Tuesday, March 31, 2015

Opinion of the Day: Modern Portfolio Theory Is Junk Science

Modern Portfolio Theory

Modern portfolio theory (MPT) is a theory of finance that attempts to maximize portfolio expected return for a given amount of portfolio risk, or equivalently minimize risk for a given level of expected return, by carefully choosing the proportions of various assets.

So why am I calling it junk science?

For example, to the extent prices in the stock market move differently from prices in the bond market, a collection of both types of assets can in theory face lower overall risk than either individually.

While it is true that stocks and bonds often move differently over shorter time frames, stocks and long-term bonds have been moving together since the early 1980s. Rates fell. Both bond prices and stock prices went up. For long-term investors, only the long-term should matter. Anyone who thinks that stocks will do okay if the widely assumed "bond bubble" pops needs to have their head examined. Junk science.

MPT also assumes that investors are rational and markets are efficient.

Hilarious! Junk science.

The framework of MPT makes many assumptions about investors and markets.

Many assumptions? Junk science.

During times of financial crisis all assets tend to become positively correlated, because they all move (down) together. In other words, MPT breaks down precisely when investors are most in need of protection from risk.

Theory prone to failure? Junk science.

The risk, return, and correlation measures used by MPT are based on expected values, which means that they are mathematical statements about the future...

Using the distant past to predict the distant future? Junk science.

Essentially, the mathematics of MPT view the markets as a collection of dice. By examining past market data we can develop hypotheses about how the dice are weighted, but this isn't helpful if the markets are actually dependent upon a much bigger and more complicated chaotic system—the world.

Basing investment decisions on a collection of dice? Junk science.

Following MPT means portfolio managers can invest in assets without analyzing their fundamentals...

Using a gambling strategy instead of fundamentals? Junk science.

I'm saving the best reason for last. In 1966, Alan Greenspan stated:

The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

I am a believer. If you are a believer as well, then surely you must realize that modern portfolio theory offers a false sense of security. The herd cannot possibly protect itself by all doing the same thing at the same time. That's a pretty darned big target for the welfare state.


mab said...

I'm not a believer. We don't have a welfare state. At least not in the sense Greensham was implying.

I'd say the wealthy are batting 100% over the course of American history.

Why? I'll offer an opinion. Under a "democracy" it's all but inevitable that we end up with bought-off politicians.

Left. Right. Republican. Democrat. Independent (what a joke). Liberal. Conservative. Moderate. All bs.

If you ignore the rhetoric, they're all the same. It's by design. A feature, not a bug.

Greensham and his conundrums!!!! The guy is a doofuss. A complete Goober. He didn't get to where he was because of his intelligence or talents. Not by a long shot.

Stagflationary Mark said...


I do think we're a welfare state.

The biggest recipients of all are the wealthy, the too big to fail banks, the corporations, and politicians.

Food stamp participants aren't even in the same league!

So maybe we just need to define what being a welfare state means.

mab said...

Yeah, Greensham would have us believe otherwise. And under a "democracy" one might easily conclude that the masses would get their way. But the facts belie that theory.

In truth (whatever that means), the masses will never be in charge. And that actually makes sense to me. But the people in charge need to be mindful.

We have dreadfully poor leadership imo. Psychopathic in many ways. Not good. Compared to that, theories and numbers are just that.

Stagflationary Mark said...


We have dreadfully poor leadership imo. Psychopathic in many ways. Not good.

The Onion: Report: Whites More Likely To Be Named CEOs Than Equally Sociopathic Black Candidates

“My race shouldn’t be a factor when I’ve proven that I’m a borderline psychopath who will step over anybody in my way to sate my fanatical lust for power,” he continued. “When it comes to succeeding in the business world, that’s all that should matter.”

I'm reminded of my girlfriend's story about how she had a dentist appointment. She made sure everyone new beforehand.

The day of her appointment, her boss's boss wanted to hold a meeting. My girlfriend must attend. She asked if she could call to tell the dentist that she couldn't be there. She was told that she couldn't. WTF! Cost her a $50 no show fee and an angry dentist. That was a good two hours of wages for her. Poof. Gone.

Psychopath behavior indeed.

Stagflationary Mark said...

new = knew

Someday I will master this phone's keyboard! I just "no" I will! ;)

mab said...

I just "no" I will

We all no you will too!

Totally unrelated, but I watched this movie "The Internship" the other night. Very entertaining!

What a welcome surprise, I thought it would be awful.

Stagflationary Mark said...


You're talking about the movie from the '80's? ;)

mab said...

So maybe we just need to define what being a welfare state means.

I think Leona Helmsley was on the right track when she quipped "taxes are for the little people."

We can define it any way we want as long as we don't discuss the preferential tax treatment of billionaire hedge fund and private equity managers.

Carried interest baby, that's what I'm talking about!

As if taxes pay for our Federal Gov't!!! What a joke.

Stagflationary Mark said...


I would never discuss the preferential tax treatment of billionaire hedge fund and private equity managers!!

Billionaire hedge fund managers can never be duty free. The duty just keeps piling up!

Some managers may even be @$$holes. What else could possiblly explain how much duty comes out of them?

Doin'' their patriotic duty? Yeah, no joke. The only cleaning up many investors will be doing though involves large chunks of duty.

Crock of duty, baby. Talking about it right now. Livin' the septic dream.

mab said...

You're talking about the movie from the '80's?

Actually, I'm talking about that movie that talked about that movie from the 80s.

What is this doing on the get psyched tape?


I call that sign the widow maker!

Stagflationary Mark said...


For the benefit of those who did not see the movie, you seem to really be putting it on the line! ;)

mab said...

Can people take college courses on the line? If so, I'm shooting for a phd in eCONomics. Maybe at the University of Phoenix!

It's the Harvard of on the line universities. Go Phighting Phoenix's!!!!

It says make good choices!!!! lol

Stagflationary Mark said...

Hahaha!! :)