Ken Fisher interview: Why investors are their own worst enemies
Posted on February 8, 2007 by Richard Beddard
Filed Under Editor's choice, Investing |
Fisher Investments’ office is on Curzon Street W1, a more exclusive postcode than Interactive Investor’s. Inside it resembles a plushly carpeted but oddly furnished private house. I’m not there to discuss my burgeoning wealth, but to talk to Ken Fisher about his new book, The only Three Questions That Count, and to hear why he thinks investors are their own worst enemies.
Mr Fisher is a “self made richie”. You might not recognise him in the street, but you’ve probably seen his face beaming at you from his column in Forbes Magazine, or promoting his company’s wealth management services on the internet. He looks like Lyle Lovett’s brother. I don’t know about his singing, but he can talk, eat and point out salient pages of his book with the fluency of a conductor.
He predicts I won’t like the book. Having read my work he knows I focus on companies and, although his three questions are universal, most of his insights are top-down; about the economy and its relationship to stock markets. Although he’s a professional forecaster, the best market forecaster according to some measures, he’s wrong this time. ‘Three Questions’ is the most stimulating investment book I’ve read.
The three questions are:
- What do you believe that is actually false?
- What can you fathom that others find unfathomable?
- What the heck is my brain doing to blindside me now?
Initially, I admit, I was bemused by them. They seem to echo Donald Rumsfeld, who confused everyone talking about what we know, and don’t know. If you question everything, where do you start?
Mr Fisher starts with the efficient market thesis and the popular academic view that you can’t knowingly beat the stock market. The few investors that do are just lucky.
That’s not what finance theory would say”, he says, “What finance theory would say is that the only basis for making a bet is that you actually know something other people don’t know.”
He’s not talking about knowing things you shouldn’t know: next quarter’s profit announcement reassembled from the shredded remains of a draft for example, but extending our primitive understanding of markets, and investor psychology.
I don’t particularly place great stock in this,” he says, “But there’s this third party rating website that looks at public prognosticators… and of the forty something prognosticators they measure I’m the most accurate over the past five years, supposedly.”
“They say I’ve got a 69% accuracy rate… If I’m the most accurate, you’d better get used to being wrong a lot.”
It’s an observation that brings us neatly back to the questions. Investors are wrong a lot, so it makes sense for an investor to find out what he is wrong about (question 1), why he keeps repeating the same mistakes (question 3), and what repeatable patterns he can actually profit from (question 2).
If you are thinking one of those patterns might be the price earnings ratio of the market, you’re right, but perhaps not in the way you think:
“I show that PEs don’t tell you anything about where the market is going in the next year. But most people believe they do. So when you see people freaking out that the market has a high PE ratio, or being sanguine that it has a low PE, that’s something you can bet against.”
If you think the budget deficits are bad for stockmarkets, think again. Pointing to a chart showing US stock returns following budget balance extremes, he says:
Half the time surpluses lead to negative returns, and on average low single digit returns. Deficits never lead to negative returns, and on average 20% returns… Why would that be?”
“First, the notion of taking something and wrapping it up and measuring it is not a technically complex concept to address, although most people won’t do it. And secondly, wondering why it might be like that is what a scientist does.”
But most people don’t invest like scientists, they think like craftsmen, says Mr Fisher. Craftsmen don’t think for themselves, they follow the rules of the craft. Thinking like a scientist, he calculates the US national income is $13 trillion against assets of £111 trillion, a return of 12%. As the borrowing cost is about 4%:
“We cannot be over-indebted. We must be under-indebted. We’ve got to be borrowing more money at 4% to accumulate more assets, to get more income so we can be better off.”
Don’t bet against budget deficits, he says. When we’re taking on more debt, we’re moving closer to that optimum point where the cost of borrowing, and the return we get, balance. That’s good news for the stock market.
Betting on a bear market? Don’t. Cheap debt means it’s economic for companies to buy back shares, and take over other companies. That drives up prices. The game only stops when interest rates rise to the same level as the average earnings yield, from about 4% to about 7%. A 75-80% rise in the stockmarket could also end it, or a fall in average earnings of about 50%.
Any combination of those could happen, he says:
“But, since you know that 80% number is big. And since you know that long rates going up by 3% - that’s big. And since you know that by having equity earnings fall by 50% - that’s big. It’s not going to happen fast.”
Unless, perhaps, something really big happens.
Events often seem cataclysmic, Mr Fisher says, but then don’t change the direction of the stock market. In 1906, his grandfather delayed his wedding when the San Francisco earthquake wiped out his home town. It didn’t move the market though. On the day of Hurricane Katrina, the stockmarket rose. A hedge fund implosion won’t precipitate a bear market, he says. Hedge funds aren’t big enough, even if ten go down. What’s $200 billion compared to a $35 trillion global equity market?
We fear these things because, “The stone age brain doesn’t scale things well.”
Our stone age brain is the target of question 3. It stops investors thinking for themselves and encourages them to follow the herd. What was once a survival instinct in the pre-historic savanna is positively Neanderthal in the financial jungle. Our brains have not evolved to cope with modern markets.
It’s preposterous to finish an interview by asking the subject if he’s a more highly evolved life form, but that’s what I’ve been plotting as he talks. Mr Fisher has a famous father: Philip Fisher, author of “Common Stocks, and Uncommon Profits”. He was, in his prime, a champion stockpicker. Ken Fisher has a demonstrably better financial brain than most of us. Did he inherit it? Or did he learn?
“I think it’s nurture,” he says. “My father and I are very different human beings… He had a great brain but a very different brain to the brain I have… I think he tought me to think in ways that freed my brain.”
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sounds pretty close to warren buffet’s approach to me: what would be the main differences between WB’s and Ken Fisher’s?
Not being much of a Buffettologist I hesitate to reply but here goes… In the sense that both men have a fiercely independent and contrarian turn of mind they are similar. But in the processes they apparently follow to select investments, they are polar opposites. Mr Fisher has a top-down approach starting with the economy and spends relatively little energy analysing individual companies. Mr Buffett, on the other hand, tends not to bother himself with extraneous factors and devotes himself to understanding, and sometimes improving the business. How’s that? Luckily for us there seems to be more than one way to crack an egg.
What Fisher seems to be saying, at least in point one, is that we should do a scientific study of the effect of all top down data on the market. I have not read his book, but I sure hope he did that work for us.
The latter two points look like pure contrarian investing. I would be very interested to see any data on how well contrarian investing works. I suspect not so well. The timing is too damn hard to get right, as one famous UK Fund manager found to his detriment. Lets face it, it’s pure guesswork
Hi Shirley,
I think you’d like his book
He hasn’t done a scientific study of all top down data - that would be an epic! But he’s done plenty. More than enough for one book. He also lays down a challenge to investors - to look at the markets scientifically.
In the interview I put it to him that contrarian investing would give much of the benefit of ’scientific’ investing without the effort. This was his reply:
“No, don’t go there. I spend a long time in the book pointing out that contrarianism does not work. The point is there’s this terrible market environment so you should be optimistic [or vice versa]… Sometimes the market does the opposite of the consensus but just as often the consensus is bullish or bearish but not bullish or bearish enough… You can actually measure that when everybody thinks it will go to 12 o’clock it won’t go to 12 o’clock, but it might go to 3 o’clock or 9 o’clock.”
In other words the opposite won’t necessarily happen - just something different to the consensus.
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