By Nick Colas of DataTrek Research
Long time readers know I (Nick) left Credit Suisse in the late 1990s to go to SAC Capital and work for Steve Cohen. No surprise, but there was a vast difference between the 2 environments. At Credit Suisse, I had a lovely private office overlooking Madison Square Park, 2 research associates and an administrative assistant. At SAC, I was on my own in a windowless, cramped trading room with just 4 linear feet of desk space to call home.
Then there were my co-workers. Credit Suisse had retained much of the staff from the old First Boston, a white shoe firm managed by Ivy League-educated WASPs. They valued hard work, deep intellectual rigor, and the ability to succinctly summarize complex ideas. Those three attributes are what makes an investment banker or sell-side research analyst efficient and therefore productive at their job.
SAC was staffed by gritty day-traders, and their approach to work was entirely different. One of their favorite sayings was “when the bank cashes your bonus check they don’t ask how smart you are”. All this group cared about was honing a process to deliver a profitable outcome. It might appear ill-informed, even naïve … All that mattered was that it worked well enough. Being able to elegantly verbalize a trade idea was worse than unnecessary; it was a waste of precious time.
The thing that struck me hardest about how truly great traders (and that was the overwhelming majority in the room) go about their daily process is they are generally LEAST busy from 10am to 3pm. Everyone was at their desk by 7am, reading, taking broker calls, and talking amongst themselves. These activities informed the day’s trade ideas, which went on the sheet pre-market or at the open. By 10am, that work was done. The conversation would shift to lunch (traders truly love discussing food), big picture ideas, and a whole range of random activities. The tempo of the room would only pick up again going into the close, as traders took profits or cut losses to set up a preliminary set of positions for overnight and the next morning.
At first, I was surprised – I thought traders would be trading all day – but I slowly began to understand what was happening: time is both the trader’s best friend and worst enemy. Here’s what I mean:
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Even the best traders only have a 55-60 percent win rate. Over a third of their ideas are clunkers.
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Good trades take time to work in their entirety. Even if you’re up 5 percent on a great idea at the open, there may be another +5 percent move coming over the course of the day or the next few trading sessions.
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Loss-making positions quickly get cut down or sold/covered.
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Collectively, this means the trick to successful trading is keeping winners long enough to fully exploit that relatively meager 5–10-point edge mentioned in the first point.
Time is also the enemy because it can tempt you into ill-considered trades. If all you do is stare at the tape through the day, the temptation to take a shot at a name or two on some random call can be strong indeed. Great traders know “don’t just do something, sit there” is often good advice.
I think much of the “time and friend or foe” idea also applies to investing. A few months ago, for example, we covered an academic paper which described how even highly successful hedge funds sell winners too early. So much of their “brand” is based on idea generation that their investment process suffers from ditching winning positions before they’ve fully run their course in favor of the latest hot new idea.
But … Just waiting for stocks to perform doesn’t always work as one might expect, even over the long term. American investors are a bit spoiled, because the S&P 500 has been a generally reliable wealth compounding machine for almost 100 years and impressively so over the last decade. By contrast, non-US equities have lagged significantly over the last 10 years (data through Q3 2021):
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S&P 500: 16.6 percent compounded annual growth rate (CAGR) over the last 10 years
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Russell 2000: 14.6 pct 10-year CAGR
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Average: 15.6 percent 10-year CAGR
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MSCI EAFE (non-US developed economies) Index: 8.0 pct 10-year CAGR
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MSCI Emerging Markets: 6.1 pct 10-year CAGR
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Average: 6.8 percent 10-year CAGR
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MSCI Germany: 8.5 percent 10-year CAGR
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MSCI United Kingdom: 5.4 pct 10-year CAGR
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MSCI France: 9.3 pct 10-year CAGR
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MSCI Japan: 8.4 pct 10-year CAGR
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Average: 7.9 percent 10-year CAGR
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MSCI China: 8.7 pct 10-year CAGR
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MSCI South Korea: 7.2 pct 10-year CAGR
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MSCI Taiwan: 13.3 pct 10-year CAGR
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MSCI Brazil: -1.7 pct 10-year CAGR
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Average: 6.9 percent 10-year CAGR
Simply put, a decade should be enough time to judge the relative long-run investment merits of different geographies and the data clearly shows non-US equities structurally underperform the S&P 500 or Russell 2000. US stocks have compounded twice as quickly as both developed and emerging market equities over this period. For all of Europe’s aggressive monetary policies since the Financial Crisis or Emerging Market’s faster economic growth, it is American equities that have powered global stock market returns.
The most important question for global asset allocators just now is “how will the next decade develop in terms of US/non-US equity returns?” Will time force a relative performance reversion to the mean between the two asset classes, or will it shove them even further apart? While it is mathematically true that international diversification helps reduce portfolio risk, it is equally valid to question the cost of that feature in terms of lost returns. They are quite simply too large to ignore.
My answer to that question is grounded in what I learned at SAC: stick with winners as long as they continue to win. Yes, there are many wonderful reasons to overweight Europe (cheap valuations, high quality companies, dividend yields) or Emerging Markets (economic growth, mostly). But here’s the thing: those reasons haven’t worked for a decade, and they are not working in 2021. Is there a catalyst for capital to suddenly shift out of the US and go elsewhere? If there is, it still sits over the horizon.
I’ll close with another version of “time as friend or foe” I learned at SAC from a veteran trader shortly after I got there. We were having a heated discussion about whether to short GM. I had many reasons to be long and laid them out in a cleverly succinct fashion consistent with my training. He had (maybe) 2 reasons to go short and one of them was “it’s GM … they’re awful … why not be short?”.
He won the argument, at least in my eyes, when he said “Look… you have to decide right now if you want to sound smart or get rich, because you’re not Soros or Druckenmiller – you can’t do both.” I heard that as “you don’t have the time to do both”, and he was right. Oh, and the GM short worked out well. Very well, in fact.
