Certain pockets of the market tend to outperform others. The classic value metrics like price-to-earnings or price-to-book were the first to be discovered back in Ben Graham’s era. Since then numerous value metrics have shown better results (we’ll get to those at later date).

Value metrics work in the long run mainly because of mean reversion and a side of behavioral bias. Investors tend to place bets based on popularity and recency bias. As Graham said, “In the short run, the market is a voting machine…”

The thinking goes like this. Companies doing well will continue to do well and companies doing poorly will continue to do poorly and nothing will change that. This works for a while until mean reversion steps in. Mean reversion is the tendency for fundamentals and stock prices to revert to a long-run average thanks to competition.

Excellent companies, with high-profit margins and growth rates, that make a ton of money, get priced with that mind but they also attract competition. That competition puts pressure on profit margins, growth rates, etc. which feeds into P/E ratios, stock prices, and more. In other words, the excellent company becomes an average company and markets eventually adjust its stock price to that reality. Continue Reading…

Wolf packs were absent from Yellowstone for 70 years. It completely changed the behavior of other animals. It removed fear from the system.

Survival for most animals means finding a balance between eating and watching for predators. Fear plays a vital role in keeping animals alive. But when you remove the top of the food chain, like wolves, the balance tilts to one side and upends the system.

Without wolves in Yellowstone, elk could eat without fear of predators. They could sit in one place and graze all day. More offspring also survived which did the same. Eventually, the number of elk grew beyond the capacity of the park. In other words, they ate and ate and ate until they ate at a faster rate than the trees and other vegetation could grow. After seven decades, they grazed the park clean of new saplings. That changed the landscape, forced other animals to change their habits (or leave for other habitats), and upended the ecosystem.

But that all changed in 1995. The reintroduction of wolves to the park forced the elk to change their behavior. They quickly learned they couldn’t sit around and eat all day. They had to move more often. They were more vigilant of predators. So they ate less and avoided higher-risk areas of the park. Things compounded from there. Continue Reading…

An earthquake struck off the coast of Japan in 2011. It was one of the largest ever, a magnitude 9. Yet, most seismologists believed it could never happen.

The earthquake itself did little damage considering its size. Nearby cities had been preparing for large quakes for decades. And they thought they were prepared for what came next.

The Tohoku earthquake triggered a cascade of events that led to the worst disaster in recent history. The earthquake triggered a tsunami, which breached the levees protecting the nearby nuclear plant, and things quickly spiraled from there. 98% of the total damage is attributed to the tsunami!

For natural disasters, it’s not a question of if, but when. Yet, we live with naturally occurring events every day. Californians, for instance, haven’t gone more than 12 hours without experiencing an earthquake — and that might actually be on the high side. Continue Reading…