Dimon Testifies on "The London Whale"

Today is likely to be a 3-ring circus as Jamie Dimon, JPMorgan CEO, testifies to Congress on the $2 billion losses incurred by the London trader known as "The Whale."

Dimon is another case of someone telling everyone else how to live and turning out to be a major sinner.  The bottom line is Dimon had weak risk controls in place and has made himself a poster child for a chops-licking Congress to skewer.

But there is another more important message, IMHO, for the individual investor to contemplate, emphasized by Dan Solin in "The Hidden Message in JP Morgan's $2-Billion Loss."  Consider that J.P. Morgan is one of the biggest trading entities in the world.  Bruno Michel Iksil, aka "The Whale," is obviously brilliant - you don't get to aggressively trade the size he traded at J.P. Morgan unless you are pretty smart.  He obviously had the very best resources including sophisticated value-at-risk models, the top graduates from the nation's business schools, etc., at his fingertips.  And still - he lost billions!

The message for individuals to contemplate is whether the fast-talking rep from the mutual fund provider/wealth manager promoting their stock picking/market timing skills can really do what they say they can do.  Dan Solin, author of The Smartest Money Book You'll Ever Read, says

The massive loss suffered by the bank is yet another indication of the inability of this huge institution (or anyone else) to predict the direction of the markets. Yet, the entire securities industry is premised on the false assumption that its members can add value by stock picking, market timing, and fund-manager picking.

He further points out:

The real skill of these "wealth managers" lies in their ability to convince you they have an expertise that doesn't exist. This latest debacle is one more example demonstrating the irrefutable fact that these investment gurus are emperors with no clothes, representing a significant, little-understood peril to your financial security.

Bulls and Bears

Source TheLanguageLab

It seems counter intuitive that indexing a portfolio can outperform very smart people who spend enormous resources analyzing company specific information, macroeconomic data, charts of price and volume history, and even sunspots. After all, in many aspects of life, those who are most talented and work the hardest get ahead. But apparently not so in the investment world, with the exception of those who work hard at studying and understanding the evidence.

Studying the evidence over many periods and from different perspectives leads to the conclusion that most managers will underperform the market after costs, whether they try to market time, pick the best stocks or funds, or use a technical approach.  Furthermore, even those who outperform over a given period do not persist in their out performance. In a practical sense, trying to pick the best performing funds on the basis of track record is futile. Morningstar demonstrated this by picking mutual funds for its 401(k) fund that underperformed on an aggregate basis.

How is this counter intuitive finding explained?  There is a whole literature that goes into this; but, from a very basic standpoint, it goes back to the notion of a market transaction.  At any point in time, the bulls and bears are evened out.

First, think about a simple economic transaction where I sell my calculator to you for $50.  The transaction means that you value the calculator for more than $50 and I value it at less than $50.  This is the essence of a market.  The same type of transaction takes place in the stock market.  When I sell 100 shares of Microsoft for $25.10/share, I believe it is worth less and the buyer believes it is worth more.  There is a difference here, however.   One of us will be wrong. .

Ramp this up to the portfolio level, and go one step further and consider market views.  Here are some views presently held:

Ralph Acampora   technician... market headed higher to challenge year's high by year end
      main idea:  VIX (primary measure of market anxiety) is high; and each time it has been this high, the market has been significantly higher 4 months  later. (DIY Comment:  Let's jump in!)

David Rosenberg  economist ...stocks headed sharply lower...main idea:  market does not appreciate how weak the economic data is...we are headed for recession... need to look at 3-month average when looking at data to even out the revisions and short term influences. (DIY Comment:  Whoa...maybe we had better hold off.)

Jay Feuerstein  CIO 2100 Xenon...Dow Jones Industrial Average headed for 8200...main idea:  GDP without Government is negative and global economy weaker than perceived. (DIY comment:  Yikes!)

Jamie Dimon CEO JP MOrgan Chase & Co....Market headed sharply higher...main idea:  companies ready to "rock and roll" once governments get out of the way, including Europe...companies have cash and much improved capital structures. (DIY comment:  Good luck lessening the influence of the government - especially with elections around the corner...note to self - send Mr. Dimon link to recent Republican candidate debate.)

Obviously, some prognosticators will look brilliant as we move into 2012 and others will look bad.  All are very smart and convincing.  All probably have their portfolios positioned to conform with their beliefs.

All of the above applies as well to sectors and individual stocks.  Again, it is in the nature of a simple transaction.