bubbles, ponzi schemes, and investments
DESCRIPTION
Prepared for CCEE Seminar, October 2013.TRANSCRIPT
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Bubbles, Ponzi Schemes, and Investments
Dale DeBoer, Ph.D.2013
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How would you know?
•The (ab)normal market
•There is no such thing
•Historical performance
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S&P 500
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S&P 500
5.7%
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S&P 500
8.7%
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S&P 500, P/E
15.7
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Thinking about P/E ratios
•Suppose P/E = 10
•Price = 10
•Earnings = 1
•Rate of return?
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Thinking about P/E ratios
•P/E = 15.6
•Rate of return?
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Thinking about P/E ratios
•P/E = 15.6
•Rate of return?
•1÷15.6 = 6.4%
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Thinking about P/E ratios
•Issues
•Backward looking
•Dividends
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S&P 500, P/E
18.1
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Importance of P/E ratios
•1 point increase above long run average correlates with 25% reduction in subsequent return
•Statistically significant at 1%
•Only captures 30% of variability
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S&P 500
1.8%
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Wilshire 5000
4.9%
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DOW
2.3%
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Can this be beaten?
•Without fraud!
•Risk-reward tradeoff
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Can this be beaten?
•Without fraud!
•Risk-reward tradeoff
•Leverage
•Hedge funds
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•$100 invested
•10% return
•$10 earned
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•$100 invested
•Same investment, but only 10% down
•Interest rate 5%
•10% return on investment
•$10 earned - $4.50 paid in interest
•Rate of return?
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•$100 invested
•Same investment, but only 10% down
•Interest rate 5%
•10% return on investment
•$10 earned - $4.50 paid in interest
•Rate of return? 55%
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Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Bubbles and the greatest idiot theory
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Text
https://en.wikipedia.org/wiki/File:Tulip_price_index1.svg
2,400% over 3 months30,417,400% over 1 year
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http://www.economist.com/blogs/dailychart/2011/11/global-house-prices
7.1% per year
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https://www.google.com/finance?cid=13756934
40.6% per year
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Series average: 3.7%“Bubble” average: 12.3%
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Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
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http://www.finra.org/web/groups/sai/@sai/documents/sai_original_content/p337731.pdf
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Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
•Insider information
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http://www.sec.gov/spotlight/insidertrading/cases.shtml
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Can this be beaten?
•Without fraud!
•No fraud, but broken fundamentals
•Fraud
•Insider information
•Ponzi schemes, pyramids, and Herbalife(?)
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Charles Ponzi
•International exchange coupons and arbitrage
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Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Initial promise: 50% every 90 days
•Subsequent promise: 50% every 45 days
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Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Making the payments
•Withdraw or reinvest?
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Charles Ponzi
•International exchange coupons and arbitrage
•Investors needed
•Making the payments
•The importance of the individual at the center
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A pyramid
•The “Prosperity Club” letter
•Denver, 1935
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http://www.silcom.com/~barnowl/chain-letter/archive/me1935-05-20br_sd_club.htm
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A pyramid
•The “Prosperity Club” letter
•The power of exponentiation
•8 rounds: 390,625
•15 rounds: 6,103,515,625
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The Herbalife question
•Bill Ackman
•Pershing Square Capital Management
•“Pyramid schemes like Herbalife [are] particularly vulnerable to product-quality concerns”
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The Herbalife question
•Bill Ackman
•Multi-level marketing
•Is it different from a pyramid?
•The question of product
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An economists simple look at
investing
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Paul Samuelson
•“Investing should be dull. It shouldn’t be exciting. Investing should be more like watching paint dry or grass grow.”
•The parable of 64 monkeys
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The Efficient Market Hypothesis•Markets (and market prices) reflect
all information
•What information is this?
•The question of $20 on the sidewalk
•Evidence?
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http://www.ifa.com/Media/images/PDF%20files/Malkiel_PassiveInvestmentStrategiesandEfficientMarkets%20(2).pdf
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Even if not true...
•Can you beat 31,000?
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Even if not true...
•Can you beat 31,000?
•7 milliseconds!
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Even if not true...
•Can you beat 31,000?
•7 milliseconds!
•You are not the bank
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
•Sloth: Overlooking Costs
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Lust: Chasing Recent Performance
•Pride: Being Overconfident
•Sloth: Overlooking Costs
•Envy: Wanting to Join the Club
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Wrath: Failing to Admit Failure
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/SB1000142412788732490630457903716308
0446646.html
•Wrath: Failing to Admit Failure
•Gluttony: Living for Today
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Avoiding mistakes
•Seven Deadly Sins of Investing• http://online.wsj.com/article/
SB10001424127887324906304579037163080446646.html
•Wrath: Failing to Admit Failure
•Gluttony: Living for Today
•Greed: Following the Herd
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Four “Rules”
•Save enough
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Four “Rules”
•Save enough
•Control expenses
•Management fees
•Trading costs
•Taxes
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Four “Rules”
•Save enough
•Control expenses
•Diversify
•Does this conflict with “control expenses?”
•The virtue of ETFs and Mutual Funds
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Four “Rules”
•Save enough
•Control expenses
•Diversify
•Reallocate