Tax loss harvesing and deduct losses up to $3,000 per year.

- the impact of transactions costs is large (sufficiently so that DFA has built a business around trying to minimize them)
Compared to casino betting transaction cost may or may not be cheaper (It is only cheaper in online betting sites, but odds are even worse). Transaction costs in stocks and future for active traders is considerable less compared to even 10 years back. For most of the traders transaction cost is not prohibitive here in US compared to even Europe or Asia.

- insiders do better than outsiders. That's got all kinds of implications, from high executive compensation (pay without performance), through to the whole IPO underperformance puzzle, discounts on Closed End Funds etc.

Again since we are comparing casino's and stock markets, even with all imperfection of capital markets, odds are still better here. House always wins in casino. There is no momentum effect in casino. They limit hot hands by changing dealers, limiting minimum bets and maximum bets. So you can not go martingale in casino. At-least theoretically, there is no such limitation in stock market provided they have enough capital and apply other statistical betting theories
- indices are manipulated and traded against. Ditto the whole problem of High Frequency Trading/ Algorithmic Trading


Your example is actually the case for active management, since indices will be manipulated by active traders

- as Nisi has pointed out many times, the performance of stock markets is fractal-- you cannot really tell if there is an upward trend, and for any sub period you cannot predict there is an upward trend (something like 7 independent observations of 30 year periods, where for the first 2 we aren't sure about the data, is really not enough to assert anything)

..

Whether stocks in the long run is truly a good idea is something we cannot really say, what we can say is that if it is, the best way to play it is Vanguard TSM and/or its global equivalent.

Agree in this case. Even though people from Japan may not agree.

[Bustoff]

Define risk any way you choose. No one can argue with the fact that the market is 3 steps forward one step back.
From 1929-2011, the record is 21 and 9 (years with a gain vs years with a loss). The chart below is a picture of a 7 and 5 record.
We must give this risk a wide berth.

[umfundi]

I was thinking the same thing. Except, your edge is mostly better than the house has in a casino.
Keith

When I made that comment, I was thinking of a single wager. In a casino, the odds are about 1% against you (and its over in a few minutes). In the market, the odds are 4% or better in your favor, over a year.

Of course, if you play continuously in a casino for a year, you are virtually certain to lose everything, no matter how large your beginning stake.

Keith

[Valuethinker]

Define risk any way you choose. No one can argue with the fact that the market is 3 steps forward one step back.
From 1929-2011, the record is 21 and 9 (years with a gain vs years with a loss). The chart below is a picture of a 7 and 5 record.
We must give this risk a wide berth.

Not enough independent sub periods to make the assertion-- US data runs back to 1840s I think, and we are not really sure of data before 1890s from memory (there are issues with the data Siegel used). That's only 6 independent 30 year periods at most.

Also we could find lots of other national stock markets that don't show that pattern.

[Valuethinker]

I was trying to think of a game analogy for investing in the stock market.

It's like playing in a casino where the "house percentage" goes the other way.

I was thinking the same thing. Except, your edge is mostly better than the house has in a casino.

Keith

Actually not:

- the impact of taxes is large-- historically very large
Since we are comparing Casino to Stock Market, betting in Stock Market is favorable with respect to taxes. Gambling taxes are higher and losses can not be deducted I believe. Here one can do Tax loss harvesing and deduct losses up to $3,000 per year.

- the impact of transactions costs is large (sufficiently so that DFA has built a business around trying to minimize them)
Compared to casino betting transaction cost may or may not be cheaper (It is only cheaper in online betting sites, but odds are even worse). Transaction costs in stocks and future for active traders is considerable less compared to even 10 years back. For most of the traders transaction cost is not prohibitive here in US compared to even Europe or Asia.

- insiders do better than outsiders. That's got all kinds of implications, from high executive compensation (pay without performance), through to the whole IPO underperformance puzzle, discounts on Closed End Funds etc.

Again since we are comparing casino's and stock markets, even with all imperfection of capital markets, odds are still better here. House always wins in casino. There is no momentum effect in casino. They limit hot hands by changing dealers, limiting minimum bets and maximum bets. So you can not go martingale in casino. At-least theoretically, there is no such limitation in stock market provided they have enough capital and apply other statistical betting theories
- indices are manipulated and traded against. Ditto the whole problem of High Frequency Trading/ Algorithmic Trading


Your example is actually the case for active management, since indices will be manipulated by active traders

- as Nisi has pointed out many times, the performance of stock markets is fractal-- you cannot really tell if there is an upward trend, and for any sub period you cannot predict there is an upward trend (something like 7 independent observations of 30 year periods, where for the first 2 we aren't sure about the data, is really not enough to assert anything)

..

Whether stocks in the long run is truly a good idea is something we cannot really say, what we can say is that if it is, the best way to play it is Vanguard TSM and/or its global equivalent.

Agree in this case. Even though people from Japan may not agree.

I wasn't really directly comparing to a casino, but arguing that the stock market is a game that does not necessarily come out ahead for the independent external shareholder.

Just on indices and manipulation. Active management works *if* you can anticipate how other people will manipulate the index *and* if your fees are low enough that the post fee performance beats passive.

I don't know of anyone who does that, except DFA (who doesn't track an index-- they are an 'active' but quant manager) and Vanguard TSM (because index promotion demotion is irrelevant to them as they just try to hold the whole market).

[blumby]

So the house percentage per day is 1 - 0.99^50 = about 40% per day. Annualized, thats...
...jeez, the Mac calculator displays 0.99^(50*365) as an exact zero.

Google displays 0.99^(50*365) as 2.1993857e-80, or for fun: 0.000000000000000000000000000000000000000000000000000000000000000000000000000000021993857

[animule]

Define risk any way you choose. No one can argue with the fact that the market is 3 steps forward one step back.
From 1929-2011, the record is 21 and 9 (years with a gain vs years with a loss). The chart below is a picture of a 7 and 5 record.
We must give this risk a wide berth.

Agreed.

Warren Buffet was on the right track when he said "Be fearful when others are greedy, and greedy when others are fearful."

So was Benjamin Graham. From page 84 in The Intelligent Investor: "'By the rule of opposites,' the more enthusiastic investors become about the stock market in the long run, the more certain they are to be proved wrong in the short run."

Or this other tidbit from Graham "while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster."

As I have said earlier, the rapid change in investor psychology of this market sets off alarm bells.

True, the top could be years away, or even days away. We won't know until after the fact. I just sense we are entering a period where asset allocation will be critical, if it isn't already.