Almost exactly 15 years ago to the day, I wrote my worst article for the Van Tharp Institute. In an attempt to minimize any additional stressors to my writing psyche, I’ll not go into the details of why the article was (ahem) less than my best. Or about the emails I received that called into question my worth as a human being with quotes such as, “…Or perhaps you could leave Van to cover position sizing and you can target what really seems to be bothering you…”.
To make a long story short(er), or perhaps to make a little lemonade out of lemons, the above email respondent really did say some nice things about other articles I had written, and we did have a very constructive email back-and-forth as a follow-up.
All that lead-in to say this, I wrote that article 15 years ago to intentionally berate portfolio diversification. I left some questions unanswered with the purpose of leaving them as fodder for answers in future articles. So yeah, the article was a bit disjointed, and I didn’t prove my point about diversification very well.
Fast forward to today, and we remember Nobel laureate Dr. Harry M. Markowitz, the economist whose work in modern portfolio theory (MPT) gave birth to the field of quantitative finance. His MPT introductory article was from 1952 (written before he got his Ph.D. from the University of Chicago in 1955). He was awarded the Nobel Prize in economics in 1990. Markowitz’s pioneering work also led to the development of the Capital Asset Pricing Model (CAPM) and the birth of the efficient market hypothesis, thus shaping modern finance. His work has significantly influenced financial modeling and the way investments are analyzed, proving invaluable to both academics and practitioners. He passed on from this life on June 22nd, 2023, just six short days ago.
Two Charts to “Do Dr. Markowitz Proud” (That’s the way we say it where I grew up.)
First, we need something to compare other assets to so that we can have something to diversify from. The most common asset for that is the S&P 500 index. I told my good friend of over 20 years, Dr. Ken Long, that his chart from Monday’s (June 26th) free VTI webinar was the best one I’d seen all year. Take a look:
I won’t say too much about Ken’s chart because it tells the whole story itself. These are three-day bars of the symbol SPY with some moving linear regression lines, Bollinger Bands, Parabolic Stop-and-Reverse (SAR) dots, MACD and a couple of other widely available NON-proprietary tools. I’ve worked with Ken on so many things and been taught by Ken on so many others – can’t say enough good things about the man or his teaching record. And this chart – why do I love it so much? The coil and release on the S&P is captured beautifully with no additional language or mark-up needed.
Let’s move on to diversification in honor of Dr. Markowitz, because the chart of Meta Platforms (META), aka Facebook, has hit an interesting place on the chart:
This stock has been one of the Mega Tech darlings and just keeps going up. In the last eight days, it has been unable to break through the $290 resistance level, shown as a black line above. But what I’d really like to point out today is how META has gone from strongly correlated 22 months ago, to almost uncorrelated (12 – 13 months ago), back to strongly correlated – all on the very long 250-day (~1 trading year) correlation coefficient.
Dr. Markowitz and Modern Portfolio Theory showed that we could get higher returns for the same level of risk with proper diversification. But like just about everything in markets, we can’t just set it and forget it. If you added the uncorrelated META to offset your SPY 13 months ago, you’d have a very different portfolio than you would today. I’d like to dig into that with you along with some thoughts on post-Modern Portfolio Theory in a future article.
I’d love to hear what you think of MPT and other tools like the ones Ken shows above.
Send your thoughts to me using drbarton “at” vantharp.com.
Great Trading and God bless you,
D.R. Barton, Jr.