Mile High View,  Return on Investment

Baltimore Stock Broker

To repeat from the beginning: Suppose you received a letter from a financial advisor who told you a certain stock was going up over the next several weeks. You watched the stock, and sure enough it went up. A few weeks later that same financial advisor sent another letter to say another stock was going to go down over the following few weeks. Sure enough, as you watched, the stock did go down. Then that same financial advisor sent a third letter to tell you to watch another stock that was going to go up. Sure enough it did. With the next letter the financial advisor told you to watch another stock that was going to go up. And sure enough it did. That same financial advisor sent another six letters each time predicting correctly the direction of every stock he told you to watch – a perfect prediction ten out of ten times. In the eleventh letter he asked for a big investment. What would you say? He had been right ten out of ten times.

What the investor does not see is the total picture—the whole story. That financial advisor began sending letters to 10,240 prospects. In 5,120 he predicted the stock would go up; in the other 5,120 he predicted the stock would go down. The 5,120 to whom he sent the letter saying the stock would go down never heard from our financial advisor. Of the 5,120 to whom he said the stock would go up, 2,560 got a second letter predicting that second stock would go up and the other 2,560 got a second letter saying the second stock would go down. The 2,560 who got the letter predicting the wrong direction of the stock those people never heard from our financial advisor again. Of those who got the correct prediction, 1,280 got the third letter predicting a third stock would go up and 1,280 got a letter saying the third stock would go down. You the reader now the full story. Only 10 prospects would get letters with 10 perfect predictions. The other 10, 230 people never heard from the advisor ever again.

This is the classic “Baltimore Stockbroker” story1. Why Baltimore? No one knows. As far as I know there never was such a stockbroker. But, I am sad to say it illustrates what happens on Wall Street.

One of the most touted marketing programs by Wall Street is diversification and improving portfolio performance through investing in international equities. In 2001 following the Dot.Com bust Goldman Sachs came out with a report predicting the economic growth in four countries would be significantly greater than economic growth in the United States. There is logical reason to believe those countries, Brazil, Russia, India, and China –the BRIC Countries—will outpace economic growth in the United States. The conclusions drawn then and even today are those country’s stock markets are going to out perform the US market. Maybe I am just cynical, but, even at that time I wondered if this study was really about the stock markets or a marketing ploy to get Goldman and other clients who had been burned by the dot.com crash to invest again. Was it a ploy to say this: “You got burned in dot.coms from the US, but you can invest with greater confidence in the BRICs.”?

Since that time we have other studies, and, even the data for which the BRIC study, that raise many questions. The data for Brazil was based on only 10 years of data. Credit Suisse analyzed the relationship of economic growth and stock market performance for 83 countries from 1972 to 2009. They ranked the countries by their economic growth on five year periods and looked at how the stock markets performed. Investing in the highest economic growth countries yielded stock market increases of 18.4% over the five year period. But investing in the lowest economic growth countries yielded stock market increases of 25.1%.

I do believe that the economic growth in those BRIC countries will be greater than the economic growth of the USA. I have said that before and that is the driving force of the supercycle we are in now—something I have written about before. But that is not the whole story. Just because there is greater economic growth does not mean the stock markets will do better than the US market. I believe it also exposes the investor to greater investment risk. Consider what is happening in Russia now.

I want international exposure, but will achieve that by finding US companies that have significant sales overseas. Like the Baltimore Stockbroker, I believe Wall Street is pushing their own agenda and most investors don’t get to see the whole story. The BRIC study is just one of a number of misleading marketing pushes I have seen over the years. Receiving ten letters correctly predicting the movement of ten stocks gives a rational and logical feeling that the Baltimore Stockbroker is really knowledgeable and capable. Getting studies from big brokerage houses and information on CNBC and in newsletters and magazines giving rational and logical concepts and investment themes seem reasonable. But what is the real agenda? What is the whole story?

 

For more information on all of these topics, I encourage you to listen to About Money, a weekly podcast and radio show. You can also follow us on Facebook and Twitter for blog updates, podcast news, and more!

I want to hear your opinions; please leave a comment below and let me know your thoughts.

 

Footnote 1:   How Not To Be Wrong: Power Mathematical Thinking by Jordan Ellenberg

 

One Comment

  • John Kirby

    Why Baltimore? I know this one! It goes back to a book called “Cut N’ Run” by Frank DeFord. A stock broker in Baltimore pulls the stunt to drum up business- he goes to bars and predicts the outcome of football games. If he’s right, he goes back the next week. If not, he doesn’t. By the last two bars, their beloved hometown Colts (the book was written in the 70s) are in the playoffs, and so he gives good news in one bar. In the other, he sadly predicts defeat for the hometown team. The Colts lose (I believe to the Browns), and he goes back to the bar. Pretty much nobody took his gambling advice, but he tells them “It’s OK- football is just a hobby of mine. Professionally, I’m a stockbroker.” They all invest with him, and he starts making good money.

    His philosophy in the book was “the market usually goes up. When it doesn’t, I just tell my clients it’s a correction, and the best thing they can do is relax and stand fast.” And they do, and it tends to work out.

    I may have some details wrong, I’m going from memory here.

Leave a Reply

Your email address will not be published. Required fields are marked *